Why Traders Should Be Extra Cautious

Bulls are still in charge, but things could easily take a turn for the worse

   

Why Traders Should Be Extra Cautious

The positive impact of the strong ADP employment report on Thursday was reversed on Friday as investors gave way to fresh doubts about the viability of the recovery. The Bureau of Labor Statistics reported that only 18,000 jobs were added in June, and the unemployment rate jumped to 9.2%. But a sharp increase in consumer borrowing brought in bargain-hunters, which offset some of the losses from earlier in the day. The result was an insignificant pullback of 0.7% on the S&P 500, and less than 0.5% for the Dow Jones Industrial Average and Nasdaq. Volume fell to just 770 million shares on the NYSE and 448 million on Nasdaq.

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The major indices took on the appearance of the Nasdaq chart — all failed to breach the early May high. A minor reversal on Friday occurred and covered the gap created from Thursday’s strong ADP number. With Moving Average Convergence/Divergence (MACD) now more overbought than at any time this year, the disappointing unemployment number could result in a pullback to the first major support line at 2,765 — the 50-day moving average. However, in the absence of a strong sell-off that takes out the 200-day moving average and the major support at 2,600 to 2,640, we should expect a normal pullback, a consolidation at around 2,750, and a further resumption of the uptrend. 

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We keep watching the U.S. dollar via the PowerShares DB US Dollar Index Bullish Fund (NYSE: UUP) noting that if the index is able to close above the bearish resistance line, now at $21.65 to $22 (weekly chart), the dollar could be headed for a dramatic trend reversal up with the implication that stocks and commodities could move down. But the opposite is more likely, and last week’s hike in European interest rates makes a strong case for another round of dollar weakness. Resistance zones like this one are created by international sources dealing in huge transactions and are therefore very difficult to break. 

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In the face of increasing unemployment, the expiration of the phony money-printing exercise called QE2 and its obvious failure to energize the economy, some highly visible technicians are taking a very bearish stance. 

They see the possibility of a head-and-shoulders top forming with the 50-day moving average (blue line) of the S&P 500 being a key technical level. They point to the February high of 1,344 as an important support line, which if breached on high volume, could lead to a breakdown since it would break the intermediate support line (red dash) and set the stage for an attack on the 50-day moving average, now at 1,317. 

My response: As a technician, I try to refrain from getting emotionally involved with the fundamentals of the national scene simply because it is charged with raw emotion that can easily influence investment decisions and lead us on down the wrong track. If a head-and-shoulders is forming, it is much, much too early to consider its possibility. Last week, I outlined the precise requirements of the formation, and so there is no need to go into that again. However, the failure of the major indices to break to new highs following the strong closing above 1,344 is a disappointment. The next support is at the intermediate trendline, and then the 50-day moving average.

We’ll take this one step at a time, realizing that as one technician put it, “This isn’t a market for the faint of heart.” But, currently, the case for the bulls gets the nod realizing that the outlook can change rapidly and that we must be flexible enough to change along with it.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.

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Article printed from InvestorPlace Media, http://investorplace.com/2011/07/daily-stock-market-news-why-traders-should-be-extra-cautious/.

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