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Don’t Trust a Dead-Cat Bounce

Despite the near-term strength, stocks are likely to falter

By Sam Collins, InvestorPlace Chief Technical Analyst

Friday’s shortened session was low on volume, but the major indices jumped making the weekly rise the best since the week of June 8. The S&P 500 reached its high early in the day and maintained it while the Dow industrials, Nasdaq and Russell 2000 rallied sharply in the last hour of trading. Better economic data from Germany led to a rally on European exchanges, and positive data from France and Italy also attracted buyers.

At the close, the Dow Jones Industrial Average was up 173 points at 13,010, the S&P 500 gained 18 points at 1,409, and the Nasdaq jumped 40 points to 2,967. The NYSE traded 329 million shares and the Nasdaq crossed 189 million. Advancers outpaced decliners 5-to-1 on the Big Board and by 3.3-to-1 on the Nasdaq.

For the week, the Dow gained 3.3%, the S&P 500 rose 2.9%, and the Nasdaq jumped 4%.

SPX Chart
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Trade of the Day Chart Key

Since Monday, Nov. 19, when we last visited the S&P 500’s chart, the index has reversed up, closed above its 200-day moving average, and even penetrated the breakdown line at 1,403, which now becomes a support line. The next resistance is at its 50-day moving average at 1,426. Note the buy signal from the MACD indicator.

Nasdaq Chart
Click to Enlarge

I last reviewed the outlook for the Nasdaq on Nov. 20, saying, “The Nasdaq’s chart is ripe with interesting technical features, the most important of which are: Monday’s opening gap at 2,860 to 2,885, which sprang from the twin lows’ lower support line at 2,837; the August low of 2,890; and the next line of resistance — the 200-day moving average at 2,989. The ‘hook’ of the MACD indicator is telling us that a buy signal is likely from this important indicator.”

Since then, MACD issued a buy signal, the index rallied through its 20-day moving average (green line) and its near-term resistance line (red-dash downward line), stopping just short of its 200-day moving average at 2,985.

Conclusion: The near-term rally I anticipated on Nov. 19 has driven the S&P 500 through the resistance at 1,403, as well as the Nasdaq’s near-term resistance line. At that time, I said, “I expect the rally to continue as far as the resistance at the 200-day moving average at around 1,380.

“I emphasize that this is not a prediction of a change in trend, but merely a dead-cat bounce that will force many shorts to cover prior to another test of the 10% downside target at 1,319.”

The rally has been so strong that it now threatens to test the S&P 500’s 50-day moving average at 1,426 and the Nasdaq’s 50-day moving average at 3,041. Internal indicators are positive: MACD is on a buy signal, and insider sentiment, reported by Vickers, has turned “sharply bullish.” However, the AAII Sentiment Survey, as of Nov. 22, has turned neutral after being very bearish, and the CBOE Volatility Index (VIX) continues to signal investor complacency. Volume was abnormally low, even for a holiday week.

Traders are supported by the near-term power of the recent bounce. But the overhead (potential sellers) is strong at the point where each index approaches its 50-day moving average. Therefore, traders should install moving stops just under current positions to protect against a sudden reversal.

Despite the near-term strength, I believe that stocks will falter and eventually turn lower, eventually testing the S&P’s 10% decline number at 1,319.

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.

Article printed from InvestorPlace Media,

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