Why You Should Sell This Week
The chances of moving through overhead resistance are slim.

Stocks closed out the week by rising again on low volume, extending the Dow’s winning streak to three straight weeks in a row. The gains were attributed to stronger retail sales numbers and better earnings from Google (NASDAQ:GOOG), but the real focus was again onEurope, and signs that some headway is being made to address their sovereign debt crisis. 

But the big question is this: Can stocks continue to rise on the hope that Europe will solve its many economic issues, or will theU.S.market go it alone just on improved results from the technology sector?

On Friday, the NYSE traded just 846 million shares, and the Nasdaq traded 434 million. These are not only very low average volume levels, but in stark contrast to the high volume that we would expect from a market that is challenging the highs of an important 10-week consolidation.

Thursday’s Daily Market Outlook charts showed the following initial resistance zones: 

  • Dow 11,550 to 11,717
  • S&P 500 1,220 to 1,230
  • Nasdaq 2,600 to 2,643

With the Dow at 11,644 and the S&P 500 at 1,228, the tech-heavy Nasdaq is the only index to break through this initial zone. Thus, the Nasdaq is the leading index and a study of its resistance picture may give guidance to the market’s next move.

Nasdaq Chart

Trade of the Day Chart Key

Better-than-expected earnings and revenues from Google helped the technology sector blow thr Nasdaq through its first resistance zone at 2,600 to 2,643. Its next line of resistance is its 200-day moving average at 2,694.

Despite the bullish excitement over these gains, the index is clearly overbought and due for a reversal: Note the very overbought stochastic fast line (red) at 96.15 (lower right) and how it compares to readings at important market tops earlier this year — 97.14 (February), 95.08 (April), 97.67 (late-April), 97.75 (July), and now at 96.15.

The stochastic is just one of our internal indicators, and others (MACD, momentum) show the same overbought patterns. Sentiment is another overbought/oversold indicator on which we rely, and a key sentiment report comes from The Association of Individual Investors (AAII). 

On Thursday, AAII released the bullish sentiment number, which usually has an inverse predictive relationship, i.e., strong bullish sentiment is an overbought indicator. Here is what they reported: “Bullish sentiment, expectations that stock prices will rise over the next six months, increased 4.5 percentage points to 39.8%. This is the highest level of optimism since July 21, 2011. It also ends a streak of 11 weeks when bullish sentiment was below its historical average of 39%.” 

This report confirms that sentiment is in agreement with our internal indicators.

Here is one more number to consider: A 66.6% Fibonacci retracement from the July high to the October low is 2,685. 

Conclusion: Bear market rallies are notorious for short-covering surges that often run 20% or more from a new low. The Nasdaq has bounced 16% from its low of Oct. 4, and is entering an enormous area of overhead (possible sellers) that took eight months to build. The statistical chance of moving through this zone of resistance is very low, and so those who have bought stocks that have been underperformers should sell this week. Traders may short or wait for a strong technical signal like a spike up followed by a bearish reversal.

If you’re interested in some specific options trades to play this market, check out my colleagues Chris Johnson and Jon Lewis.

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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