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Crash Watch Update 3: Standoff

by Michael Nystrom
Tuesday September 20, 2006
Cambridge, MA

Part I
Part II

In my last two reports, I offered the charts of two stocks that suffered 10%+ single day declines - Ford and Yahoo! - as evidence of a weakening market. Today, we have the opposite:

Last night Oracle announced numbers that the market got excited about, and this morning it was off to the races. The stock market sprang awake and broke through the May highs in the first half hour of trading. The bulls were happy as the market notched a new 5-1/2 year high just prior to the Fed announcement at 2:15.

If you've been following along with my reports (links above), you know that I expected the Fed announcement to trigger a selloff, and signal an end to this overextended rally. The market did sell of sharply - but only briefly - after the announcement. It looked like the bears would take control, but the bulls clawed back to close the day precisely at 1325:

So where does this leave us? I had been relying on price behavior around the May highs to give us some clarity. If prices broke through, they would keep going up; if the resistance repelled them, we were likely to see a sharp correction. But we ended in a draw.

The bulls clearly won the day, but the larger picture remains as ambiguous. To see what I mean, take a look at what prices did the last time they were at this level, back in May:

This was the bulls' last chance to add to their 5-year highs. It looked like a breakout on May 5th - a strong up day, with prices closing near the high after a steady advance. But over the next three days the bulls couldn't muster any follow through and on the fourth day, prices broke down convincingly:

We have to be extremely cautious around this level, because prices could go either way, and then move quite quickly. I had originally expected a crash - and that is still a possibility. Hoever, if the evidence changes, we'll have to change our minds accordingly, and quickly. If prices move up convincingly in the next few days, it is the poor bears who will be providing fuel for the rally with more short covering.

As a trader, there is no use fighting the market - it will do whatever it is going to do. We cannot influence it, only take advantage of its movement and for this we need to remain nimble and flexible. Whether you are long or short, be extremely cautious and remember that losses are part of the game of trading. The key is to limit them so you have enough to come back and capitalize on the opportunities that arise each day. Take them voluntarily when they are small, so you are not forced to take them to cover a margin call!

To recap the market action - the key is to see how prices behave around the May high resistance levels. I will remain on watch, and update subscribers accordingly, as conditions warrant. Best of luck to all. Subscriptions are free.

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