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3 Reasons Why Stocks Are Supposed to Rally

If you’ve read any of my articles before you know that I have a mini obsession of reading (and quoting) headlines. As a contrarian, I always like to have a pulse on the media’s outlook because it can provide valuable contrarian clues.

Here are some of the headlines featured last week:

‘Greek default could trigger chain reaction’ – AP

‘Why Wall Street still says buy, and you shouldn’t’ – AP

‘Is the bull market over?’ – Barrons.com

Interestingly, the Barrons.com article commented that: ‘A look at four different sentiment measures suggests that more pain may await investors.’

I looked at similar sentiment measures and my conclusion was just the opposite.

Bearish Sentiment Extremes

By last Thursday (June 16) the market had recorded a number of bearish sentiment extremes. The most notable was the CBOE Equity Put/Call Ratio, which spiked to the highest level since early 2009.

Bullish sentiment captured by the AAII and II polls had also dropped significantly. In fact, the percentage of bullish advisors and investors was almost as low last week as it was in the summer of 2010 when the S&P was just barely above 1,000.

The VIX (Chicago Options: ^VIX) was the only sentiment gauge that wasn’t in dangerous territory. However, the VIX set up to trigger a buy signal for stocks on Wednesday (June 15).

The chart below featured last week by the ETF Profit Strategy Newsletter, neatly summarizes the various sentiment indicators. The Newsletter’s simple conclusion was that: ‘Things might be so bad, it’s actually good.’

Support Levels

Sentiment gauges are valuable, but basing decisions merely on sentiment can be dangerous. For that reason, the ETF Profit Strategy Newsletter always looks at structurally important support/resistance levels.

Here are some of them mentioned in Wednesday’s (June 15) Profit Strategy update:

1) A trend line originating at the March 2009 low 2) Fibonacci support 3) March 16, 2011 low 4) 200-day moving average 5) Weekly pivot support

All this support was clustered between S&P (SNP: ^GSPC) 1,259 – 1,245, and the Newsletter recommended to close out short positions and establish long positions as soon as the S&P entered this range. It did so on Thursday.

The short positions were established when the S&P reached the Newsletter’s upside target at 1,369, an important Fibonacci resistance level.

Bullish Dow Theory Non-Confirmation

Last week, The Dow Jones Industrial Average (DJI: ^DJI) dropped to a new 3-month low on Wednesday (June 15), while the Dow Jones Transportation Average (NYSEArca: IYT – News) recorded its low previously on Monday (June 13). According to Dow Theory, this is bullish as long as the Dow Jones Transportation Average does not fall below 5,043.21 and not close below 5,072.58.

Another bullish non-confirmation was found between the DJIA (NYSEArca: DIA – News) and the S&P 500 (NYSEArca: VOO – News), Russell 2000 (NYSEArca: IWM – News), Nasdaq Composite (Nasdaq: ^IXIC), and Nasdaq-100 (Nasdaq: QQQ – News). The senior DJIA was the only major index that did not fall to a new low on Thursday (June 16).

How High Will it Go?

The key question now is whether this rally is merely a bounce within a new bear market or an attempt to reach new highs. The initial target range for this bounce, outlined by the ETF Profit Strategy Newsletter last week, is 1,300 – 1,325.

Once we reach the target range, we’ll use the same technical indicators that have guided us well in the past to re-evaluate whether the rally might be followed by a sharp decline, or a continued rise toward new highs.

However, there is important resistance at 1,298, so investors do well to keep a close eye on any long positions, particularly leveraged ETFs like the Ultra S&P 500 ProShares (NYSEArca: SSO – News), or UltraPro S&P 500 ProShares (NYSEArca: UPRO – News).

How to Profit in this Market

From the lows of March 2009 to the May 2 recovery highs, stocks (NYSEArca: VTI – News) have more than doubled. The easy money has been made already. Going forward, hope in the Federal Reserve won’t be enough to grow your nest egg and avoid pitfalls. But using important support/resistance levels and combining them with various facets of technical analysis and sentiment indicators, can put the odds in your favor.

Such an approach to investing/trading takes the emotion out of trading and provides a mechanical and duplicatable approach to the markets. You won’t win all the time, but you’ll win more often than you lose. You also avoid missing out on big breakouts, because no move starts without either breaking above resistance or falling below support.

The ETF Profit Strategy Newsletter consistently monitors the market’s vital signs and formulates important support/resistance levels that can be used as entry or exit, buy or sell points. Updates are provided at least twice a week.

Adapted from Yahoo Finance (By Simon Maierhofer)

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