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Short term Frothiness could lead to an Intermediate Top

Posted By Barry Ritholtz On June 1, 2005 @ 11:31 am In Markets,Trading | Comments Disabled

A number of my indicators are suggesting that markets are getting way too frothy and a short-term top may be likely at any time. Given the recent internal strength, however, I would expect the downside to be rather contained.

On May 18th [1], we mentioned the breakout levels warranted adapting a Bullish stance. But given how extended the rally has become, new buying might be more profitibly done on a pullback. It is prudent to gradually leg into new postions, and use caution. Many individual stocks are reaching major resistance — or flashing technical sell signals — and should be exited on a trading basis.

Guy Ortmann, Technical Analyst at Capital Growth Financial, notes the following data points:

1.) The NYSE McClellan and 21 Day OB/OS are very overbought short term (+132 and +7581 respectively).
2.) The OTC McClellan and 21 Day OB/OS are also overbought at +107 and +3197.
3.) The 10-Day Arms index is at .95. It was below.90 yesterday which is a “yellow flag”. 
4.) Our proprietary WST Intermediate Trend Indicator experienced a downward reversal yesterday from101.4 to 97.1. A three-point reversal suggests a change in the intermediate trend.

The upside is being driven by under-invested/under-performing hedge funds — they are the fuel propelling markets higher. 

But we agree with Ortmann’s observations that yesterday’s action was "suspicious" as well. After the rally of the last few weeks, the markets saw their first real day of “distribution” in quite some time.  The trading in the last hour resulted in a failed rally attempt with VOLUME INCREASING AS THE MARKETS SOLD OFF INTO THE CLOSE. Yesterday’s volume was the highest we’ve seen in the last 5-6 trading days.

As a result, it is our belief that “caution” is the key word for the near term.


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[1] May 18th: http://bigpicture.typepad.com/comments/2005/05/_line_is_the_sa.html

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