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Breakfast with Brodsky


Pay attention this week....

Good morning. The theme of last week seemed to be intra-day volatility as the indices (mainly the S&P and Dow) tried to breakout to new 52-week highs. That feat seemed within reach on Friday and although the S&P briefly traded at a new 52-week high, a close at that level did not happen. Where does this leave us now?

Looking at a weekly chart of the S&P 500 we can see a channel that we have traded in over the past seven weeks. The weekly levels of resistance and support are 1165 and 1137, respectfully. The last time we trended in a channel on the weekly was from June until mid-December when we finally broke out and went from 1075 to 1138 before settling into the current range. What if anything can we take away from this? To me it puts things in perspective that even during the heart of the bull of 2003, we were range bound for five straight months. So while we are seven weeks into our current range we may have some more time to go before another breakout takes hold.

The next question is, if we do breakout, where is the next level of resistance? Again, taking a look at the weekly chart of the S&P we can clearly see that in late 2001, early 2002, the S&P double topped at 1175 before making its decent into the 800 range. Does this mean that we can't clear the 1175 level now? Of course we can but the level of importance is something to note. With the S&P trading at the top of the short-term channel range (1165) and so close to longer-term resistance (1175) one has to begin to wonder what catalyst could pack the power to really break us out of this critical level?

That is such an open ended question that I could not begin to speculate as to what it may be. What I can speculate on is the risk/reward to being long at these levels. I will be honest in saying that the market over the past few weeks has been a bit scary. Not in the sense of the wild moves in the broad indices (there have not been any,) but rather on some wild high beta and micro cap names. I get a bit nervous when I start seeing stocks like Ask Jeeves (ASKJ:NASD) up 45% in one day. I mean when people start to buy Natus Medical (BABY: NASD) because its ticker is BABY just because (MAMA: NASD) is breaking out, red flags go off in my head.

Our human emotion element wants to jump up and down and scream that the big bull is back! But seriously, look at what's been going on in the NDX for two months. Look at a chart of the Dow Transportation index, which has been stalling. These are not bullish charts. Could they breakout? Sure, but the action is not bullish. When we start focusing on to lead our trading style, something is a bit off.

So before I go committing myself to being heavily invested on the long side, I think that it is better to trade lightly at these levels and wait for a confirmed breakout. Just look at the RSI on the S&P! We traded at new 52-week highs (although we did not close there) and the RSI is closer to its low than to its high. That is an unhealthy divergence in my opinion.

There are a lot of divergences at these current levels. Another one is the fact that the BKX (banks) has been breaking out to new 52-week highs and the overall market has not. How many times have we said that this sector is a market leader? The fact that it is breaking out and the overall market is not sends up another red flag in my mind.

In conclusion, there are a lot of divergences within the markets and if we were to breakdown, we would all look back and say, "Man! How did I not see the writing on the wall!?!?" That being said, I will be trading in and out of positions and certainly not take the market for granted at these levels (i.e. counting on the "bull" to bail me out of bad longs). Good Luck!

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No positions in stocks mentioned.

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