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Not All Breakouts Are Created Equal

By is not the breakout that counts but the ensuing action after a breakout that tells the story.

At the breakout to new highs just over a week ago, I offered that there was but one of two courses for the market as reflected by the S&P: either the market was going much higher or once again as in July the S&P was making a marginal new high, a fake-out breakout that would see no follow-through.

Once again there is no other course for the market as reflected by the S&P and now the NDX; either the S&P is tracing out a classic pullback to the breakout point or the recent tag of the key 1576 level satisfied a trifecta of technical levels as to time, price and pattern.

To recap, 1576 is precisely an important six squares or cycles up from the bear market low in October 2002. The week of the recent high occurred on the anniversary of many important highs and lows, such as the 1998 low, the 1990 low, the 2002 low and the beginning of the crash in 1987. In addition, last week I showed the Megaphone/Diamond pattern that is often present at significant peaks.

Going to the NDX, this index broke out to all time new highs on the back of the action in the Four Horsemen on Tuesday: Apple (AAPL) powered higher on blowout earnings, Research in Motion (RIMM) exploded out of a high level consolidation/ compression on news of a deal in China, Google (GOOG) was doing a good imitation of Tom Cruise in Top Gun: "I feel the need, I feel the need for speed" as analysts fly upside down and backwards over each other to be the first on their block to raise the target, and the momentum junkies drove up Amazon (AMZN) in front of earnings due after Tuesday's bell.

However, a funny thing happened on the way to the coliseum: some of the momentum gladiators got clawed by the lions. After the close, AMZN gave up the lion's share of the day's gains. Juniper Networks (JNPR) got hit and Riverbed Technology (RVBD) got spanked.

As I like to say, it is not the breakout that counts but the ensuing action after a breakout that tells the story. Not all breakouts are created equal, as evidenced by the marginal breakout in July by the S&P. Breakouts can be the most opportunistic time in the market but the other side of that sword is that it can also be the most dangerous time.

So, the action following Tuesday's breakout in the NDX after a high level consolidation will be important to watch. A failure below Tuesday's low would be a warning flag while trade below Monday's low that sticks would seem to indicate that the pattern in the index may be a fractal of the false breakout or Bull Trap in the S&P in July. Is the past prologue?

Click here to enlarge.

Despite how good the market may look based on the NDX and the bounce back in the S&P from the key 1500 level, the market is very dangerous now. Not only is the market narrower and narrower with fewer and fewer names doing the heavy lifting, but there is a substantial negative divergence in the action of the S&P versus the NDX. Something's gotta give. Either the NDX is headed lower or the S&P is going to ketchup. But this is not only the divergence: there is a negative divergence in the price action of the S&P versus the Russell 2000. The Russell 2000 is beginning to look like a double top is in place. There is also a significant divergence between the S&P and the Transportation Index, which has never come close to recapturing its July high.

Moreover, shares of the Four Horsemen now account for over 22% (at Tuesday's open) of the value of the NDX. In the past when the weight of the value of the index was concentrated in a few names, the NDX has pulled back meaningfully, often seemingly out of the blue. It is a classic case of momentum focusing on a few leaders to the detriment of a broad array of names, a classic divergence where a few names outstrip a wider list of laggards. While the Four Horseman are up over 100% this year, 28 of the NDX names are actually red for the year to date.

Is this a sign of strength or petrification within? Is it possible when the high flyers correct, the index can collapse?

On Tuesday, the S&P drove up to the 1520 resistance courtesy of a market on close buy program. However, the futures were down meaningfully Tuesday night. The market is truly at another crossroads: either the S&P has pulled back to kiss the August high and the early September high both in the vicinity of 1500 or Tuesday's high defined a snapback rally and new lows are ahead. If the S&P breaks 1497 I would not be surprised to see downside acceleration.

Editor's Note: Want more of Jeff's insight and trading ideas delivered to your inbox daily? Minyanville is proud to announce that we have launched Jeff Cooper's Daily Market Report, complete with Jeff's day trading and swing trading setups. Email Josh Sander for more details and how to sign up.
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