Rosy Rear View, Murky Future

The rear view mirror looks fairly good, but the road ahead is once again getting cloudy. As earnings season winds down, GDP disappointed in the fourth quarter, and Europe is once again looking uncertain, traders are starting to hit the sell button.

Chart Courtesy of StockCharts.com

The Dow Jones Industrial Average (INDU) started showing signs of weakness last week, even as small and midcap stocks showed some relative strength. The Russell 2000 Index (RUT) and the S & P 400 Midcap Index (MID) moved higher last Friday, even as the Dow dropped over 70 points. Normally, we would consider that bullish. And if it remains in place, we will keep that stance. But now, as uncertain climbs, and the traditionally bullish month of January winds down, we have to be on our guard.

Chart Courtesy of StockCharts.com

The two big indicators to watch are the Nasdaq advance decline line (NAAD), and the Nasdaq Hi-Lo line (NAHL). Both of these indicators have been very positive of late. The rise in NAAD is a sign that more stocks are moving higher than those that are falling. That means that the odds of picking winning stocks rises.

Chart Courtesy of StockCharts.com

The rise in NAHL means that there is positive momentum in the market. In other words, more stocks are making 52 week highs than those making 52 week lows. Both Nasdaq indicators are better at showing the status of the stock market than the corresponding NYSE indicators. The NYSE statistics are polluted by the high number of bond funds, ETFs, convertible and preferred stocks that trade there

Chart Courtesy of StockCharts.com

Other indicators to watch are the U.S. Ten Year bond yield (TNX) and the U.S. Dollar, especially in respect to the Euro.

Chart Courtesy of StockCharts.com

The key parameters are the 2% yield on the Ten Year Note and the 80 area on the U.S. Dollar Index. If bond yields start to climb again, as they had been, it would be a sign that investors are confident in the future of the U.S. economy, and its political system, at least in relative terms to the same criteria elsewhere, such as in Europe.

A rising dollar would be a sign that uncertainty is back on the front of the important factors affecting the financial markets. With the new worry being the potential default of Portugal, we could see a new round of price adjustments in all markets.

Conclusion

The bullish case for stocks could be yesterday's news as the fickle markets begin to worry less about Greece and more about Portugal. That means that if Portugal stabilizes, in a few weeks we could be worried about Spain, then France, and eventually Germany. In other words, we could be back into another messy trading environment for the next few months.

The way to play this is first to acknowledge that things have changed. Last week's indicators are not exactly as good this week, at least not without getting through the action in the next couple of days.

Second, each position should be viewed on its own merits. If it's working keep it. If it's not working then let the sell stop take care of the decision.

Third, consider hedging your gains by using ETFs that sell the markets short. See our individual sections for details.

When you understand the big picture, the next step is how to survive and profit from what lies ahead. That's why we recommend: "Market Timing For Dummies." and "Trading Futures For Dummies." The Trading Manuals for All Seasons. Also Available As Kindle Books.