Gabe Velazquez is a professional trader with 14 years of experience. His focus is intra-day and swing trading the ER2 (Russell 2000 e-mini) using technical analysis as his primary tool. Gabe has managed both stocks and futures accounts as well as conducted educational seminars on technical analysis for the past ten years. He is a frequent guest on Biz radio, where he shares his market knowledge and utilization of technical indicators. Gabe also teaches the 5 day E-mini course for Online Trading Academy.

Are Happy Days Here Again?

The post-FOMC rally has swung the market pendulum from one of extreme angst, to that of an almost eerie complacency. All those fears about housing and the credit crunch throwing the US economy into a recession have been replaced with a more sanguine- and in some sectors -outright euphoric outlook for stocks. The Dow has not only reclaimed the prior high, but also on Tuesday made a fresh all-time high along with the Nasdaq Composite, which posted a six and a half year peak.

Evidence of this newfound giddiness can be found in Chinese stocks. Over the last two-week period, a large number of these stocks have embarked on what we technicians refer to as "parabolic" moves. For readers who may not be familiar with this term, a parabolic move is a chart pattern that looks very much like a rocket launching into space. The trajectory is at a 90-degree angle and is rarely sustainable. Below is a visual example.

If you were to cull through the entire universe of Chinese stocks traded here in the US, you would find this pattern repeatedly. These charts hearken back to the tech-bubble days of the late nineties. By this, I'm not at all suggesting that there are parallels to that period, but what I am saying is that the speculative fervor going on in these issues may be a bad omen for the market in the short-term.

As a rule, the steeper the angle of ascent, the more speculative the stock or futures contract becomes. Traders must be very careful when trading in this type of momentum, as the reversals coming off such strong moves are usually swift and very violent. If you are fortunate enough to get on board a move like this, make sure you are trailing a stop snugly below the market. This way when the move finally culminates, you will have locked in a profit, thus avoiding giving back too large a portion of those gains.

Let's redirect our attention to the Nasdaq 100. This tech-heavy Index is currently a bit over-extended. In my most recent newsletter, I pointed out the strength of the Nasdaq and how that might be construed as a portent for a positive market. Indeed, this market has performed very well. However, I suspect that the pace of this rally is unsustainable and therefore, a correction or pause may be in order. As you can see from the chart below, it's beginning to resemble one of those Chinese stocks mentioned earlier.

In regards to ER2, the picture does not look as healthy. It's a good 36 points away from its late May life-of-contract high of 871. (See chart below)

Note that it's come up to the gap from late July, which would constitute an area of resistance. This gap, coincidentally, was the trigger that kicked off the summer sell-off. Traders should always look to gaps (particularly large ones) as an indication of a change in trend.

The last chart we'll peruse is the hourly chart of The ER2 below. Observe how long the stochastic has stayed overbought.

This could be interpreted in two ways: One may say that the market is very strong, hence the persistent overbought reading. And yet another will argue that the market is long overdue for a correction based on the same reading. My sense is that since the ER2 has had a very strong rally coupled with all the other indices being stretched here; I would lean towards the latter.

In Summary: The market is trading as if every problem that was of concern during the summer has all gone away. On a short-term basis, this is a bit worrisome. The first sign of a frothy market is starting to emerge in some of the aforementioned Chinese stocks. We have a Non-Farm payroll report on Friday. These releases are usually catalysts, so we'll just have to wait and see. The trend is still up, so don't fight the tape. Nevertheless, be very careful as these markets can change very quickly.

So until next time, I hope everyone has a profitable week.

DISCLAIMER:
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.

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