A Short, Sharp Rally From Here (SPY @ 107.82) is Likely

A Short, Sharp Rally From Here is Likely

Wednesday, May 26, 2010 (SPY @ 107.82 before the market open):

Several bullish factors are in place:

1.) Key reversal – market gapped open sharply lower, then rallied back to close higher.

2.) Failed downside breakout – market violated most recent spike low only to rally higher, confirming at least short-term support there.

3.) Higher volume on last 2 up days than on 4 of the 5 last down days – a bullish sign of accumulation.

4.) Near-term support also from the 104 February low.

5.) Market oversold – 14% sharp decline on heavy, panic volume with many down gap days since April 122 peak.

6.) 2b bottom in place according to Vic Sperandeo's criteria (fudging a little on the trendline violation).

7.) Long upside day on heavy volume with close near the top and open near the low.

8.) News from Europe and the Gulf and Korea is unremittingly bearish (which, in the contrarian world of trading is bullish).

Is this is a significant market bottom? Unlikely, but again, we don't have to guess. If you are short or flat, consider dipping a toe back in, buying a little at 108 stop and a little more at 110 stop, the bottom of the last down gap. Place sell stops immediately at the market low of 104.38 (I usually go a bit lower, perhaps to 104.35 or 104.3). If you are filled near 108, you will have fewer than 4 points of risk. If the market does rally, watch how it behaves around 112 (the 200 day average), 116 (the bottom of the most recent flag) and 118 (if it clears the 50 day and the most recent relative high).

Remember that markets exist to frustrate and disappoint most people, so stay very flexible here, but it is worth a shot. Covering shorts is probably not a bad idea until things settle down.

What is true of the broader market is even more true of certain sectors, such as Basic Materials:

Shorting China remains a very profitable trade, but expect a pull-back (possible Chinese rally):

The financials still look weak and the fundamentals are atrocious (weak balance sheets, pending regulation, probable paradigm shift as they go from being gambling houses to boring old utility-like banks):

A weekly chart shows that despite the pullback, financials still have quite a ways to tumble:

The dollar looks over extended and ripe for a pullback:

The Swiss franc continues to get crushed with little technical evidence of any end in sight, although the currency is probably short-term oversold. Notice the extremely high volume up day three days ago: