Rally Lacks Conviction
by Carl Swenlin
August 1, 2008

The rally that began nearly three weeks ago, out of the jaws of a potential crash, has become rather unimpressive in the last two weeks. As I said in my last article, the rally seemed to be contrived from the beginning, and support for the rally has faded rather than grown, as we normally see in bull market rallies. At this point (about an hour before the close on Friday), the technical chops seem to be lacking for the rally for the market to power upward to the primary declining tops line (in the area of 1375).

One of the things that is lacking is volume. As you can see on the chart below, initial volume was pretty good, but recent volume is substandard.

The next chart is one that always has my primary focus. The CVI (Climactic Volume Indicator) measures extreme OBV (On-Balance Volume) movement within the context of a short-term OBV envelope for each stock in the index. When a rally is launched from the deeply oversold conditions we have seen recently on virtually all our medium-term indicators, we expect to see the CVI move upwards to at least +50, and preferably to the +75 range. This kind of upward spike presents evidence of a broadly-based initiation climax, which indicates that most on the stocks in the index are participating in the new rally.

As you can see, over the last several weeks, the CVI has remained in a fairly narrow range, neither getting severely overbought or severely oversold (which would be a good bottom sign in these circumstances). It is clear from the chart that CVI overbought spikes do not always result in extended rallies; however, I am certainly not confident in any rally that does not have such a spike.

Finally, the chart below has three medium-term indicators -- one for price, breadth, and volume. It is typical of most of our medium-term indicators, reflecting extremely oversold conditions at the July low. While we normally expect these conditions to result in a pretty vigorous rally, so far the oversold condition is being cleared with a not very inspiring price advance. This indicates that there was not much compression associated with the oversold conditions, compression which would be needed to power prices significantly higher. Another way to say it is that there was no build up of buying pressure, even though selling pressure seemed to have become exhausted.

Bottom Line: If we keep the fact that we are in a bear market foremost in our mind, it will help us maintain our guard, and temper our enthusiasm for positive market action. If the rally continues, more buy signals will be generated by our primary timing model, but I suspect that these will result in whipsaw. Long positions should be managed on a short-term basis.

We rely on the mechanical trend models to determine our market posture. Below is a recent snapshot of our primary trend-following timing model status for the major indexes and sectors we track. Note that we have included the nine Rydex Equal Weight ETF versions of the S&P Spider Sectors. This may seem redundant, but the equal weighted indexes most often do not perform the same as their cap-weighted counterparts, and they provide a way to diversify exposure.

Technical analysis is a windsock, not a crystal ball. Be prepared to adjust your tactics and strategy if conditions change.

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Sell & Sell Short gives excellent coverage on a subject that many traders shy away from. And, since we are in a bear market, the subject is especially timely. If you are an old Elder fan, my recommendation is not needed. If Elder is new to you, then I do recommend this book to you, as well as his earlier works, all of which you can find on elder.com.

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BIO: Carl Swenlin is a self-taught technical analyst, who has been involved in market analysis since 1981. A pioneer in the creation of online technical resources, he is president and founder of DecisionPoint.com, a premier technical analysis website specializing in stock market indicators, charting, and focused research reports. Mr. Swenlin is a Member of the Market Technicians Association.