Our Zweig Breadth (ZB) indicator fell short today of going overbought. I thought that the 875 area was going to hold or even burst through and that we would get another overbought on the ZB. This leaves open the possibility of either another day to set a higher high in order to get into that overbought area or a small sell off. Sitting overbought is great because it lends high confidence that the market will sell off the next day. We don’t have that. Our indicator is very close to overbought and the market has quite consistently pulled back from these levels. If we do not rally tomorrow into new highs and drag the indicator up but in fact pull back, the pattern has been a 3-4% pullback. The pullbacks from a full overbought condition have been much larger, between 3.8% – 6.6% range. The chart below illustrates with red arrows ZB overbought pullbacks, the orange arrows the near miss pullbacks. A 3% pullback from today’s high would bring us back down to the 856 area.
I know there are many calling for a major pullback. The banks are weak, everyone is worried about the
Swine Flu H1N1 virus, and that we are just due. You must remember we are in a bull market run which thus far has consistently recovered from bad news. We have rallied back hard from weak opens a few times in the past couple of weeks. You must keep the strength of the market and its behavior in mind when making your trading decisions. I am holding short tonight but here is what I will be watching tomorrow:
- A gap open below that 856 area: I will watch the behavior if we close in on the 856 area. Perhaps covering at 856 as a stop.
- An open above 856 that falls to the 856 level: I will lighten my load and tighten my stops.
- Anything below the 847-846 level will make me think we have broken the recently established pull back pattern.
- A rally to new highs won’t surprise me since we are still not overbought on this indicator that has gone overbought 4x in the last month and a half. I will add to my shorts if we close higher.