Santa’s Buying Stocks, So Should You!

10/19/2011 10:48 am EST

Focus: STOCKS

Thomas Aspray

, Professional Trader & Analyst

The Advance/Decline (A/D) lines for major indexes suggest stocks can head significantly higher into year end. Be prepared to buy quality stocks on corrections to strong support.

Monday’s sharp decline took many stocks in the strong sectors back to first good support, while the market averages held well above their first retracement levels. With Monday’s drop, many called an end to the rally from the October lows and expected stocks to go much lower.

This view was supported by the weaker-than-expected earnings from Goldman Sachs (GS), but instead of dropping, the stock moved higher. Tuesday’s sharp gains are characteristic of a stock market that is internally strong and can go much higher.

The Advance/Decline (A/D) lines broke out of their trading ranges last week and are leading prices higher. This typically is seen in a market that surprises the majority by going higher than anyone expects. This is why I wrote last week to “Be Bold, Be Fearless…Buy the Dip.”

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We could see action similar to the fall of 2010 when the NYSE A/D line broke its downtrend (line a) and started leading prices higher in early September. Stocks did pull back on September 7, as the A/D line formed a bullish zig-zag formation that is very similar to how the A/D lines look now.

It may take a move above 1250 on the S&P 500 and 12,000 on the Dow Industrials to really squeeze those on the short side and convince the skeptics to buy. The favored sectors for year end remain technology, consumer discretionary, health care, and utilities.  There is also one sector that topped out in 2006 and may have finally bottomed out.

There are likely to be further one- to two-day drops as worrisome news from either the Eurozone or emerging markets will continue to scare the market. Despite the disappointing earnings from Apple, Inc. (AAPL) after the close on Tuesday, the futures are holding up well in early-Wednedsay trading.

NEXT: Latest Chart and A/D Line Analysis for Spyder Trust

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Chart Analysis: The Spyder Trust (SPY) has traded in over a four-and-a-half-point range in the past four days, as the minor support in the $119 area has held. The 50% retracement at $122.38 was overcome on a closing basis on Tuesday.

  • This implies a move to the 61.8% Fibonacci retracement resistance level at $125.82
  • The daily Starc+ band is at $127 with the 200-day moving average at $127.70
  • The major daily downtrend, line a, is now at $132.80, which could be reached before the end of the year
  • If the $119 level is broken, there is first good chart and retracement support in the $117-$117.30 area
  • There is now much stronger support in the $115 area
  • The downtrend in the NYSE A/D line (line b) was broken on October 11. After Monday’s slight pullback, it has again turned higher
  • One or two days of strong A/D numbers will confirm the bullish formations

NEXT: The Surprise Sector Finally Near a Bottom

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The PowerShares QQQ Trust (QQQ) also had a shallow setback on Monday, as it held above the minor support in the $56.50 area. There is next resistance in the $59-$59.40 area.

  • The daily Starc+ band is at $60.15 with longer-term trend line resistance above $62
  • The Nasdaq 100 A/D line formed higher lows in early October, line d, and then broke its downtrend (line c) on October 10
  • The A/D line has moved above its prior swing high and shows a bullish zig-zag formation
  • If the $56.50 level is broken, the former downtrend (line a) is at $56 with the rising 20-day exponential moving average (EMA) now at $55.59
  • There is more important support in the $54-$54.50 area

Tuesday’s Housing Market Index was stronger than expected and buying was heavy in the homebuilders, as many showed gains in excess of 5% on very heavy volume. This morning, housing starts also jumped sharply. The SPDR S&P Homebuilders ETF (XHB) closed Tuesday at the September highs, line e, in the $15.41 area.

  • The 50% Fibonacci retracement resistance is at $15.70 with the more important 61.8% retracement resistance at $16.60
  • The downtrend from the spring highs at $19.21 is now in the $17.80 area
  • The daily on-balance volume (OBV) broke its downtrend, line f, last week, and has turned up sharply this week
  • The relative performance, or RS analysis (not shown), now appears to have bottomed, suggesting this sector may finally be ready to lead the S&P 500 higher
  • XHB had a low Tuesday at $14.31 with further support in the $13.80-$14 area

What It Means: The action of the A/D lines suggests that stocks will be the big winners in the fourth quarter of 2011. Though there is always the possibility of a “Black Swan” event, the stock market now seems to be reacting well to negative news.

As long as the bear market headlines persist and the bearish sentiment remains high, corrections should be well supported.

How to Profit: The pullbacks in individual stocks are likely to be greater than those in the popular ETFs, and stocks should have better upside potential. I still like the retail stock recommendations from last week.

For the SPDR S&P Homebuilders ETF (XHB), try to buy at $15.28 with a stop at $13.74 (risk of approx. 10%).

For the PowerShares QQQ Trust (QQQ), go 50% long at $56.04 and 50% long at $54.96 with a stop at $52.88 (risk of approx.4.7%).

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