The Charts Point Up

12/22/2008 11:00 am EST

Focus: OPTIONS

Lawrence McMillan

Founder and President, McMillan Analysis Corporation

Lawrence McMillan, editor of The Option Strategist, says the market appears to be moving up for now, and he cites some benchmarks to watch. 

All through the decline since last August, we have refrained from turning bullish, mainly because the chart [of the Standard & Poor’s 500 index] has not been able to interrupt its bearish down trends.

Recently, however, it put together a “higher high, higher lower” pattern, and that tilts the intermediate-term picture towards the bulls. As long as that up trend line remains intact, we will view the market with a bullish bias. Currently, the trend line is at about 840, with the (still-declining) 20-day moving average at 850.

We would not like to see that area violated. Specifically, we need to see the 20-day moving average turn upward, which it should be able to do in the next few days. If it does, it would be the first time it has done so since last August.

There may, in fact, be an up trend channel in the S&P, which doesn’t change anything, but could indicate that the market will bounce back and forth within this rising channel–eventually making some upside progress.

The equity-only put-call ratio charts had been wavering at very high levels recently, but recently rolled over to buy signals once again. This, of course, is a positive intermediate-term development, and should bolster the bullish case.

Market breadth has been quite positive since the late November lows. In fact, for the first time since last May, both breadth oscillators reached overbought territory. However, a couple of days in which declining issues dominate advances could throw these breadth oscillators back into sell signals.

Volatility indices have not responded with a bullish signal of their own. They remain, marginally, in up trends. As long as that persists, they will continue to be bearish. If $VIX were to close below the 47-50 support level, it would be a bullish sign. (It closed below 45 Friday—Editor.)

Volatility derivatives have slowly responded in a bullish manner as the market has rallied since late November. The futures contracts are now trading at only minimal discounts. One thing to beware of: If the VIX futures should begin to trade at a premium for any length of time, that would be a sell signal–and, given the high levels of VIX, it would likely be a very negative development.

In summary, we are going to give the bullish case the benefit of the doubt as long as the S&P can remain above its rising trend line. So far, the bulls have failed to really capitalize on what are generally positive signals from our indicators.

If the market can’t rally when the indicators are positive (or if it rallies only weakly, as it did last July-August), then that usually means the next decline is a rather nasty one. A close below 820 in the S&P would turn the entire picture bearish—perhaps extremely so. (It closed near 888 Friday—Editor.)

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