Wednesday, May 5, 2010

Minding the Index Gaps

It has been a long while since we looked at the major indexes in relation to some old "gaps" created by premarket magic. To review, gaps on individual charts sometimes never fill, but generally do. Gaps on indexes... except for perhaps a rare exception decades old, always seem to fill. (obviously it has been helped by 2 epic bear markets in 1 decade) And usually do it rather quickly - within 6-9 weeks.

Currently there are 2 major gaps for both the S&P 500 and NASDAQ - essentially its the same chart, so I'll just speak S&P 500. I had thought somewhere between late March to mid April we'd see a quick gap fill because (a) that's usually the time frame it happens considering the original gap was in mid February and (b) we have not had one 10% correction this entire rally from March 2009; the largest has been 9%. Hence as the indexes marched ever upward, filling the gaps from their peak will now require a 10%ish correction (a bit more).

[click to enlarge]

Buying the dip has been the "go to" game plan for months and it has been a "can't lose proposition". Anyone with caution was laughed and mocked at by both the market, and the bull crowd. Finally in the past week or so we've seen 2 occasions the "buy the dip" crowd finally lost. So the obvious danger here is a trend works until it doesn't. With both major indexes having dropped to their 50 day moving average we have an obvious "buy the dip" moment. But with the non stop rally for 2.5 months, the variance between the 50 and 200 day moving average is substantially wider than it has been in a long while - perhaps the greatest of this entire rally. Hence we have a big air pocket and lack of support below the 50 day.

And then of course there are those gaps... which at this point if both fill would actually take the markets below the 200 day moving average. So... buy the dip, any dip? For the very nimble another opportunity ... but judging by the multiple distribution days we've seen the past 2 weeks, the increase in volatility (market indecision), and the reasons outlined above - the risks are rising.

Until the 50 day moving average is clearly broken on a closing basis, such talk is premature ... but with the action the past week it is now time to dust off these observations.

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