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Gauging Market Posture

Posted on February 25, 2009 by Adam

Good Morning Traders,

Yesterday’s sharp rally came as no surprise to me, given the grossly oversold nature of most broader market indicators. As such, I was able to reap the rewards by positioning myself slightly to the bullish side.

After the rally, we have inched our way north from extreme oversold levels, but an enormous amount of risk to the upside still exists if you are short here.

The NYSE McClellan Oscillator still reads -63, which is still far below its normal range, hinting at some follow through from yesterday’s strength. Likewise, NYSE Bullish Percent is also oversold, and even moved further down after yesterday’s price action. Finally, the Put/Call Ratio showed a bullish sentiment among short-term traders, with a high ratio of calls to puts traded yesterday.

I’ve also been watching treasuries to see how they are moving. Treasury yields, tracked by the $TNX, tend to move higher when the stock market is bullish, and lower when stocks are bearish. This post outlines that relationship in more detail.

Lately, Treasury note yields have been coiling up in a small triangle pattern. Yesterday we reached the upper resistance line of the pattern, but couldn’t quite break out. If we do manage to break out to the upper side of this pattern, which should come at 28.60 or so, look for stocks to scream higher, and treasury yields to climb to 30, which is equivalent to a yield of 3% on the 10 year note.

However, if we turn away from resistance, this rally will fizzle out. If we break down from this triangle pattern, we will test the lows from Monday once again.

Hence, I am bullish, but cautiously so. If stocks decide to move lower with any sort of conviction, I’ll look to take profits on my bullish positions and take on some new bearish ones.

Treasury yields are coiling up tightly, and approached resistance after yesterday's rally. Since stocks are positively correlated with treasury yields, look for a breakout in either direction to fortell the direction in stock prices.

Happy Trading!