When We Can Break Out the Bubbly

In yesterday’s column, I reminded you that it was the fifth anniversary of the NASDAQ high. I also said that I was not jumping with joy about this most recent technical break above 2000 on Tuesday. And, instead of a pullback, the NASDAQ advanced another 26.50 points on Wednesday and closed at its highest level since closing at 2034.98 on March 15, 2005. The index subsequently closed below the psychological 2000-point support level on March 22, 2005.

 But I’m still not reaching for the bubbly, despite the five-day rally in the NASDAQ. Investors may decide to drive the NASDAQ and attempt a break at the key 2100-point resistance level, last breached on March 7, 2005, but, as I said yesterday, the current buying is not driven by the mass market.

 Don’t get me wrong; I’m not here to put a damper on the party. I actually love parties. I truly want the market to trend higher. Just like the majority of investors, I too lost some money back in 2000.

 I only want to point out some of the warning signs embedded in the technical metrics. As I briefly touched upon yesterday, the lackluster trading volume and other technical metrics in this recent rally cause me to be somewhat suspicious. Remember, we have seen several breakouts at 2000 so far in 2005, and none of them have been sustainable.

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 You should watch the trading volume on both the up and down days to gauge the market’s sentiment. A rise in the market in conjunction with reduced trading volume is what technical analysts like me call a bearish divergence. Trading volume was relatively low in February and March, suggesting increased caution on the part of investors. In April, we saw a daily average of 1.81 billion shares traded. In an upward trending market, you want to see rising trading volume accompany the advance. Without rising volume, the technical strength would be suspect, causing a “negative divergence.”

 In the first 19 trading days of 2005, daily trading averaged over two billion shares. But trading activity since then has been relatively low. In the 75 sessions since, daily trading has been below two billion in 63 of the sessions. So, where are all the buyers?

 Let’s take a look at the market action during the recent five-day rally. The upward move in the NASDAQ on Wednesday was bullish, as it was accompanied by just over two billion shares traded. This is a good sign, and it reflects the psychology of the market. What we also want to see is the “herd” moving in line with the flow of money. Watch the flow for signs.

 Prior to the strong volume on Wednesday, we saw two low volume days of 1.44 billion and 1.56 billion shares, well below the five-day and 200-day moving averages of 1.74 billion shares and 1.76 billion shares, respectively. What this tells me is that investors are still safeguarding their cash, reflecting the apprehension in the mass market — a bearish divergence.

 Now the reality is that the NASDAQ could continue to trend higher and break 2100 over the next few days. I’m wondering whether the rally is sustainable going forward, given the lack of market commitment. A good rule to go by is that if the buying is not driven by the herd, then you need to question its strength.

 Should the NASDAQ continue to trend higher on stronger volume, then, by gosh, I’m going to break out the bubbly and rally cap and join in the party. You know I love parties!