Sunday, May 25, 2008

NASDAQ Bear Showing Its Face

As you know I've been cautious to bearish on the Dow, but now I'm beginning to see bearish signs in the NASDAQ as well.

Above is a weekly chart of QQQQ better known as the Q's and below that is VXN which is the volatility index for the NASDAQ. You'll notice that the Q's just put in a weekly bearish engulfment pattern. For those of you who are not familiar with candlestick charts a bearish engulfment is a reversal pattern that takes place at the end of a move. One important feature in using bearish engulfment patterns is that is must take place at a time that the market is overbought. A reversals pattern needs to have something to reverse if it is going to be considered a trend reversal pattern and right now the NASDAQ is over extended in my opinion.

If you look at the volatility index in the lower pane, you will see that VXN is currently at a low level. Now I know some of you are thinking that I am wrong and that VXN is not at a low level because a year ago we saw VXN at even lower levels so how could I possibly consider the current levels low? Well this is where some thinking is required.

Look carefully at what the NASDAQ was doing last year compared to what the NASDAQ has been doing this year. Last year the NASDAQ was making higher highs and and lows which is not what we've been seeing since November 2007. For the past 7 months, the Q's have been making lower highs. So in my opinion, we need to adjust our levels of what is considered low for VXN.

My interpretation of VXN is that last week investors and traders were very complacent or bullish on the NASDAQ which is actually bearish from a contrarian point of view.

I think the combination of a low VXN reading with a weekly bearish engulfment in an overbought condition is a sign that we may see the market heading lower in the weeks to come.

One more thing, a move above the high of the weekly bearish engulfment would negate my bearish outlook on the market and cause me to become neutral.

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