Stocks Look to Go Higher, But Will Face Resistance

The first quarter is completed. For stocks, it was positive in spite of several bouts of volatility. The small-cap Russell 2000 finished the quarter tops, advancing over seven percent. Technology has also been showing some attraction in the recent weeks.

Now, as we move into the second quarter, the month of April has been the best performing month for the DOW, averaging two percent since 1950, according to the Stock Trader’s Almanac. A major reason for the buying in April is the positive anticipation of first-quarter earnings.

And whether it is penny stocks, micro-cap stocks, or S&P 500 companies, you have to be impressed by the sustainability of the positive sentiment. The real test now comes as stocks edge higher. We need to see a strong break higher or we risk a relapse.

The major stock indices have closed higher in eight of the last 10 sessions to Wednesday, but there is a red flag, as the associated trading volume continues to be light, which fails to help confirm a strong buy signal. Unless we see increased volume on the up days, you have to question the lack of mass market participation in the current rally.

The near-term signals have a positive bias, but you need to watch the overbought condition.

The sentiment in the market is bullish, as stocks continue on a nice two-year rally from the March-2009 low. The trend of the NYSE new-high/new-low (NHNL) has been edging higher, with 172 of the last 182 sessions bullish as of March 30. In the technology area, 128 of the last 140 sessions have been bullish. All the signs point to additional gains ahead.

As of March 30, about 81.33% of all U.S. stocks are above the 200-day moving average (MA), down slightly from 82.38% a month ago. For the shorter-term MAs, the monthly decline has been more significant. For instance, about 59.87% of U.S. stocks are above their 50-day MA, down from 69.76% a month ago. We could be seeing a pending market decline.

So, while the momentum points to additional gains, I feel somewhat nervous that there hasn’t yet been a correction of any significant magnitude, albeit there have been several down days of over one percent over the recent month. This is not to say stocks are overvalued, but I feel they are fairly valued based on the current economic and earnings metrics.

And, unless there are fresh data that support additional gains, stocks could trade sideways in a tight channel in the upcoming months.

With the two-year bull market, investors and traders are looking for a reason to sell and take some profits. At the same time, there is also a feeling of not wanting to miss out on more potential upside opportunities. Option traders could use call options to play potential gains, while taking some profits on current stock positions. In this way, you can manage the risk.

I also believe in adopting strong risk management to protect your investments and hard-earned capital. Take some profits and use put options to hedge against a downside move.

George is a Senior Editor at Lombardi Financial, and has been involved in analyzing the stock markets for two decades where he employs both fundamental and technical analysis. His overall market timing and trading knowledge is extensive in the areas of small-cap research and option trading. George is the editor of several of Lombardi’s popular financial newsletters, including The China Letter, Special Situations, and Obscene Profits, among others. His trading advice on stocks and options is also found on his daily trading site, Daily Profits. He has written technical and fundamental columns for numerous stock market news web sites, and he is the author of Quick Wealth Options Strategy and Mastering 7 Proven Options Strategies. Prior to starting with Lombardi Financial, George was employed as a financial analyst with Globe Information Services.

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