Financials reverse higher at pivotal level

Stocks whipsawed their way through a volatile, indecisive session yesterday, before finishing solidly higher across the board. The ongoing tug-of-war between the bulls and bears caused the main stock market indexes to oscillate in wide ranges of 1% - 2% throughout the first half of the day. In the afternoon, the stock market settled down, and generally consolidated near its intraday highs. The S&P 500 gained 1.5%, the Dow Jones Industrial Average 1.3%, and the Nasdaq Composite 1.2%. Curiously, small and mid-caps lagged the broad-based advance. The Russell 2000 and S&P Midcap 400 indices closed higher by just 0.5% and 0.8% respectively. The major indices finished below their best levels of the day, but still within the upper quarter of their intraday ranges.

Turnover rose across the board, enabling both the S&P 500 and Nasdaq Composite to score a bullish "accumulation day." Total volume in the NYSE was 6% greater than the previous day's level, while trading in the Nasdaq ticked 3% higher. So far in this holiday-shortened week, the Nasdaq has had two "accumulation days" (Tuesday and Thursday), and one "distribution day" (Wednesday). The higher volume gains, followed by higher volume losses, followed by even higher volume gains has been indicative of the major indecision surrounding the current market environment. With total volume levels still below average for the tenth straight day, it would be unwise to place too much faith in either the bulls or bears definitively taking control at this time.

In yesterday's commentary, we illustrated how the Bank Index ($BKX) was sitting at a pivotal level of support. We suggested that a break below the low of its recent consolidation could lead to a swift move lower, but also cautioned that support of the 50-day MA could make any downside move short-lived. On yesterday's open, the $BKX gapped down below its consolidation, but convincingly reversed back to the flat line after just one hour of trading. This resulted in what is known as an "undercut," a bullish formation in which a major level of support is briefly violated, but the stock, ETF, or index quickly snaps back above it. This causes traders' stops to be hit, thereby shaking out the "weak hands" and absorbing the overhead supply necessary for an uptrend to resume.

Upon spotting the "undercut" yesterday morning, we decided to tighten our protective stop in UltraShort Financials ProShares (SKF) to the breakeven area. Several hours later, the protective stop was triggered, causing us to scratch our entry into SKF with no harm done. But because pivotal levels of support/resistance can easily make a sharp move in either direction, we continued watching the banking sector for signs that it could actually be a good play to enter the long side of the market. In the final hour of trading, the banking sector began showing bullish divergence (relative strength) to the broad market. This prompted us to take action and do something we rarely do -- reverse the position.

With the SKF trade closed near the breakeven level, we sent an Intraday Trade Alert to subscribers, notifying them of our new long entry into the Bank Index SPDR (KBE), which closely follows the chart pattern of the actual $BKX index. Our entry coincided with KBE rallying to a new high of the day, breaking out above its hourly downtrend line in the process. The "undercut," and subsequent break of the downtrend line, is shown on the hourly chart of KBE below (moving averages removed so you can more easily see the downtrend line):

If KBE follows through on yesterday's late-day momentum, it should gap above that day's high. Such action should lead to a bullish change of sentiment in the short-term, which carries KBE back to test its May 8 high. That level also coincides with resistance of the 200-day moving average. For this short-term trade setup, our protective stop is placed just below the 50-day moving average of $16.77 (not shown on the hourly chart above), thereby giving us a better than 2 to 1 reward-risk ratio on the swing trade setup.

Upon closing our SKF position, we were left with two more open positions: CurrencyShares Japanese Yen (FXY) and iShares Silver Trust (SLV). Though we liked it for potential swing trade entry above its hourly downtrend line, FXY gapped sharply lower on the open, thereby preventing our swing trade setup from triggering for buy entry. However, major support of the 50 and 200-day moving averages lies just below the current price of FXY, which is why we remain long our original position. The good news is yesterday's bullish performance in our other position (SLV) made up for the decline in FXY. As shown on the daily chart below, SLV gapped up above resistance of its February 2009 high to close at a fresh nine-month high:

Because SLV is approaching resistance of its long-term, weekly downtrend line, we have trailed our SLV stop tighter, to lock in gains in the event of a bearish reversal. But as long as SLV continues to exhibit relative strength and a steady uptrend, we remain long.

Going into today's session, we're stalking the Oil Service HOLDR (OIH) for potential long entry. As commodities have begun showing considerable strength, energy-related ETFs have outperformed the broad market as well. In the case of OIH, it has moved back to test resistance of its multi-week consolidation,after finding definitive support at its 20-day exponential moving average. More importantly, OIH is now firmly above its 200-day moving average, which should now act as support on a pullback. As such, we like OIH for potential buy entry above the May 7 high of $105.10:

Nothing new to say about the broad market. Overall price action remains schizophrenic, as evidenced by the large day-to-day percentage swings in both directions. There's really no reason to think about trading broad-based ETFs such as SPY, QQQQ, or DIA, at least until the major indices eventually make a clear break in either direction, above their 200-day moving averages, or below their 50-day moving averages. Laying low, with a mostly cash position, has enabled us to preserve capital in our model account as stocks try to make up their mind.