“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via Email, Facebook or Twitter.

Last week, I asked a simple question:

“Was Monday’s rally an oversold bounce or the return of the “bull market?”

As I stated then, the short-term oversold condition of the market set the stage for a rally. I updated the analysis on Saturday discussing the two possible paths of the market this week.

“As expected the market did rally last week. As I noted it would be the success or failure of the rally attempt which would dictate what happens next. 

1. “If the market can reverse course next week, and move back above the 50-dma AND break the declining price trend from the March highs, then an attempt at all time highs is quite likely. (Probability Guess = 30%)
2. However, a rally back to the 50-dma that fails will likely result in a continuation of the correction to the 200-dma as seen previously. From current levels that would suggest a roughly -5% drawdown. However, as shown below, those drawdowns under similar conditions could approach -15%. (Probability Guess = 70%)”

As of Friday, the market failed at resistance closing below the 50-dma for the week. As denoted by the red dashed lines, the current price action of the market being compressed within a downtrend.

A “breakout” will likely occur next week which will fulfill one of the two potential outcomes noted above. “

Chart updated through Monday’s open.

As noted the “breakout” did occur which sent the markets pushing back above both the 50-dma and the previous downtrend resistance from the March highs. The “short covering” surge following the French elections now puts a retest of old highs within reach. As noted last week, the oversold condition is the “fuel supply” for the rally.

“The chart below is the ratio between the 3-Month Volatility Index and the Volatility Index (VIX). As shown, when this ratio declines to 1.00, or less, it has generally coincided with short-term bottoms in the market.”

Importantly, for the roughly one-percent rally on Monday, there was a significant reduction in the “fear” of the market suggesting that while we may indeed get an attempt at old highs, it may well not be much more than that. Also, the 14-period Wm%R indicator has already swung from extreme oversold to extreme overbought with Monday’s move as well. Again, the “fuel” for the rally is being quickly absorbed which suggests a rather limited advance heading into the seasonally “weak” period of the year.

On an intermediate term basis, the market is still wrestling with an overall downtrend currently as shown below. The good news is the rally on Monday has kept the secondary “sell” signal, bottom of chart, from being registered. If the secondary signal is registered it would suggest a more cautionary approach to portfolio allocations. As shown below, during previous periods where both signals were in play, vertical dashed red lines, it coincided with deeper corrections, if not immediately, in the near future.