Weekend Newsletter of March 23, 2003

Summary of this newsletter

Part 1. War talk and the markets

Part 2. Continued education, Breakaway Gaps

Part 3. Breakaway Gaps on Nasdaq and Negative Divergence

Part 4. Market Index, daily analysis and conclusions

Part 5. Big picture

Part 6. Gold, US dollar

Part 1. War talk and the markets

Wow and amazing are two words to describe the current rally that began on Thursday 13th. The DOW had it's biggest rally in over 20 years by rising 8.2% in on week! Since the markets how now been up for the last 8 trading days, at least a short term pullback is due. It's not surprising though that that we've had this powerful rally when you take into the account of the war, and low volume in the downtrend. First off, the war, the main stream consenus was that the markets would continue to fall into the war, and then rally once the war began. However, the rally started before the war in anticipation of a rally. Secondly, the volume during the downtrend was light, therefore the overhead resistance was weak and easy to traverse.

As for the war, I'm not going to go into too many details, as many of you have no doubt been watching the progress all weekend. However, there have been some interesting developments which could effect the short term market direction early this week. While the war started off so well, there has been some disturbing events: While most of the Iraqi soldiers have all been surrendering, recently some Iraqi soldiers have feigned surrender, only to ambush allied forces. Here is a something from Yahoo News service, title Allies Hit Setbacks on Road to Baghdad,

"Iraq (news - web sites) used ambushes and even fake surrenders to kill and capture U.S. troops Sunday, inflicting the first significant casualties on the allied forces driving toward Baghdad. U.S. war leaders declared the invasion on target despite the bloody setbacks."

"Up to nine Marines died and a dozen U.S. soldiers were taken prisoner in surprise engagements with Iraqis at An Nasiriyah, a southern city far from the forward positions of the allied force."

"On the third day of the ground war, any expectation that Iraqi defenders would simply fold was gone."

Also, the consensus is that once US troops get into Bagdad, this type of "cowardly" resistance fighting will become much worse. I can't help but think of the US soldiers how are now being held as prisoners. They could be dead, but I cannot imagine what a hellish nightmare it is for them. Keep these guys in your thoughts, wether or not you support the war, these are Americans like you and me.

Anyway. How will this effect the markets this week? As I write this, the futures are down, however that can change like the wind. Anyway, as you'll see later in this newsletter, I'd expect at least a short term pullback in the markets starting early this week probably Monday. After 8 days up in a row, something has to give. At the roulette table, once in a while black will hit 8 times in a row, but it's very rare to hit much more than that. Also, as you'll see, the market indicies have Negative Divergence on their 60 minute charts, as well as resistance nearing on the daily charts. Everything is lining up to suggest a short term market pullback.

However, the recent market rally has broken a lot of technical resistance during this rally. Remember that once resistance is broken, it becomes support. Therefore, even though I see a pullback coming early this week, I also don't think the markets will fall all that hard yet. Because the market has taken many resistance levels out, I think the imminent pullback will be short and the market will basically hold up. I see the markets then basically going sideways to slightly up for awhile. Again, I don't see them starting a major crash right now. Therefore, I would not short heavy on a pullback at this time, if you want to short, be ready to take profits quickly.

Part 2. Continued education, Breakaway Gaps

Last weekend I talked about how Positive Divergence was very useful in determing a rally was going to happen. The current rally that started on Thursday 13th was predicted on this website on Wednesday afternoon by the Positive Divergence via a message on the message board.

This week, let's continue our education by talking about Breakaway Gaps. On Thursday March 13th, Breakaway Gaps formed on the 60 minute charts of the Nasdaq, DOW, and S&P respectively. Breakaway gaps are the most bullish off all gaps and produce very powerful rallies after they occur. Upon seeing this Breakaway Gap, one should have been able to tell that the rally was going to be a big one, and not some short 1 or 2 day rally. Please visit the Education center on this website and read the section on Breakaway Gaps.

Breakaway Gaps:

Breakaway gaps are the most bullish of all gaps. They occur when a stock or index gaps above resistance on high volume.High volume is key! Breakaway gaps occur usually when a stock or index is in an extended downtrend where a clearly defined downtrend resistance line can be drawn. Note, breakaway gaps can occur with stocks that have horizontal resistance, however experience tell me the ones that have a clearly downtrend resistance work better. The gap here is very bullish because it takes out the resistance by gapping above the downtrend resistance line on high volume. These gaps are usually the start of an extended uptrend and may not be filled for a long time.

This is where inexperienced traders can fall into a trap. There is an old saying on wallstreet that gaps must be filled. Therefore, when a breakout gap occurs, many traders get caught and lose money by shorting the gap because they think it must be filled. Breakaway Gaps may eventually be filled, however they represent a change in trend and are very bullish. Typically, the gap may take months, even years to fill. Breakaway gaps represent a low risk entry point for a long position if they are bought early on, especially on the day the gap occurs. Breakaway gaps, sometimes upon breakout, will pullback for a few days. Use this pullback as a gift and either add to your long position or go long if you missed the day of the gap up

Breakaway Gaps and Negative Divergence

How should one trade breakaway gaps? The breakaway gap should be bought ideally on the day of the gap up or on a pullback shortly after the gap occurs. Now, the big question is, how long should one hold the position? One thing I've found very useful is that after Breakaway Gap has a substantial run-up, Negative Divergence usually warns the trader that the rally is over, and to exit the long position. Therefore, when buying breakaway gaps, look for negative divergence as your warning to exit the position. For more information of negative divergence, go to the education section on Negative Divergence.

The chart below of Yahoo is a good example of breakaway gap and its bullish nature. Yahoo was in a downtrend from May of 2002 until early October 2002, as noted by the clearly defined downtrend line. The gap on October 12th cleared this downtrend resistance line on very high volume which confirmed the pattern. Many traders shorted Yahoo on the day of the gap up as well as many days afterward based on the poor fundamentals of this internet stock. This decision obviously was unwise and cost many traders lots of money, especially those who added to their short position on the way up.

Notice how Negative Divergence occurred after the substantial rally - the astute technical trader would have used this to exit their long position.

This example also illustrates how trading in the short term off fundamentals can get one into trouble. Long term, fundamentals eventually win out, but in the short term, technicals rule. Read the section on Technical Analysis for more information on technicals vs. fundamentals.

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Part 3. Breakaway Gaps on Nasdaq and Negative Divergence

On Thursday March 13th, Breakaway Gaps formed on the 60 minute charts of the Nasdaq, DOW, and S&P respectively. Below is a chart of the 60 minute Nasdaq chart. Notice the Breakaway gap that occurred that stated the rally on March 13th. After reading about Breakaway Gaps above, now it is not surprising why/how the markets rallied so hard because these types of gaps usually produce vicious rallies.

However, Because this Breakaway Gap is on a small time frame, I expect it's effect to have been fully seen by now. Also notice the Negative Resistance showing up. Remember from above that Negative Resistance often signals the top of the rally after a Breakaway Gap. This looks to be the case this time as well and further supports my view that a short term pullback is in order early this week, probably on Monday.

Negative Divergence is also seen on the DOW and S&P 500 60 minute charts:

Part 4. Market Index, daily analysis and conclusions

How do the indicies look on a daily basis? Well, first let's look at the Nasdaq. The Nasdaq has had an impressive rally following the Breakaway Gap on the 60 minute chart and has even broken it's downtrend line connecting the highs of the previous two rallies.

However, the Nasdaq is stopped DEAD ON the gap of 1430 which is also a a 61.8 fibonacci retracement line. I bet the Nasdaq will pull back here first before attempting to break out of this resistance.

Please note, that when we do get a pullback, I don't think the market is going to melt down. Enough technical resistance has been taken out that the markets are not going to simply roll over and die yet.

The VIX has also broken it's uptrend or Ascending Triangle and has brokne down. It now looks possible that the VIX could continue to fall which would cause further upside in the markets (after a short term pullback is completed early this week).

Part 5. Big picture

Part 6. Gold, US dollar

Gold really needs to be looked at. After a beautiful text book breakout in early December 2002 and a rally to about $390, gold has have a viscious pullback that has made even the some of the most die hard gold fans queezy. Gold has fallen all the way back to the uptrend line that was started in December of 2000!!! This is a very significant level and a very likely place for gold to bounce. This might be a good place to start picking up some gold for the aggressive gold buyers. However, for the more cautious trades, you may want to first make sure gold finds support at this multiyear uptrend line before buying.

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Also, the XAU which is also a composite of 10 gold stocks also has a similar uptrend line that goes back to November 2000. Support seems to be in the low 60's. This may change if you use a logarithmic vs. a linear chart.

The HUI is also close to a support line if one uses a Logarithmic chart.

Since most of use don't trade the metal itself, we trade gold stocks.

Note, many of the gold stocks are having technical bounces at the moment, basically they've falling so far so fast that a bounce was imminent. However, very few of these stocks have fromed nice consolidation patterns such as triagles, flags, or wedges that would signal a big run-up here. Therefore, in the mean time, I view most of the bounces you are seeing as a technical bounces that will not produce large price run-ups.

I think it is now save to start accumulating a SELECT few of these stocks (IN SMALL QUANTITIES) - Don't load the boat!!!.

Drooy is an example of a gold stock that may have bottomed out:

There are a few gold stocks that look decent, but not many, and gold stocks can really mess with your emitions, therefore if you've never traded gold stocks, I wouldn't start just yet - wait for some nice technical patterns to develop such as Triangles, Flags, Wedges, etc. Also note that while many of the gold stocks have formed lower lows, none of them have Positive Divergence.

Here is a list below, just click on the symbols to pull up a real time chart.

< $2.00	SLGLF	PMU	MYNG	CALVF	MNG	BGO	GSS
$2 - $5	DROOY	VGZ	HL
$5 - $10	KGC	ASL	RANGY
$10 - $20	GLG	GG	GFI	HMY	MDG	RGLD
> $20	NEM	AU

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Below is a chart of the US dollar and this is important to golds direction. The US dollar is current stalling at 101.85 resistance. However, this is not strong resistance and could easily be broken, especially a quick win to the Iraq war. However, I'll bet my last virgin (I'M KIDDING FOLKS) that the resistance level at 103.40 will never be broken this year. It is very strong resistance, as it was the last support of the US dollar before the big dump.

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