By Sol Palha
The Dow traded as low as 10050 and Dow futures traded as low as 9994 and then bounced back very strongly. The break below 10,200 turned the trend negative but the Dow needs to stay below this level.

Trends are determined by key price points and for a trend to remain valid the market must remain below that price point. Thus if the Dow trades past 10,200 for 3 days in a row it will neutralize the previous signal. It will not however, negate the fact that breaking below a channel formation after a strong run up usually produces a strong downward move; it will only delay the action.

We have further signs that all is not well in the markets. MMM a stock that rallied strongly with Dow actually closed lower on Monday, and today it closed unchanged; in the past two days, the Dow has tacked on over 200 points. If you look at the banking sector many former higher flyers are also not performing all that well.

The Dow dropped from 10729 to 10000 in a very short period of time; the intensity of this pull back was extreme. The markets had not experienced anything like this since March of last year. Thus this pull back has fooled many players to adopt the old strategy of buying on the dip. We also have a large group of traders that sat out of the market for a very long time, and they probably view this large pull back (large only because it took place so fast) as a buying opportunity. This is more like a trap than a buying opportunity.

The safest position is to be on the sidelines until a very strong sell signal or another buy signal is generated. To let out enough steam and move the risk to reward ratio in our favour, the Dow would have to at the minimum shed 1500-1800 points, and so far it barely shed 700 points.

Despite the strong rally, the Dow has mounted in the last two days, the volume has not even hit the 6 billion mark; on Monday volume barely hit the 4.7 billion share mark, and today it came in at 5.47 billion. On the 21st and 22nd of January when the market sold off, volume spiked on both days and surged past the 7 billion mark. If you need one thing and one thing only to remind you of the very dangerous structure of this market then remember this. The Dow put in 22 new highs (this is a huge number) in a period of just a few months and not even once did the volume surge to the 6.8 billion mark let alone the 7 billion mark. Yet when the market sold off, for two consecutive days in a row, the volume surged over 7 billion shares.

Remember this for it is a very important development. Long term the market is clearly treading on a very shaky ground.

We would like subscribers to remember just how fast the Dow dropped from 10729 to 10050; this is just the prelude of what lies in store. If the markets should surge to test their old highs or maybe even put in new highs do not let this move up fool you. Pay attention to the volume and to the divergences.

The Dow utilities broke down one month before the markets, and so they appear to have resumed their leadership role. If the Dow should rally to new highs, a failure by the utilities to match them and surge to new highs before the Dow would be another clear signal that the markets are heading into a danger zone. Copper another leading economic indicator is trading well of its highs and the Baltic dry index has put in a double top formation.

If the Dow rallies to test its old highs without pulling back to the 9200-9400 ranges then it will be setting itself up for an extreme correction. This rapid move down was simply not enough to let out all the steam this market has built up and a strong rally now will result in a move similar to one that took place in the bond markets between Dec 2008 and July 2009. Bonds shed over 20% in 6 months, for bonds this is a massive move, so for stocks a comparable move would be in the 40% plus ranges.

Volatility readings have surged to yet another new high indicating that violent moves are going to continue to plague this market. Look how fast this market pulled back and look how fast it reversed. The moves though have still been one sided in nature (mostly to the upside) for the most part, but the next move will be for the majority of the swings to occur on the downside.

Finally, if the current daily sell is neutralized and a buy signal is issued on the daily charts, we will send out an interim update as it could be an early signal that the Dow is going to re test its old highs. Right now we still have a daily sell signal, in effect; the weekly while closer to the sell zone has not generated a sell signal yet.

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