Just to review, the warning signs consisted of 1) leading stocks breaking down 2) an increasing number of distribution days 3) very high bullish sentiment and 4) too many breakout failures.

Since my last post, we have observed even more distribution days (which is defined as heavy volume selling by the institutions). If you look at a NASDAQ chart, you will notice big volume down days on 1/20, 1/21, 1/22, 1/26, 1/28 and 1/29. The worst part is that the selling accelerated in volume last week with Friday 1/29 being one of the heaviest volume down days in the past year!

I view this as obvious “dumping of shares” by the large institutions. I said this before and it’s worth repeating: “WHEN THE BIG BOYS ARE GETTING OUT OF THE MARKET, I DON’T WANT TO BE IN!” Why? Because you need institutional support to keep stocks in an uptrend. Right now, this support does not exist. In addition, “breakout failures” in leading stocks such as $PEGA $STX and $MTL confirms the unhealthy nature of this market.

Although we may see some low volume short covering rallies, my best advice is to simply stay out of this market. If you feel that it’s too late to sell and you want to “ride it out,” keep in mind that you will likely deal with more downside volatility over the near-term.

One of my favorite trading rules is: “Always protect your confidence.” By putting our clients in cash in mid-January, not only did we survive the past two weeks, but we will also be more confident when it comes time to re-enter the market. In other words, if the market corrects 10-15%, while everyone is struggling to get back to even on the year, we can start from a stronger position and trade with a higher level of confidence when the market becomes healthy again. Until then, sit out and wait patiently for a better environment. Who knows? It might not be that far away.

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1) Big Caps: I have said all along “watch the action of the Big Caps.” Why? Because the large institutions traffic in this area and watching these stocks usually shows us what they are doing. Last week $GOOG rose on strong volume and $AAPL $ISRG $PCLN $AMZN $BIDU all pulled back on light volume, a sign that the large funds are not selling their shares yet.

2) $AAPL: After reviewing RIMM’s earnings Thursday night, I don’t see how Apple doesn’t obliterate their upcoming quarter’s earnings. In their last conference call, Apple said they “couldn’t keep up with demand.” In this economy, there are FEW companies who can say that. I think you can trade Apple as a “buy the rumor, sell the news” play. In other words, buy it here at $195 (it should have support in the 186-188 range) and sell it into a potential run to $220 by its earnings in late January.

3) The Dollar rally is over! There is INSANE speculation in the $UUP 23 calls for Dec, Jan and Mar. There’s a reason why the specialists closed it Friday RIGHT ON $23! If you don’t understand this, don’t worry about it. All you need to know is that the market tends to fool the majority. In other words, when the entire world speculates the same way, it almost never happens. I don’t expect the UUP to close above $23 anytime soon. Therefore: Dollar Decline = Stock Market Rally.

4) $CML: Compellent Technologies. Strong technical Daily and Weekly chart, hot sector, 16 quarters of revenue growth…sounds “compelling” to me! The entire Storage sector is strong ($STX $WDC $CAVM). You can buy CML here at 22.50, it should have support in the 20-21 range. I’m expecting the stock to be up 30-50% in the next 12 months.

5) Internet Security: This entire group acted very well this past week. Stocks to watch include: $RAX $ARST $BCSI $FIRE $FTNT (recent IPO).

6) India: Many Indian-related stocks showed great relative strength this week. Ideas include: $WIT $RDY $CTSH $INFY $TTM.

7) China Water/Infrastructure stocks: $RINO $TRIT $HEAT. China plans to more than double its spending on environmental protection in the five years from 2011-2015. They plan to invest $454 billion during this period, compared with the $205 billion allocated for the five years between 2006-2010. I expect this increase in spending to benefit these stocks and I look for continued announcements of government contracts to help their strong earnings and sales growth.

8) Miscellaneous ideas: $HGSI (continues to trade in a very tight range, a sign that institutions are not selling shares) $LULU (46% of its float is short) $SWM (strong chart, added to Goldman’s Conviction Buy List recently).

9) One final note, if I am dead wrong about my call for a market rally, it doesn’t bother me at all. Why? Because I trade with stops and I don’t have an ego when it comes to trading. Remember two VERY IMPORTANT trading rules: “Always cut your losses,” and “Separate your ego from your trading.” The market doesn’t care if you have to provide food for your family or if you have 10 kids to put through college. In other words: respect the market, take what it gives you, and ALWAYS protect your portfolio!

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