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Dear Toolbox Readers,

Last week I told you that this market is extremely overbought... and you know what? It still is! This market has been defiant by rising yet higher after several weeks of gains and a whole parade of bad news.

I don't get it... Have investors shrugged off the bankruptcy of Chrysler, the Swine Flu and the big banks basically failing the stress test?

There are many reasons to believe that we have not yet seen the real bottom and I remain in that camp. Sooner or later all the ridiculous spending and bail-outs will come home to roost.

The biggest thing to fear right now is the next wave of mortgage defaults which by all measures so far is going to be bigger than the last round.

How can already weakened banks cope with such a blow at this time?

As if the last banking debacle wasn't big enough... this one looks like it will be worse.

The volume has been lower the last few weeks but never-the-less the market pushed higher closing up for the week.

I know what you are thinking... this is a strong market. But as far as I am concerned now would be a time to look for short entries rather than long side trades.

Simple reason will tell you that this market is (still) overbought and we are likely to get a pullback even if the market is going higher.

There are several key indicators that I would look at when we want to see into the future.

Let's start with the Bullish Percent Index...

The BPI was invented in 1955 by a group of market technicians and is calculated by counting the number of bullish signals on point and figure charts.

For example...

If 70 of the NASDAQ 100 stocks had bullish point and figure charts the index number would be 70.

You can use the BPI to "time the market" when you see an index BPI above 70 and then it gives back more than 6%... that would be a sell signal.

If you saw an index BPI under 30 and it gained more than 6% that would be a buy signal.

As with any indicator you need to get confirmation by using other indicators to really set the odds in your favor, but the BPI is a great place to start.

NOTE: In the Desktop Toolbox Financial Portal, on the charts page, there are links to the DOW, S&P and NASDAQ Bullish Percent Indicator charts.

You can also learn more about the BPI by clicking here and looking around at some of the great information online.

Further to the point is that many indicators are flashing overbought right now and I am not sure how much higher this rally can go.

We used to think that the VIX was high at 35 or so... now that looks low on the chart. The NASDAQ BPI is at about 85 and should surely give some back this week.

The BPI on the S&P is at 67.8 so there might be a little more room to the upside, but not much. Interestingly it was 8 weeks ago when the S&P BPI gave a buy signal when the market was extremely oversold.

The DOW BPI is at 53 and the most unreliable of the three as it only represents 30 stocks, many of which are currently being "messed with" by the government.

It was roughly two weeks ago that we warned you that this rally could be coming to an end and since then the market has "dripped higher" but nothing substantial.

I would be on the look out for a move lower in the next few weeks and make sure I had stops under any open long positions.

Finally... I want to remind everyone about the show on Sunday Night at 8pm. We will dig deep into the market outlook and as always we'll be taking your questions too!

If you have not done so already...

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Until Next Time...

Best Wishes and Good Investing,
Bill McKinley & Doug Newberry

The Investing Systems Network

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