Bear in bull's clothing, or more bear stew?

The pullback week that we have all be waiting and yearning for is finally here. After a historic monster of a rally, stocks took a much needed breather last week with the indices down between 3-5%. However, some sectors took bigger hits, e.g. XLF, IYR, XLE and XME were down between 6-11%. I think it is safe to assume that the 'character' of this rally will be tested in the coming week, if not the next few days. Is it a bear in bull's clothing, or is the bull setting up a trap for more bear stew?

This move sets up a much important test for the market. Many stocks are at 'logical' pullback buy points - whether you are looking at stochastics, CCI, MACD, etc. or simple pullback chart patterns. Additionally, many stocks are resting at the 20 or 50 MA on daily charts. Declining 200MA resistance still sits comfortably above the majority of stocks and the indices. Usually, the first test of this resistance fails, and the second test on strong volume is a good indication of a recovery in the chart pattern.

Although the daily charts do look very promising technically, the corresponding weekly charts are pointing to an even more significant pullback if the lows of last week are taken out convincingly. The SPY weekly is setup perfectly for a stochastic sell signal on the weekly chart and has historically been a very accurate indicator if/when triggered. Obviously, this does not mean the same thing will happen. It is very possible we may not even retest or breach the lows of last week. Also remember, that there are now 'trapped' longs who jumped in late on this rally and will be anxious to 'break even' the longer we do not get back up to the highs (more fuel to the selling fire).

Additionally, my TA system is showing a strengthening of the US Dollar vs. Euro and GBP, which could adversely affect commodities and oil - meaning a more severe pullback might be in store. Furthermore, MOO closed with a 'doji' on Friday with above average volume. Ags have been unstoppable the last few weeks and are due for a pullback, especially with the 200MA in close proximity as resistance.

In conclusion, I think it is safe to assume that this is becoming more and more a stock picker's market. Focus on the strong stocks in strong sectors for long positions (i.e. the leaders), and short the weak stocks in the weaker sectors. There is no shortage of watchlists for both longs and shorts in this market, so be prepared for both scenarios and look to book profits when you have them.

The burden of proof now lies squarely on the shoulders of the bulls. Is the worst over? Will more banks fail? Is unemployment going to hit 15%? I don't think ANYONE really knows the answers to all these questions. The market will let us know in due time. No need to guess or force our opinion on anyone, including the market. Prices are THE best leading indicator - follow the market for your cues, and stick to your trading plan.

I hope everyone had a great weekend and is ready to make some profits this week. Good luck and I'll see you on Twitter.