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Monday July 26, 2010 - Comments After the Close - Overbought and Weakening

|Includes: SPDR S&P 500 Trust ETF (SPY)

This afternoon I had some thoughts one what to expect as this bounce, and it is still a bounce in my view, tires ahead of what should be another leg lower. I mentioned we should get overbought conditions, but with subtle bearish diverging behavior, which we are starting to see.

Chart 1 - McClellan Oscillator

The one day and five day lines have both gotten above 1.5 standard deviations from the 200 day mean. You can see that these levels are typically reached before some kind of sell off.

Chart 2 - Up Down Volume Ratio

A phenomenon I mentioned (but did not post a chart until now) was the declining Up/Down volume ratio. We can see here that the rally days have been occurring not only on declining volume in the NYSE and trading in the ES, but up/down volume ratio also shows a decline in internal strength. Typical behavior in a corrective trend ending.

Another observation I made is that I expected a close above the 200 DMA, which occurred today in most of the major indexes. This believe it or not is a good sign for bears. The 200 DMA is a very widely followed indicator, and as such today's close will be heralded by many as a technical victory for bulls. Victory for bulls means optimism goes up, which ironically means the potential for a further rise in stock prices goes down.

So the pieces are starting to fall into place. What I am waiting on now is more divergent behavior in momentum indicators, but with rising bullish expectations. The put/call ratio 5 DMA closed today at .91, close to the 200 day mean. While it clearly is trending in the right direction (getting more optimistic), ideally it should get lower still, perhaps to near .80 or so.

Chart 3 - Put Call Ratio

Chart 4 - Possible Cycle Peaking

We also have a possible cycle peaking over the next few days. Cycles are a pesky indicator; working, working, working, then suddenly disappearing, or being eclipsed by a larger degree cycle. That being said there is a possible 13 day cycle + or - 2 days that should being peaking this week. I've outlined that area in the red target boxes. A bearish candle, or other indicator sell signals that will be a good first sign the rally is done. If I see other notable occurrences in the charts, I will publish them here.

Disclosure: Long SPY puts.