I'm not buying this rally - not yet anyway.  This past Sunday night, I calculated max pain for the ETFs that track our major indices.  After staring at the numbers, I wondered "can they do it again"?  By "they", I meant the market makers.  You see, a month ago while I was in Seattle at StockCharts' ChartCon conference, an astute member of ours pointed out mid-week (August 10th) that max pain was WAY above current prices.  In options lingo, this simply meant there was a TON of net in-the-money put premium on the table just as EXTREME pessimism was kicking in.  Take a look at the chart below:
EOPCR 9.17.11

The green arrows highlight the EXTREME levels of pessimism.  Notice how each of these extremes marks a bottom on the S&P 500?  I've been noticing it for years, which is why sentiment analysis should be a big part of every trader's arsenal.  Now take a look at the blue circle highlighting the S&P 500 bottom the second week of August.  In addition to extreme pessimism, max pain suggested a SIGNIFICANT upward move was likely based on the imbalance of equity calls and equity puts.  Extreme pessimism hit the -20% threshold on August 8th.  The S&P 500 bottomed on August 9th.  More importantly, the S&P 500 rallied over 100 points from the August 9th low to the August 17th high.  I think that qualifies as a SIGNIFICANT upward move.  Chalk up more TARP for the financials (market makers).
So there I was last Sunday night, wondering if it could possibly happen again.  Could the "Goldman Sachs of the world" help to direct prices higher, thus minimizing option payouts for a second month in a row.  Depending on the index ETF I was looking at, potential gains for this past week were anywhere from 3% to 12% to eliminate net in-the-money put premium.  Needless to say, I really wasn't surprised to see our major indices tack on from 4-6% last week.  Call it manipulation, coincidence, or even another round of TARP for the financials if you like, but the bottom line is that many financial companies were able to make/save a BOATLOAD of money.
Knowing this, it's difficult for me to give the bulls their due in assessing the technical health of this rally.  I'm very skeptical.  Some parts of it look for real.  It's hard to ignore the huge rally of semiconductors as they tend to be a leading indicator of economic activity.  Check out this chart:
S&P 500 9.17.11

Semiconductors broke out on both an absolute and relative basis and I REALLY like to see that.  It's an "under the surface" type of development that can lead to much bullishness in the weeks and months ahead.  But I need to see more.  I rarely take index moves at face value, instead looking for "under the surface" signals to either corroborate or contradict what I'm seeing on the indices.
Happy trading!

- Tom

Tom Bowley
About the author: is the Chief Market Strategist at, where he provides stock market education, guidance, and trading strategies using a unique combination of technical, fundamental, and historical analysis. Tom provides members with four portfolios (Model, Aggressive, Income, and Value), all designed to beat the benchmark S&P 500, and a revolving Watch List of hundreds of companies reporting strong quarterly earnings (must beat both revenue and EPS estimates) and exhibiting technical strength as well. These companies comprise EarningsBeats' annotated Strong Earnings ChartList (SECL), from which Tom trades exclusively. Tom writes a Daily Market Report (DMR) for members to include an executive summary, market outlook, sector/industry watch, and trading ideas. Learn More
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