BONDS SURGE ON FED STATMENT -- STOCKS GIVE BACK EARLY GAINS -- DIA HITS RESISTANCE -- CONSUMER DISCRETIONARY SPDR FORMS BEARISH ENGLUFING -- USING STOCHRSI -- ENERGY SPDR BECOMES OVERSOLD

FED CUTS RATES ... Today's Market Message was written by Arthur Hill. John Murphy will return tomorrow. - Editor

The Fed cut the federal funds rate and the discount rate by 0.25% each. This is the seventh cut in the federal funds rate since September. At 2%, this key rate is at its lowest level since November 2004. In its policy statement, the Fed noted continuing inflationary risks and hinted at a more neutral monetary stance. Today's Fed action sent bonds higher and rates lower. Chart 1 shows the iShares 20+ Year Bond ETF (TLT) trading down to support from the 200-day moving average and its prior lows. TLT found support just above both. Overall, TLT has been locked in a trading range since December (over four months). Hmm, it seems that bonds moved to a neutral stance well ahead of the Fed. The bulls still own the long-term trend because key support around 90.5 has yet to be broken. Chart 2 shows the 10-Year Note Yield ($TNX) hitting major resistance around 3.9% (39 on the chart). A break above this level is needed to reverse the long-term downtrend in rates.

Chart 1

Chart 2

STOCKS DECLINE AFTER POLICY STATEMENT ... After trading higher most of the day, stocks gave up their gains and moved lower after the Fed's policy statement. Chart 3 shows the Dow moving higher in early trading and then surging above 13000 just after 2PM. The Fed's policy statement came at 2:15PM and the Dow sold off after that. 13000 did not hold long as the Dow declined to its lowest level of the day by the close.

Chart 3

SHOOTING STAR FOR DIA... Chart 4 shows a candlestick chart for the Dow Industrials ETF (DIA). Indecision rules as the ETF formed nine indecisive candlesticks in a row. All nine have small bodies that show little change from open to close. Today's candlestick looks like a shooting star. These are potentially bearish candlestick reversals that form after an advance. Confirmation with further downside is required. The long upper shadow reflects a failed intraday rally. As noted on the intraday chart above, the bulls dominated early trading, but the bears took over by the close to force prices lower.

Chart 4

DIA closed around 128 on 18 April (Friday) and near 128 today (nine days later). There is nothing to show for almost two weeks of trading. Resistance is the reason for this indecision. Resistance around 130 stems from broken support and the falling 200-day moving average. In addition, the Stochastic Oscillator is trading above 80, which marks overbought territory. Upside looks mighty limited from current levels.

XLY AND XLF BATTLE RESISTANCE ... The Consumer Discretionary SPDR (XLY) and the Financial SPDR (XLF) are two of the most important sectors in the stock market. The Consumer Discretionary SPDR represents the most economically sensitive sector. The Financials SPDR represents the banks, brokers and financial system. I noted resistance for DIA above and John has been talking about resistance levels recently. Chart 5 shows the Consumer Discretionary SPDR bottoming in mid April and surging to resistance over the last few days. This resistance zone stems from the February-April highs. After a strong open today, XLY closed sharply lower and formed a big bearish engulfing pattern to reinforce resistance. Chart 6 shows the Financials SPDR stalling near resistance. XLF did not form a big bearish engulfing, but the ETF has a formidable resistance zone of its own. The highs from late February to April mark resistance in this area. After stalling the last three days, the bulls need to find their mettle to force a breakout.

Chart 5

Chart 6

USING STOCHRSI ... StochRSI is the Stochastics formula applied to RSI. Instead of using security prices, the closing values for RSI are inserted into the Stochastic formula. This makes it an indicator of an indicator. Even though both are momentum oscillators bound between zero and 100, the Stochastic Oscillator produces more overbought and oversold readings than RSI. Chart 7 shows IBM with the Stochastic Oscillator becoming overbought numerous times this year. RSI, on the other hand, became overbought only two times, in late February and mid April. In contrast to the Stochastic Oscillator, there were no overbought readings for RSI in March.

Chart 7

The bottom indicator window shows StochRSI, which is much more volatile that both RSI and the Stochastic Oscillator. Applying the Stochastic Oscillator formula turns RSI into a much faster indicator. In addition to numerous overbought readings, there were also oversold readings in early February, late March, early April and mid April. As one of the more volatile oscillators, StochRSI is more in tune with short-term trading than long-term investing. You can click on this chart to see the settings.

IDENTIFYING PULLBACKS WITH STOCHRSI... Sometimes there are strong stocks in strong uptrends that we want to buy. However, catching a fast-moving train can be daunting. Because it is one of the faster moving oscillators, StochRSI can be used to identify short-term pullbacks within bigger uptrends. The energy sector has been a top performer over the last few years. No one knows exactly how long this uptrend will continue, but the big trend is clearly up and this means declines are corrective in nature. Chart 8 shows the Energy SPDR (XLE) with StochRSI. Even though the big trend is up, StochRSI became oversold a number of times over the last six months (below .20).

Chart 8

Oversold in an uptrend is not exactly bullish though. Oversold conditions occur after sustained selling pressure and we need to look for signs that buyers are returning. The midpoint for StochRSI is .50 and this can be used as the bullish or bearish threshold. Momentum favors the bulls when above .50 and the bears when below .50. Therefore, a move into oversold territory followed by a surge above .50 would show that buyers are returning. StochRSI is currently below .20, which signals oversold conditions. These oversold conditions could extend for a few days or a few weeks. Nobody knows for certain. Look for a move above .50 to signal the return of the bulls. You can click on this chart to see the settings. Next week I will talk about using StochRSI with the Market Carpet.