From our perspective, this trend needs to be watched closely over the next few weeks as a dramatic change in the 50-day’s “slope” could lead to a tipping point for the market.  In addition to the 50-day trend, the market should watch for support at the 1,340 level (green horizontal line) which represents the March lows.  A break below this level for more than a day or two will draw more technical sellers into the market.

Typically, spikes in volatility occur when the market makes a quick, sharp, unexpected move.  The corresponding spike in volatility is usually the result of options traders rushing to buy options as protection for their portfolios.  It has been our experience that a very quick, spike in volatility can turn into a quick buying opportunity as the market can often “over correct” itself.  For example, the VIX spiked higher in early March as the S&P 500 made a quick move lower.  The spike was quickly followed by a five percent rally in the SPX.

On the other hand, there are shifts in the volatility trend.  These occur when the VIX, or other volatility measures, begin to trend higher instead of spiking.  As with the market indices, the VIX’s trends can be judged by its trendlines.  From a short-term trader’s perspective, the 20-day moving average helps to gauge the VIX trend.  For a longer-term investor’s perspective, the 50-day moving average offers a gauge of where the VIX is trending, higher or lower.

As of this week, the 20-day trendline of the VIX is on the rise while the 50-day is in a potential transition from a declining (bullish) pattern.  A shift in the 50-day trendline will count as another reason to stay clear of further buying as an increase in selling pressure will be likely to follow.  Charts of the VIX with both the 20- and 50-day moving averages are below.

The short-term trend in the VIX has served well to uncover the current market volatility.  The intermediate-term trend has yet to provide a decisive trend, suggesting that the market may be able to pull itself from its recent weakness.  A bullish catalyst such as resolution in Greece or some positive economic data here in the US would serve to act as a catalyst to reverse the short-term VIX trend back into a bullish decline.  Unless this happens, we’re witnessing a shift in volatility that will increase the bearish implications for equities.

A short squeeze occurs when a highly shorted stock begins to move higher, putting pressure on the short sellers as they still have a liability to repay the shares they’ve borrowed.  For this reason, it is wise to watch for the signs of a potential short squeeze as they build.

The table below identifies ten companies and exchange traded funds (ETFs) that represent excellent short squeeze rally potential.  Each stock or ETF is a highly shorted issue, currently trading above their respective 50-day moving averages.  To increase the odds of finding short squeeze candidates, we filtered our short interest database further to include only companies whose 50-day moving average is trending higher.  This sign of technical strength means that the short sellers that have sold into strength, a counterintuitive move that strengthens the contrarian implications of the short interest.

As with many market-based situations , there is more than one way to gauge a breakout for an ETF.  The simplest method is to view the price chart to identify is an ETF is making a new 3-, 6- or 12-month high.  From our perspective, this approach leaves something to be desired though as an ETF’s moves are based on the sum of their parts, the component companies.  For this reason, we like to track the trends of the component companies to help determine where the strong breakouts are ocurring.

In Short, an ETF’s breakout performance is strengthened when there is a larger percent of the component companies breaking to new period highs.  We find that it is good to track the number of three-, six and 12-month highs to give a short- intermediate- and long-term perspective of this data.  THe higher the percent of companies breaking to new period highs the better.

Applying this approach to current market data, there are a few sectors that investors should find of particular interest for continued breakout candidates.  The table below displays the top ten breakout ETFs based on their current component company 6-month new highs.  The six-month timeframe gives a great representation of the intermediate-term strength of the rallies in these ETFs.

With more than 50 percent of its compnent companies forging on to new 6-month highs, the iShares Dow Jones U.S. Real Estate Index Fund ETF (IYR) is driving to strong highs as the ETF itself is breaking to new 12-month highs.  In addition to the New High analysis, the price chart for the IYR shares is further evidence of its potential to remain a relative strength leader in the current market rally.  The daily IYR chart (pictured below) strikes a similarity to the late-December price activity as the shares surged forwards along their top Bollinger Band.  We’re expecting to see an acceleration in the upside momentum of the IYR shares given the current price activity.

Finally, for those asking, another aspect of our New High analysis is that it allows us to zero in on the companies that are breaking to new highs among the sector or ETF.  The table below displays the 43 IYR component companies that are pressing to new six-month highs along with each company’s current price, short interest ratio and analyst recommendations.  the sentiment data is useful as companies moving to new highs are more likely to initiat short squeeze rallies and analyst upgrades.

The table to the right displays the returns for the two periods in question (May – October & November– April) for each year since 1990.  Clearly, the bottom line averages work to support the notion that selling in May has credibility as a strategy that may help to beat market returns, though there’s a simple way to improve this strategy.

Any investor that has heard the “Sell in May” rule has likely also heard of the comparatively simple rule, “The Trend is Your Friend”, the notion that you should hold stocks when the market’s averages are trending higher.  By combining these two simple rules, the results of “Sell in May” improve dramatically.

For the purpose of this study, we determined whether the trend was the market’s friend based on whether or not the S&P 500 was trading above its 20-month moving average.  This same evaluation is often used as the measure of whether or not the market is in a bull market or not (SPX above its 20-month = bull market).  If the SPX was above this trendline then we stayed in the market through the May through October period and if below we sold in May.  In fairness, we extended the same rule to the November through April period to determine the effect of the “Trend” rule on both periods.

Bottom line, combining the two rules increased the May through October returns from 0.9% to 3.9%, a marked improvement and certainly a move in the market that is worth participating in.  Not surprisingly, the November through April period’s returns also improved from 6.8% to 8.4% when the “Trend Rule” was overlaid.

With the S&P 500 currently trading well above its 20-month moving average (chart below), the historical results of the “Sell in May” and ”Trend is Your Friend” combination suggests that the market may be able to break investor’s expectations as we’ve certainly seen a lot of ballyhooing about this age-old rule as May approaches.  This could be another situation where the market’s expectations could be dashed.

The table to the right displays the S&P 500 companies that broke above their respective 50-day moving averages as of Friday’s close.  Of these companies, nine of them have moved back above 50-day trendlines that are trending higher, indicating that they are picking up on a positive trend after a short break.  Among these names are Cerner (CERN), W. W. Grainger (GWW) and Zimmer Holdings (ZMH).  These are just a few of the names that we’re expecting to see short-term strength from as the market heads into May.

With that in mind, we thought it was time to look at some relative-strength leaders in the S&P 500 Index. The table below displays the top 20 S&P 500 relative-strength-leading companies, based on their respective three-month performance compared to the S&P 500 Index (a/k/a relative strength).

On its own, this list is typically a good place to start when looking for bullish trades, but for the purposes of leveraging the rally, there are a few other criteria we like to use to find companies with a little more potential to slingshot higher. For this, we filter the relative strength list to find companies that are currently trading just above (within one percent) their 50-day moving average and with a 20-day moving average that is above their 50-day moving average, one sign of a positive technical trend.

This filters the relative-strength leaders down to companies that are poised to benefit from a bounce off their 50-day, usually a nice boost for a short-term rally.

Priceline .com Inc (NASDAQ:PCLN): Travel-related company Priceline.com continues to benefit from a strong technical pattern as the stock is one of those few that has been driving to new all-time highs on a monthly basis through 2012. The latest pullback in the market knocked the stock down to its 50-day moving average (the stock tested this trendline yesterday).

The successful test of the 50-day should serve as a “buy signal” for this high-flyer as the technical traders will start increasing their holdings in this relative-strength leader. No one likes buying a $700 stock, so this is a situation where options will offer an opportunity to leverage a move and participate in a move with less capital.

Visa Inc (NYSE: V):Visa has spent the last two months consolidating at $120 and appears ready to break through to new highs. The consumer-related company will benefit from any improvements in the economy as consumer’s charge back into their buying habits. The stock’s rising 50-day moving average should help usher Visa higher, allowing the stock to break above the $122 level.

Options traders are picking-up the activity on the June 120 Calls. These at-the-money options are trading for just over $4 and provide leverage for a portfolio when the stock takes out its recent highs.

Limited Inc (NYSE: LTD): Historically, the retail sector and its component companies lead the market higher during economic recoveries.  The outperformance is driven by the return of consumer activities after a period of rest. We’ve seen the Retail ETF (NYSE: XRT) emerge as a great leader for the last six months, driven by performance of companies like Limited Inc.

Limited shares just bounced off of the $48 level as they’ve spent the last month consolidating above the 50-day moving average. We expect the shares to break back to the $50 level and higher in the near-term future.

For the most part, these returns suggest that we may be due for some short-term buying with the S&P 500 trading higher 60 percent of the time for an average of about four percent a month after these signals.

Those of us that watch the VIX know that some of these signals are likely to have been little more than short-term bounces that ultimately wound-up reversing, but traders should still be able to navigate some profits from the short-term snap.

The catch, because there’s always a catch…  Tuesday’s trading took the S&P 500 below its 50-day moving average, making it three of four of the major indices to close below their respective 50-day trendlines (The Nasdaq Composite being the only above its 50-day).  We view, as does much of the market, the 50-day moving average as the best barometer of intermediate-term technical health.  So the catch is that the we need to see the S&P 500 move back above its 50-day moving average, currently sitting at 1,373, to confirm the bullish VIX signal.  We expect to see this confirmation or rejection over the next two days, so get your trades ready.

To date, the S&P 500 is up almost five percent from the December 31 close as better-than-expected economic data here in the United States has helped fuel some optimism from investors while the news from Europe has been less urgent as Greece continues to work to avoid what could be the first default among the EU countries.

Putting the strong performance aside, the SPX has now hit what would be a natural resting place as the benchmark index moved above the psychologically significant 1,300 level last week.  Typically, crosses above round-numbered levels like this serve as a convenient checkpoint for investors that can cause them to take profits, especially when the level of uncertainty in the market is high, as it is now.  The simple rule here is the more zeros the more potential resistance.

I mentioned the seasonally weak week above so let’s look at this phenomenon that may take hold of the market this week.  In reviewing the S&P’s performance in comparison to historical averages an interesting trend in the weekly SPX performance surfaced.  Looking at the weekly performance for the S&P 500 since 1950, the index posts positive returns an average of 57% of the time through the first five weeks of the year.  Over that time period, the least successful week of the year is the fourth which is only positive 52% of the time.  These figures support the strong January seasonality that we are all accustomed to, but there’s a twist.

When the look back period is shortened to the last twenty years (since 1990) the results change dramatically.  Since 1990, the fourth week of the year posts positive returns only 39% of the time highlighted in red in the table below).  Looking closely at the performance of those fourth week returns reveals that when the market is lower for the fourth week it’s typically down an average of -2.2 percent.

In addition to the weekly seasonality, the S&P 500 and other indices are teetering on technically overbought situations, as indicated by their respective short-term Relative Strength Index readings.  The current RSI for the SPX is slightly higher than 70, a reading that the indicator has only seen a total of four times over the last year (indicated in the chart below).

 The previous three instances of overbought conditions for the S&P 500 resulted in drops of the index by an average of 3.5% in a matter of days.

While there are many groups of stocks that are high on my bullish radar screen right now it makes a good deal of sense to take this same research to the stock level to find potential opportunities in the current market.  That in mind, today we’re taking a look at the stocks in the S&P 500 that have seen golden crosses in 2012.

Scanning the entire S&P 500 index, I found only 23 stocks that have formed a golden cross pattern in 2012, suggesting that they are likely to see a continuation of their bullish trends.  While the technicals make for an attractive trade, I wanted to whittle the group down even further.

Given the popularity of dividend yielding stocks, the search concentrated on stocks with healthy dividend yields, knocking 23 stocks down to about 13.  Finally, I added my unique research approach of evaluating sentiment on each stock to narrow our search down to stocks that are under-loved by Wall Street, despite their strong performance.  The reason for this is that these stocks have a higher chance of seeing upgrades as analysts and short sellers start to buy into the already-formed positive trend.

The following three stocks are among the eight stocks that have yields that are better than the current S&P 500 yield of 1.91%, though that is likely to be only a small portion of the gains that you may get from these stocks over the next six months if their charts are any indication of where these stocks may go.

People’s United Financial (PBCT): Regional bank stocks have been one of my favorite areas of the market as investors are starting to realize that being too big to fail may not be as good as it sounds.  Regional banks have been able to spend their time focusing on their businesses instead of potential legislation that could be coming in 2012.

Currently, 74% of the analysts covering the stock rate it a “hold”, despite the fact that this stock has outperformed the market and that the company has been able to meet or beat earnings expectations every quarter over the last year.  PBCT announces earnings on Thursday, January 19.  Another successful earnings report will get the analyst community off of the sidelines on the stock, resulting in upgrades.

Finally, this regional bank currently pays a 4.6% dividend on top of the stock’s performance.  All of these factors make PBCT an attractive intermediate-term play on the financials.

Paychex (PAYX): Investors are starting to take note of the improvements to the employment market, which is one of the reasons that PAYX has been outperforming the market lately.  The stock formed a Golden Cross last week, making it a candidate for strong performance moving forward.

The current dividend of $1.28 means that the stock’s dividend yield is an attractive 4.1%, about double the S&P 500’s dividend yield.

Like PBCT, PAYX has been more-or-less ignored by the analyst community as 70% of the current recommendations on the stock are in the “hold” category.  I love the potential for this stock as the analysts will likely upgrade their outlook on the stock as the fundamental and technical picture for PAYX continues to improve.

Nucor Corp. (NUE): Basic material companies spent the second-half of 2011 getting beaten-up as expectations for global growth continued to slide.  While there hasn’t been an improvement in the economic outlook, the basic material stocks have clearly put in a technical bottom and are now in some strong bullish trends.

NUE is moving to new 52-week highs helping the stock form its golden cross pattern last week.  The last golden cross for NUE occurred in January, 2011, just before a nine percent jump in its price in just over a month.

The stock will announce its quarterly earnings results in a week, providing a potential catalyst for a move higher.  Looking back, the last four quarter’s results have been better than analyst expectations.  A positive quarter of earnings is likely to provide investors with a catalyst to buy this trend-setting stock.