Yesterday's Big Stock Rally

Yesterday, the Dow Jones Industrial Average rallied to a gain of 379 points. The volume of shares being traded was good but, still less the number of shares that were traded on 2/27; just 6 trading days earlier and on a big down day.

The market supposedly rallied on the CitiBank/Citigroup-leaked news that it was profitable in the first two months of this year. But, let's not forget the Citi had received $45 billion in Federal bailout money. That amount of money is almost equivalent to two years of profits by Citi when things in the world of banking were a lot more rosy. However, the rest the banking system is still in a mess and what has happened to Citigroup isn't necessarily transferable to the rest of the industry.

Caution about this stock market is still seriously warranted. In a bear market, like this one, there is a lot of money sitting on the sidelines just waiting to get in on the ground floor on the slightest sign of a market recovery. Secondly, there is tremendous short trading being done in a downwardly spiraling stock market. Dramatic up days, like yesterday, have a tendency to look better than they really are because there are a lot of "short traders" who are buying up stocks to closeout their positions.

For those who don't know what "short trading" is, it is a strategy of "borrowing" shares of a stock to sell them in the open market with the primary assumption that the stock price of those shares will fall or continue to fall. A profit is achieved when the stock price has fallen significantly and the trader is able to buy back the shares at a lower price and return the borrowed shares, plus interest, to the person or broker they were borrowed from. If a trader "shorts" shares and then those shares rise in price, he or she can sustain heavy losses including interest charges for borrowing the shares.

Yesterday saw heavy trading volumes and a quick snapback in stock prices because much of the trading was done in closing out shorted shares (a trading activity called "short covering") to protect the profits that had been gained from weeks and days of falling stock prices. Further, when prices are seen as jumping, as they did earlier in the day, the sidelined cash starts rushing in to try and take an early advantage of a perceived bottom. Bear markets have a habit of fooling people with big, one-day gains; only to start falling again.

The problem with yesterday is that it was primarily based on the Citi news and not on any broad economic data. Therefore, it was based on a single, uncorrelated fact; or, perhaps, fancy. Before this market really does start to recover, we are are going to have to see if others in the banking industry can make similar claims. Furthermore, in order to confirm a valid turnaround in the stock market, the trading volumes have to be sustained over a period of time. The volumes should be at least 80 percent of the trading volumes that had been seen when the market was falling. If trading volumes fall off in the next two or three days, the market is very likely to continue its trek downward.

Now, I have no crystal ball to say whether or not yesterday was a true bottom in the stock market. I am still of the belief that 4800 on the Dow is a possibility; maybe even lower. While the "early bird may catch the worm," don't ever forget that famous line by Elvis: "Wise men say, fools rush in..." Don't be fooled!