During the past two weeks, investors have rallied the stock market following a period of heavy distribution during the preceding two weeks. Judging from trader comments, there seems to be a considerable amount of bullish sentiment, and the sense that we’ll again see new yearly highs very soon. Here is a look at the daily chart for SPY:

While the market may be on its way to new highs once again, several factors signal caution going into the middle of this week’s trading. First, the McClellan Oscillator shows us to be well into overbought territory. Odds favor more consolidation, or a correction phase.

Several emerging market ETFs are also appearing less-than-bullish. FXI, the China ETF, looks particularly vulnerable. Price is sitting below the 50 and 200 day moving averages, with a bearish cross imminent. We have a rounded top pattern, and price failing (so far) to make a new high during 2010. Should the overall market show signs of selling off, I will be looking to short FXI.

For EEM, the emerging markets ETF, price is struggling with the 200 day moving average, although it has support in the 37.00 area. The orientation looks to be sideways or down from here.

For the India ETF, IFN, the yearly high occurred last June. The action is still sideways for now, but appears to be turning lower.

Looking at EWZ, the Brazil ETF, we see price bounced off the 200 day moving average after having dropped from around 78.00 to around 60.00. Price is now hitting the 50 day moving average on decreasing volume. Odds favor a retest of the 200 day moving average.

Equity traders should also consider recent action and news in the currency market. With the US Federal Reserve raising the discount rate, and signaling an end to quantitative easing, the US Dollar looks to continue its intermediate trend higher. The Eurozone faces mounting problems in Greece, Spain, Portugal, and Ireland, which will almost certainly lead to further pressure on the Euro.

From a technical analysis perspective, the Japanese Yen looks ready to strengthen in the intermediate term future. Bear in mind that Dollar and Yen strength can signal lowering risk appetite, which is bearish for stocks. Looking at the EURJPY pair, we can see that Euro has retraced underneath its breakdown level around 127.00, but appears to be losing steam.

- CHFJPY looks essentially the same as EURJPY, and is hitting resistance.

- GBPJPY has not yet broken key support around 138.50, but looks headed in that direction.

I am shorting strength in each of these pairs and scaling into healthy short positions in each case.

There are still quite a good number of bullish setups in stocks (I am currently long CAAS, APL, FNSR, SIRO, and NEWN). In any case, I will be proceeding with caution levels raised.

In yesterday’s sector overview I commented that several sectors still appeared technically bullish despite last week’s heavy selling. After today, I don’t see anything that looks bullish on the equity side. Later this evening I will be scanning for short setups, and will try to post them before the open tomorrow.

The forex market is confirming the bearish environment for stocks, as money flows into the US Dollar and Japanese Yen. The Dollar and Yen each broke through important support/resistance levels against other major currencies, promising further strength to come. Check out these currency pairs, and the important technical breaches that occurred today (I will be shorting strength in any of these pairs):

- EUR/JPY actually broke major support last week, and had a major confirming move today.

- AUD/JPY broke down decisively through the 200 day moving average today.

- CHF/JPY looks like EUR/JPY, but a week later.

- AUD/USD found some support at the 200 day moving average, but looks set to head lower.

- GBP/USD looks to be in the process of breaking key support.

Looking at equities, it was selling across the board today. Yesterday I noted the bearish setup FXI. The China ETF sold off today on huge volume, promising more downside to come.

- XLI: Yesterday I said this one was holding up well. Today it is on the verge of falling off a cliff. This looks like a good short below today’s low.

- XLF: Still above the 200 day moving average, but for how long?

I am holding short positions in JPM and PFG, and a long position FXP, all from this morning. For the most part I was caught up trading the forex market, and then kitesurfing. Tomorrow I plan to be more prepared for equity trading, so check back for more short picks. For now, here are the JPM and PFG charts.

After today’s trend day higher, investors may continue to look for bargains through the middle of this week. Certainly the market’s nature has changed during the past two weeks, with many trading days characterized by sustained distribution and an absence of dip buyers.

Today we are getting some news that Senator Dodd wants to water down President Obama’s bank proposals. The President’s newly aggressive stance on banks (which I support) was a catalyst for the current bearish cycle, as investors worried about the impact of trading restrictions and potential loss of liquidity in the equity markets. Considering Wall Street’s influence in Congress, we should see some pushback, which in turn could instigate an oversold bounce.

All the same, I will consider any bounce to be a dead cat, until I see indications to the contrary. Meanwhile, a number of stocks have held up through the recent carnage. I will be focusing some attention on stocks with high short interest, considering that squeezed shorts will provide much of the fuel for the next rally.

- IMAX

- REXX

- CAGC: I will be looking for a clear break of the downtrend.

- CAAS: Today’s low provides a good place for a stop loss.

- COCO: We are seeing some accumulation coming off this base near the lows. High short interest.

- VLO looks ready to break out.

The forex market is serving up some interesting charts, with several currency pairs trading near key technical levels. Here are three pairs I am watching most closely:

- EUR/JPY: JPY has been strengthening against most major currency, with the exception of the Dollar. The Euro, on the other hand, is under pressure as the EMU struggles with debt issues in Greece and potential problems elsewhere. From April 2009 until last month, EUR/JPY bounced several times off of the 127.00, creating a clear support/resistance level. EUR/JPY made a clear break below that line during the last week, and looks likely to test the 122.50 area.

- CHF/JPY: A very similar pattern to EUR/JPY, but the pair is trading above support.

- AUD/USD is trading sideways, and close to breaking support near .8727. The RBA just announced that there will be no rate change (a .25 raise was expected), and AUD sold off in reaction. A breach of support appears likely.

Bear in mind that an oversold rally in the stock market could reverse short-term forex trends, at least temporarily. Specifically, with rallying stock market, traders will be more likely to sell USD and JPY. Given the overall technical picture, I would expect any such reversals to be short-lived.