Despite the absolute euphoria pouring out of your TV set, it is important to keep in mind that the strong rally this week is -- so far -- nothing more than an oversold rally. It is very similar to many other such rallies in the past, including the one at the end of October.

The chart of $SPX (Figure 1) shows that at last week's lows, $SPX was nearly 150 $SPX points below its 20-day moving average. At the same time, there were heavy oversold conditions in breadth, put-call ratios, volatility, and so forth. When those conditions combine, an oversold rally is likely to take place.



So, here we are, having rallied about 150 $SPX points since last Friday, and about to run into the declining 20-day moving average. Not only that, but the short-term trend line of this market (red line on chart) is at current levels as well. So, if you can remove the emotion, you can see that so far this rally has proved nothing as far as its staying power or as a possible bottom for the bear market

Admittedly, this has been a strong rally. But even if it overshoots to resistance at $SPX 910-920, it might still be a bear market rally. In order for this to be something more, we would continue to look for the elusive "higher high, higher low" pattern that we did not get earlier in November. Then and only then would we have an intermediate-term buy signal on the $SPX chart. There are other scenarios that might occur, I suppose, but it is quite logical to expect to see this pattern, for it is evident at most major bottoms.



The equity-only put-call ratios are trying to turn bullish again. The standard ratio appears to have done so just yesterday, rolling over enough to be considered a "buy." The weighted ratio isn't quite there yet, but appears to be close to confirming a buy signal as well.



Market breadth was terrible last week, and -- by Thursday's close -- had reached all-time lows in terms of massive oversold conditions. That was greatly responsible for the oversold rally that we've seen since then. That oversold condition has been fully worked off now, and buy signals have been generated.

Volatility indices have collapsed from their all-time high closes of November 20th. That creates a short-term buy signal. Furthermore, the short-term rising trend line of $VIX has been violated (Figure 4), and that is more bullish fuel. The longer-term, more slowly rising trend line is very near today's $VIX close. If $VIX falls and closes below there, that should be even more bullish.



In summary, the current rally is a short-term bear market rally. Such rallies are often very violent, as this one is. We would reclassify the rally as something stronger (i.e., an intermediate-term rally in a bear market) if we see a more constructive pattern on the $SPX chart. Despite the buy signals from the other indicators, it is the $SPX chart that must come around. The entire situation is very similar to what we saw at the end of October. At that time, the $SPX chart did not come around, and the market collapsed. Finally, whether or not last week's lows are the lows of this bear market, we fully expect them to be retested before any sort of bull market could take place.

Lawrence G. McMillan is the author of two best selling books on options, including Options as a Strategic Investment, recognized as essential resources for any serious option trader's library.