Sunday, August 23, 2009

Technical Update 32.09

Another week of rallies has put the major averages at new highs for the year. From where I sit, there is limited resistance between 1025 and 1075 on the S&P 500. However, large moves into options expiration Fridays have a tendency to reverse hard the following week (aka. hangover), so caution would be wise. Every step higher the market takes is part of the process I have been watching since late February when I wrote about the possibility of a multi-month rally. Each step of the way I have made observations of clues the market leaves as to it's eventual stopping point. Oftentimes, these observations have led to minor reactions in price, only to be met with further bids and higher prices. Such is still the case, and it demands respect. So while technical observations can prove correct temporarily, price is the ultimate arbiter. Right now the trend in price is up and that is the single most important factor.

I am half expecting a parabolic finish to this rally. Perhaps an enormous gap and run that fails and reverses just as hard as it came. The November-January rally finished like this with an "island" reversal. Perhaps this one will as well.

The last few weeks of August and into Labour Day are typically very quiet. So I would not be overly excited for a big move or a jump in volatility before this period passes.

Below are various measures of market internals. Most are at either multi year bullish extremes or are showing negative divergence relative to their strength earlier in the spring/summer. These are the types of readings one would expect to see prior to a major shift in the markets. But while they are "extreme," they can just as easily become "ridiculous."

The first chart is that of the Put/Call ratio. Lower readings are typically associated with more call buying and thus more bullishness. It is used as a contrary indicator. Friday's trading saw this ratio drop to 0.59, its lowest since late 2007 - when the market began a 20% decline into January of '08.

Next is a chart of the advance/decline ratio. It is calculated by subtracting the total amount of gainers by the total amount of losers on any given day. The blue line is the 50 day moving average of this number. We can see that as the market has been pushing higher in August, it has been doing so with less and less leadership.

Likewise, fewer and fewer stocks have been making new 52 week highs as we push higher - another hint of declining leadership.

The bullish percent index is the percentage of stocks in the "up" phase on their respective "point and figure" charts. Typically, any reading over 80 is thought to be a bullish extreme, while anything under 20 is overly bearish. Back in March, this index registered its lowest reading in the history of the data - since 1987. We are now sitting at the opposite extreme - the highest reading ever, just above 90%.

The following chart shows the percentage of stocks trading above their 50 day simple moving averages. Earlier in the spring, a greater percentage were accomplishing this feat than are now. This is indicative of potential exhaustion in previous market leaders.

Lastly, the NYSE closing TICK data is showing some negative divergence from its previous highs. Traders appear to be shying away from overnight risk. The blue line is a 10 day moving average of the reading.

It is not often that one finds such a synergy between the various market internals. When one does, the odds for a turn in the opposite direction are very high based on my previous experiences. However, being measures of market psychology, most are inclined to ignore them at precisely the time their messages should be heeded.

Have a great week!

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Roger J said...


From many aspects of technical analysis, don't you think this rally is running out both in terms of price and time?

Here are some (additional) factors to consider:

1. VIX forming a huge, declining wedge (bullish pattern). Wedge is running out of time & space. And significant positive divergences.

2. The dollar's corrective pattern is in similar situation as the VIX.

3. If you use E-waves closely, this huge rally (S&P 500) is primary wave 2 (P2). Depending on your count, it could either be ZigZag, double ZZ, or triple ZZ. No matter which one you have, the counts are near the very final stages.

4. A wide range of momentum indicators show strong negative divergences on S&P 500.

5. JNK fails to make new highs -> intermarket negative divergence.

6. Bearish wedges (reverse to that of VIX) are forming in many significant stocks/indices leading the rally. To name some: GS, MS, QQQQ.

7. Bear in China -- the hope of global recovery.

Roger J said...

Here's a very interesting comparison between JPY in 1991 & present USD. Never mind the article, I didn't quite read it and went straight to the charts. They are telling!

Matt Stiles said...

Wow those two charts are eerily similar!

Yes, I do think we're nearing an end. I sold my AIG calls today and was on the bid to increase my index put position. But there is two sides to every trade. The preferred ewave counts you gave are correct. But there are other lower probability counts that could prove correct. Wave X of (C) could just be starting today, for example. This would see a retrace to 950 and new highs again - perhaps to 1050 in September and October.

The VIX is diverging but it is still selling at about a 40% premium to 20 day historical volatility - the largest premium in over 3 years. This means that a Sept/Oct correction is being overwhelmingly expected by options traders. They could be right of course. But they could also be made subject to "the path of maximum frustration." The market could levitate or drift higher for those months and suck the premium out of their options - only to prove them ultimately correct by rolling over in November or December.

The key is to respect the above possibilities while knowing that they are of a lower probability.

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