Non-Confirmation in Major Stock Indexes - What to Expect Next

Stock Market Update 12-12-13  Non-Confirmation in Major Stock Indexes - What to Expect Next This stock market update video covers the DIA etf abd shows a bollinger band set-up that indicates that the market is likely to experience at least another day or so to the downside before reaching its nearby fibonacci support level. However, there is a significant non-confirmation between the market indexes in that only the Nasdaq reached a higher high for the rally into Dec 9th. The Dow, S&P 500, Russell 2000, and NYSE all topped lower than there Nov 29th highs. This may be an indication that the stock market is topping on the current leg up, and that stock may experience a correction from these levels. A typical correction is ~10-11% and 6 weeks duration based on historical corrections in the S&P 500.

Wednesday Is a Key Reversal Day - Top Warning

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This chart is the Nasdaq 100, QQQ, and is a daily chart of prices.  Wednesday the stock indexes formed wide ranging bearish engulfing patterns which is a top reversal candlestick pattern where the price gaps up and then closes back below the opening price of the prior day.

In this case there was considerable range expansion with a higher high and a lower low in addition to a substantially lower close.  So this also forms a traditional "key reversal" day in bar chart terms.  Given the technically extended nature of this rally, the length of the rally being longer than median historical legs up, extreme "smart money" commercial futures short position, and multiple signs of historically surging "dumb money" into stocks of late, I think we need to pay special attention to this reversal and any possible subsequent failed breakout above it.

The gap up from 5/3/13 would be a first target on a continued decline from these levels.  A move down to fill that gap would make the current decline larger than any decline in this uptrend since November, so that would warn of a larger correction being in force.

Sentimentrader.com reports that over the last few sessions the ratio of bullish to bearish funds in Rydex funds has risen to historical extremes and that total leveraged bullish funds are greater than 6 times the amount of bearish funds.  The Nasdaq and Russell 2000 bullish funds are 14 times greater than bearish funds.  This is significant in that from 2007 to 2010 the ratio had run around 1-2, with occasional spikes to the 6-10 level at  significant market peaks in the 2011 to 2013 time frame.  But now we see a big surge higher which is clearly a dumb money surge into stocks now that the indexes are basically at new highs.

At highs it will feel like the market is likely to continue to rise and the lay person and average investor who has been on the sidelines will now be overpowered emotionally and finally act on putting money into the markets if they had been unsure before.  If you think about someone considering whether or not to put funds in the market, and not really following a systematic strategy, what is it that separates the moment of action from the long period of consideration and inaction before it??  It is an emotionally driven trigger that reaches a threshold and spurs one into action.  But unfortunately it is very untimely for the typical investor.

So time will tell what significance this current level holds in the markets, but one of my main goals in this blog has always been to highlight times when it is wise to take protective action or sell stocks.  In my experience both with my own development as a trader and working with other traders, it is not that difficult to find decent to good entry/buy points in stocks.  And most investors really only think deeply on the buy side.  But understanding when to sell, take profits, or rotate portfolio funds into a protective asset, are much more difficult for investors.

Much of this has to do with the different nature of market tops and bottoms.  The emotional nature of tops is often a drawn out complacency that leads to churning  action and lengthy periods of low volatility.  But at bottoms, brief periods of high volatility, spike lows, or spike followed by sharp retests are the norm, which may make them more recognizable and precisely timed.

So to be clear, I view this as one time where risk is high for a decline in stocks.  For some that may mean to look for short trading set-ups.  For others it may mean to take action, or partial action, NOW on stock investments rather than waiting for the eventual price movement lower to convince you.

The price move up since the mid April 2013 low has been dramatic, especially if you compare it to the average volatility during the period, or even the peak volatility on April 18th.  It has obviously brought the dumb money in, and in the face of persistently historic short positions by commercial stock index futures traders.  When the dumb money public is pouring it into the markets, and the most informed hedgers in the world are shorting the heck out of it, is NOT the time when you want to be buying stocks in for sure.  You either want to be getting out (possibly "early") or have a concrete exit or rotation strategy in place.

This chart shows the VIX (implied volatility index).  It typically falls as the market rises but at major turns it will tend to not confirm the price movement in stocks.  Currently we are seeing such a non-confirmation, and on a large scale.  Volatility has not moved below its March trough despite broad strength in stocks and extreme vertical price movement to new all time highs over the last 5 weeks.  The divergence is both sharp and of long duration compared to other such patterns at the highs of recent legs up in stocks.  Basically all tops of legs up going back to 2010 have displayed at least a minor non-confirmation pattern between the VIX and stocks.  So the current VIX pattern is typical of a topping market, and the size and angle of the divergence suggests to me that we could see a sharp rise in volatility as this high in stocks completes.

This is just an added evidence to help understand the underlying market sentiment.

Commodity Producer Stocks to Fall - Australia, Canada, Etc.

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Hopefully this will be followed up with a video, but the currencies have been not confirming the strength in stocks of Australia and Canada.  Additionally, the US Dollar has not been weak as expected with the current US market strength.  The charts above show that when the currency to stock ratio becomes extreme as indicated by the Bollinger band configuration above, inflection points are typically near.

So expect a correction in these markets.  Additionally there is daily time frame technical divergence coupled with over zealous bullish sentiment (historically so by several measures).  So the picture fits for a correction.

Non-Confirmation of Nasdaq and S&P 500/Dow.....Which Side Will Win?

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There are several things probably worth showing today, but I am going to limit it to the 2 charts above. The most important is the top chart which shows the S&P 500 in the upper pane and the QQQQ/Nasdaq in the lower pane. The important thing was that yesterday the Nasdaq made a new high for the rally but the S&P, Dow, and Russell did not. This is called a non confirmation where some indexes do not confirm the new high (or new low) in other indexes. The key thing here is that this particular occurrence has happened at every major turn down from the 2007 bull market high to the bear market bottom to date. The chart above shows the non-confirmations at every bear market rally since 2007. So while price is in bullish configuration relative to moving averages, it would take the other indexes making and holding new highs to really be technically convincing that this rally will/may continue.

The lower chart shows a 60 min MACD of the S&P 500. It has just made a bearish cross. If you looked at lower time frames you would see bearish divergence on the 30, 15, and 5 minute time frames. Also there is minor divergence on the 60 min stochastics. From that perspective, this appears to be a good time to consider bearish trade if not already positioned. For the blog we are already positioned, so please don't average down unless that was allowed in your orignal money management plan when entering the current trade. A stop should go at a level corresponding to yesterday's highs or at the June highs depending on how loose or tight is comfortable.

For interested chartists the Russell ($RUT or IWM) Index is showing a nice head and shoulders pattern currently. I have a suspicion of what is occurring in the other indexes, but at this point, we have to see major price declines in the next 2 weeks to confirm a top. After the June highs, the S&P never made a faster retracement than the previous rally. That is the kind of action that really tells you that the psychology has shifted, and it is the kind of thing that will need to happen if the market is indeed making its last gasp this week.

Pete

Looking For Stocks Not Confirming New Highs in the Broad Market

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I thought I'd take a little break from the broad market averages today since it is just a little waiting game on that front now as far as blog trades go. Instead I'll talk about a subject I mentioned back in early January.

Whenever a rally in the stock market is maturing and breaks out to new highs like today, I like to look for stocks that are not confirming that breakout. These stocks may be weak and lead the market down when a correction starts again. I think this is also a sign of a market topping, when you see significant numbers of stocks failing to make new highs with the market.

There is a specific pattern that I look for when analyzing the charts and considering a trade on stocks that are not confirming the breakout. The pattern is a vertical decline off the recent highs followed by an orderly ABC type correction back up toward the highs as the broad averages break to new highs. The chart above is CAM which is an oil field service stock that I have followed for several years and traded a few times, and it is showing exactly the type of pattern I look for.

This chart is a 30 minute chart and comprised of the last few weeks of action. I will not go into detail on the chart since you can look at it yourself, but I will highlight the cluster of resistance in the 24.60 area. That is the area of the initial unfilled breakaway gap down off the high a couple weeks ago, and a high there for this pattern would complete a Gartley pattern ABC correction which I consider very aesthetically pleasing to look at from a trading standpoint.

Here's what I would look for to trade this......I would like to see one more high above today's high which shows bearish divergence on the MACD 15 or 30 minute charts. Then either enter short immediately at that point with a stop at 25.60 (above the high of the entire pattern), or wait for the green trendline (of wave C) to be broken, and enter at that point. If using the second entry strategy, you could move the stop down to the highest point of wave C to get a better potential risk and reward ratio.

For exit, the larger pattern is suggestive of a move down to the 19.00 level within about 2 weeks time, but I would try to get a minimum of 3:1 reward on risk as defined by your entry price and stop loss.