StockCharts Blogs - ChartWatchers

SAFETY FIRST

It's very easy to get caught up in the euphoria of this market run.  I'd be careful to do that.  Invested Central turned from aggressively optimistic to cautiously bullish in early May and we've maintained that more cautious stance since.  Call us conservative if you'd like.  We view it as a compliment.  After all, if we don't protect our capital, who will?  Does anyone believe the folks on Wall Street have our personal best interests in mind? 

 

As I've mentioned in recent articles, price/volume trends are bullish near-term.  That can be all you need to forge to higher levels.  But we cannot ignore some of the risks associated with the market.  I like to follow the equity only put call ratio ("EOPCR") as an indication of market sentiment.  Currently, the 60 day moving average of the EOPCR is at .59.  Since the CBOE began providing the data, this ratio's lowest 60 day level has been .56.  Low levels mark investor optimism and overconfidence and generally sends red flags flying high.  Take a look at the 6 year weekly chart of the S&P 500 (coming off of the 2000-2002 bear market).  I've plotted the two .56 readings that have occurred:

 

It's important to note that extreme levels of investor optimism doesn't have to send the market plummetting.  It USUALLY suggests that we've simply come too far too soon and that the market could use a pause, or breather if you will.  Those last two readings of .56 that were plotted above didn't have any long-term implications.  Rather, the market rested for awhile after complacency set in.  Once complacency was no longer an issue, the uptrend resumed.  We're still relatively optimistic and bullish the intermediate- to longer-term, though we have lines in the sand should the market begin to fall again.  Everyone should have their battle lines drawn.

 

We're not to that .56 level just yet, but getting closer.  For only the second time since the CBOE has been providing the equity only data, the DAILY equity only put call ratio has been at that .56 level for 10 consecutive days.  I do want to point out that it may take a few weeks of continued optimism for the equity only moving average to hit .56.  So we have to trade what we see.  That means continue thinking long for now with price/volume trends bullish.  If you're nervous about the market at current levels, taking a breather and sitting in cash is not a bad option.  The major point here and in my most recent articles is that while the market remains on a buy signal, we need to view the clouds on the horizon with caution.  There may be a storm brewing in the distance.

 

Happy trading!

OIL ETF BACK ON BUY SIGNAL

In my September 25 article I headlined the fact that the Oil ETF (USO) had generated convincing sell signal, so I think it is appropriate to report that the signal has recently turned to a buy. Below is the chart from the 9/25 article showing the breakdown from the triangle formation that accompanied the sell signal. It still looks good to me, but that breakdown turned out to be a shakeout, a final decline clearing the market of sellers and setting up another advance.

On the next chart you can see how the shakeout lows redefined the lower limits and shape of the triangle. Prices rallied off the shakeout base and broke through the top of the triangle. Prices have also broken through the 200-EMA, so I think this move has a lot of credibility. Of course, I also thought the sell signal was very credible too, but we must change our opinion as the evidence demands.

Gold has also made a decisive break above important overhead resistance. I have been concerned that gold would not be able to do this because a rally in the dollar seemed imminent, but the dollar has failed to rally, and gold has shown its strength. At this point I wonder if the oversold condition of the dollar will lead it to decline even further. The technical expectation for gold at this point is for a pullback toward the recently penetrated resistance, now support.

Stock prices have continued to move higher in spite of broad expectations for a decent correction. Looking at the weekly chart of the S&P 500, we get a longer-term perspective. The price index is headed into an apex where the long-term declining tops line and the top of the ascending wedge pattern converge. It sure looks like a rally stopper to me. The crystal ball says rally top should be in place within a week or two.

Bottom Line: Breakouts in the prices of oil and gold indicate a lack of confidence in the ability of the dollar to rally. Stock prices are approaching long-term resistance, and there is a strong possibility that the rally will finally end. That is not to say that the bull market will be over at that point, but a healthy correction is overdue.

SHORT-TERM RATES AND THE DOLLAR

While there has been a negative correlation between the Dollar and stocks this year, there has been a positive correlation between the Dollar and short-term interest rates. The chart below shows the US Dollar Index ($USD) with the 1-Year Treasury Yield ($UST1Y). Both rose in January-February and then declined from March to October. Notice that stocks declined when these two rose and advanced when these two declined. While correlation is not the same as causation, there is clearly some sort of connection here. Therefore, we should be watching short-term rates for clues on the Dollar. A rise in short-term rates would be positive for the Dollar. Should the negative correlation between stocks and the Dollar hold, a rise in the Dollar would be negative for stocks. Right now, however, both short-term rates and the Dollar remain in clear downtrends, which is currently positive for stocks.

Click this chart for details.

NYSE AD LINE NEARS 2007 HIGH

NYSE ADVANCE-DECLINE LINE NEARS OLD HIGH ... One of our readers asked for a look at the NYSE Advance-Decline line, and this may be a good time to start keeping an eye on it. Chart 7 shows the NYAD nearing a test of its 2007 peak. What's surprising is that the NYAD has retraced nearly its entire downtrend while major market indexes have retraced only half. That's probably good news since the NYAD is viewed as a leading market indicator. One possible concern, however, is that the AD line may meet some resistance near its old high. That's why it's worth keeping a close eye on as its retests its 2007 high.

INTERNET CONNECTION AND DATAFEED UPGRADE REPORTS

Internet Connectivity Upgrade Progress Report:

On Monday night we moved our site traffic off of our old 180 megabit T3 connections and back onto the gigabit Fiber connection.  Later we ran a test of our new automatic failover configuration by physically disconnecting the fiber cable from its router and we saw that our traffic immediately moved back onto the old T3 connections.  We then plugged the fiber cable back in and traffic immediately moved back onto the fiber cable.

This means that we should not have a repeat of last month's site disruptions - at least not because of lost connectivity here at the StockCharts offices.  And that is a very good thing indeed.

(BTW, we have ordered a second gigabit fiber connection to replace the T3s as a backup circuit.  That second fiber circuit should be in place by the end of the year.)

Datafeed Upgrade Progress Report:

On the data feed side of things, we continue to have a frustratingly high number of issues with our ThomsonReuters datafeed.  The good news is that because we now also have the IDC/Comstock datafeed, the problems with the Thomson feed have not been as disruptive as they might otherwise have been.

For example on Thursday morning, completely out of the blue, the Thomson feed stopped providing us with US stock information as well as with delayed Canadian information.  If we had not had the IDC/Comstock datafeed here, we would have been unable to provide charts of US stocks at all.  The IDC feed saved us from disaster.

We are continuing to move more and more of our data traffic away from the Thomson feed because of these problems but the process takes time - among other things, we need permission from the numerous exchanges as we move the various indexes across.

Our goal is to have the ability to use either the Thomson or IDC feeds for all ticker symbols that we track.  When we get to that point, a failure of one feed shouldn't disable our charts.  Right now, we have that kind of redundancy for US stocks and may common indexes.  We are working on getting that same level of redundancy for all of our symbols and hope to have that in place by the end of the year.

TECHNICAL ANALYSIS 101 - PART 14

This is the next part of a series of articles about Technical Analysis from a new course we're developing. If you are new to charting, these articles will give you the "big picture" behind the charts on our site. if you are an "old hand", these articles will help ensure you haven't "strayed too far" from the basics. Enjoy! 

(Click here to see the entire series.)

Fibonacci Lines

How high is "too high?" How low is "too low?" Think back to any time that you've owned a stock and think about when you started to get worried about it's performance. At what point did "your gut" start to tell you that you needed to sell? Chances are your gut started talking to you after the stock had moved up (or down) by 38.2%.

Wow, that's a really specific number - "38.2." It seems kind of arbitrary also. There's no way that could be correct, right? I mean, without knowing anything about the stock you were trading, or the amount of money involved, or the overall market conditions, or anything else - how can we stand here and tell you that you got nervous right at 38.2%?

The reason is because 38.2 appears to be programmed into the human psyche (as well as many other parts of nature). 38.2 is one of a set of numbers called "Fibonacci Percentages." They are derived from the "Fibonacci Sequence" which is a list of numbers where each number equals the sum of the previous two. i.e.,

1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610 etc.

The branching in trees, arrangement of leaves on a stem, the flowering of artichoke, an uncurling fern and the arrangement of a pine cone - all these things exhibit Fibonacci characteristics . In addition, if you take any large Fibonacci number and divide it by the previous number, you'll get something very close to 1.6180339887 (the larger the number, the closer you'll get). Now, 1.6180... has been known for centuries as "The Golden Ratio" - mostly because we humans tend to prefer things - art, sculptor, architecture, etc. - that have proportions that equal the Golden Ratio.

Which of these picture looks the most "natural" to you? The middle one has Golden Ratio proportions.

Getting back to stock charting, R.N. Elliott made the first well-known connection between price movements and the Golden Ratio. He noted that many reversals occurred around 61.8% or its compliment 38.2% (i.e., 100 - 61.8). Combined with 50% and 100%, they make up the standard set of Fibonacci Percentages.

Regardless of how the numbers were arrived at, chart analysts have observed that prices often will reverse after moving up (or down) by one of those percentages. Basically, those percentages are where something tells many people that it is time to take action - and thus prices reverse. Strange but true. Check it out:

The Fibonacci Lines on this chart were created based on the move from Feb. 9th to May 30th - so just focus on the shaded blue area of the chart. Like a weatherman, the lines "forecast" that support for IBM would occur around 118.35 essentially because lots of people would probably feel that IBM had "fallen enough" and would start buying it again. That is precisely what happened at the end of June (red arrows).

Unfortunately many people have gone on to claim that Fibonacci lines (and their variants) have almost "magical powers" to predict price movements. Like most Technical Analysis tools, we think Fibonacci Lines are useful forecasting tools - but not magical.

You can add Fibonacci Lines to your charts using our ChartNotes annotation tool. To get started, simply click on the "Annotation" link below any SharpCharts.

Power Tip:  If you hold down "CTRL" while drawing Fibonacci lines, we'll add the 23.6% and 161.8% lines as well.

Next time: Gaps!

BREAKDOWN IN BOND YIELD MAY BE BAD FOR STOCKS

One of the catalysts behind Thursdays heavy stock selling was the breakdown in Treasury bond yields. The 10-Year T-note yield fell below its July low to the lowest level in more than four months. Bond yields are an indicator of confidence in the economy. When investors are optimistic, they buy stocks and sell Treasuries. That pushes bond yields higher. When they're more pessimistic, they sell stocks and buy Treasuries. That pushes yields lower. So the direction of Treasury bond yields has some bearing on the direction of stocks. That's been especially true over the last two years. The weekly bars in Chart 1 compare the trend of the 10 Year Treasury Note Yield (TNX) to the S&P 500 (green line). At least two things are apparent. One is that bond yields and stocks have usually trended in the same direction. The second is that bond yields have tended to change direction first. Bond yields started dropping during the summer of 2007 several months before stocks peaked. Bond yields started bouncing at the start of 2008 and anticipated a stock rebound that spring. After falling together during the second half of last year, bond yields turned up several months before stocks. Chart 2 shows bond yields turning up in January of this year two months before stocks' March bottom. Bond yields peaked in June, however, and have been weakening since then while stock prices have risen. That "negative intermarket divergence" grew more serious with yesterday's breakdown in yields.

Major Indices Hit Major Resistance and Fail

I've cautioned recently about the risks of being long in the market.  There were too many warning signs.  Yes, the market could have kept its head down and pushed to higher levels.  But that wouldn't have been the healthy way to extend the recent uptrend.  Many of the major indices failed at critical long-term resistance and now must regroup from lower levels as they approach key short-term support levels.  I'm featuring a few key indices/ETFs in order to highlight the importance of the resistance levels tested.  Check these out below:

I used the SPY chart above instead of the S&P 500 in order to reflect the gap resistance present on SPY that doesn't appear on the S&P 500 chart.  Notice how the price of SPY climbed almost exactly to the top of that gap before failing and rolling over to the downside.  Sellers were lined up at that level, knowing full well that a close above gap resistance would likely trigger more short covering and more technical buyers.  The failure on this first test should come as no surprise.  You can also see that the technology-laden NASDAQ and the economically-sensitive transports also failed at key resistance.  Given the recent overbought conditions, negative divergences on the MACD, and complacency readings on the equity only put call ratio, a pullback was very much needed.  In my last article, I indicated the record number of equity calls traded on September 16th and 17th.  Take a look at the NASDAQ 30 day chart below to understand why following this sentiment indicator is so important.  The combination of a very low equity only put call ratio AND the high volume of options traded suggested that an important top was forming, just as it did in early May.  While the top didn't occur exactly on September 16th/17th, the market had little fuel in the tank after the extreme complacency readings that were mentioned two weeks ago.

Many of the red flags that have tormented the market the last few weeks have been eliminated, making it easier for the uptrend to resume.  However, we must all be aware of the fact that the July breakout occurred from much lower levels and that the 50 day SMA may not necessarily hold as support near-term.  A final line in the sand should be drawn at the price level where June highs were eclipsed during the July uptrend.  That's your critical price support level.

Happy trading!

COMPLACENCY IN THE MARKETS

Complacency, complacency and more complacency. While the media worries about a correction in the strong cyclical bull market, they should quite simply be considering whether or not the cyclical bull has indeed topped out and a cyclical bear market has begun. This is the nature of higher prices; market participants tend to extrapolate the present far into the future - and this is what most market participants are doing right now.

To wit, note the CBOE Volatility Index ($VIX) has forged a low at the 23 level after having traded to mind-numbing 80. Where everyone was bearish the broader market at the highs; they are bullish at the lows. But the lows now look to be turning higher once again, and we should see traders start to notice that trendline resistance was in fact given in bullish fashion; we should further note that the weekly stochastic is turning higher from oversold levels once again. In the past, this has increased the probability of a larger market decline than not; so buyers should be beware. The time to have been bullish is past; the time to consider bearish positions is here. Rallies are to be used to put on short positions; not dips to be buyers. There is a distinction; and it is important to one's trading health.

SUPPORT STILL HOLDS CORRECTING PRICES

The market has begun another correction, but so far no serious technical damage has been done. The S&P 500 remains within the grasp of an ascending wedge formation, the dominant feature on the daily chart. On Friday prices hit their lowest level of the correction, but they remained above the support of the 50-EMA and the rising trend line. Next major support is at the 200-EMA.

As regular readers know, it is most likely that prices will break down from the rising wedge pattern, and I am inclined to believe that will happen in this case. Internal conditions for the medium-term are neutral to slightly overbought, and I think the market needs to get medium-term oversold before the correction will end. Also, it is October, and a certain amount of ugliness should be expected. I hear that a number of people are expecting a crash, but I see no evidence that would make me anticipate anything more than a normal correction.

The following Participation Index (PI) chart shows that the short-term market condition is oversold. This could signal a short-term bounce, or the end of the correction. The latter is unlikely because the market needs to get more oversold medium-term before another up leg begins.

Bottom Line: It is very likely that the S&P 500 will break down out of the rising wedge pattern soon. With luck a breakdown will be followed by a healthy correction, but we are in a bull market and I wouldn't bet on anything worse than that.  

TECHNICAL ANALYSIS 101 - PART 13

This is the next part of a series of articles about Technical Analysis from a new course we're developing. If you are new to charting, these articles will give you the "big picture" behind the charts on our site. if you are an "old hand", these articles will help ensure you haven't "strayed too far" from the basics. Enjoy! 

(Click here to see the entire series.)

The Infamous Head and Shoulders Reversal Pattern

One of the most common reversal patterns is the Head and Shoulders pattern. 

This pattern forms in an uptrend and its completion marks a trend reversal.  The pattern contains three successive peaks with the middle peak (head) being the highest and the two outside peaks (shoulders) being lower.  The reaction lows of each peak can be connected to form line of support called a neckline. The top reversal pattern is completed when price breaks below the neckline.

While it is preferable that the left and right shoulders be symmetrical, it is not an absolute requirement. They can be different widths as well as different heights.

It's important to realize that up until the point where prices move back below the level of the left shoulder, things look like a normal, ongoing uptrend.  It is only when the left shoulder's price level is violated that the bulls become fearful and the bears start to smell blood.  The right shoulder forms as the bulls try to reestablish the uptrend and then fail - usually because many of the more skittish investors will take profits at that point.

As the Head and Shoulders top reversal pattern unfolds, volume plays an important role in confirmation.  Buying volume (volume on up days) will slowly translate into selling volume (volume on down days) as the pattern develops.  This is seen when volume that previously expanded on rallies begins to expand on declines and contract on rallies. 

The Head and Shoulders bottom reversal pattern is just the reverse of the top reversal pattern with volume acting as a confirmation. 

As with the Head and Shoulders top reversal pattern, volume action is helpful in confirming the trend reversal.  Volume that was previously expanding on declines begins to expand on rallies and contract on declines as the trend reversal develops.

Traders begin noticing lighter selling volume on the declines and heavier buying volume on the rallies.  This kind of price and volume action is quickly noticed by the market which results in additional buying volume supporting the trend reversal.

A couple of other comments about this pattern:

• Sometimes several left shoulders will form before a true head appears.  Sometimes several right shoulders appear before a true neckline break occurs.
• When a neckline break occurs, the stock will often fall at least as much as the distance from the neckline to the top of the head.
• Head and Shoulder patterns are easy to find but hard to confirm.  Make sure that the pattern is based on real fear/greed and confirmed by volume before acting on it.

Other Reversal Patterns

Many of the technical analysis books out there will go on to talk about several other kinds of reversal patterns - the rounding bottom, the V-reversal, double tops, triple bottoms, and others.  (We have many of them cataloged in our ChartSchool area.)  I'm going to tell you a secret - most of those are just variations of the Head and Shoulders reversal which didn't form "perfectly" for some reason.  For example, the triple top is a Head and Shoulders pattern where the head didn't go above the left shoulder.

The key point here is this - don't worry about what type of reversal is occurring.  Knowing that it's a triple top instead of a H&S top won't make you more money.  Focus on the fact that the chart is telling you that the fear/greed ratio is changing and react accordingly.

Next time, we'll look at the question "how much is too much?"

BREAKDOWN IN BOND YIELD MAY BE BAD FOR STOCKS

One of the catalysts behind Thursdays heavy stock selling was the breakdown in Treasury bond yields. The 10-Year T-note yield fell below its July low to the lowest level in more than four months. Bond yields are an indicator of confidence in the economy. When investors are optimistic, they buy stocks and sell Treasuries. That pushes bond yields higher. When they're more pessimistic, they sell stocks and buy Treasuries. That pushes yields lower. So the direction of Treasury bond yields has some bearing on the direction of stocks. That's been especially true over the last two years. The weekly bars in Chart 1 compare the trend of the 10 Year Treasury Note Yield (TNX) to the S&P 500 (green line). At least two things are apparent. One is that bond yields and stocks have usually trended in the same direction. The second is that bond yields have tended to change direction first. Bond yields started dropping during the summer of 2007 several months before stocks peaked. Bond yields started bouncing at the start of 2008 and anticipated a stock rebound that spring. After falling together during the second half of last year, bond yields turned up several months before stocks. Chart 2 shows bond yields turning up in January of this year two months before stocks' March bottom. Bond yields peaked in June, however, and have been weakening since then while stock prices have risen. That "negative intermarket divergence" grew more serious with yesterday's breakdown in yields.

Chart 1


Charts 2
 

QQQQ Tests the 50-day

With a sharp decline over the last eight days, the Nasdaq 100 ETF (QQQQ) is testing support from the rising 50-day moving average and RSI is testing support around 45-50. QQQQ broke the 50-day moving average briefly in July, but held the 50-day during the May, June, August and September pullbacks. Some bounces were bigger than others, but the moving average held for the most part. A clean break below the 50-day would be negative for the current uptrend.

Click this chart for more details.

The bottom indicator window shows 14-day RSI. Notice the support zone around 45-50. RSI held this support zone in May, June, August and September. Again, the only breach of support occurred in July (red arrow). This also coincided with the breach of the 50-day moving average. With RSI again in this support zone, a momentum test is upon us. Failure to hold this zone would be negative for momentum and possible signal the start of an extended correction.