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Market Cracks After Unprecedented Overextension at Trader’s Narrative

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After six trading days wound tight into a narrow trading range, the stock market finally cracked decisively and fell lower. The range, as measured by average daily true range was extremely slim at 16 points (for the S&P 500 index). The range became a razor thin 5 points when we look at the highest and lowest closes.

SPX narrow range breakdown Sept 2009

Of course, we’ve been anticipating this for some time now. We’ve gone over the sentiment data, the seasonality argument as well as the pattern provided by the aftermath of bear markets throughout history.

As well, it was impossible to ignore how incredibly overextended the stock market had gotten. Take for example, the breadth as measured by the percentage of stocks trading above their moving averages. For the S&P 500 index, last week, we had 91.6% above 10 day moving average, 92.6% above 50 day moving average and 94.2% above their long term, 200 day moving average.

And it wasn’t just that index. Pretty much every single proxy for the wider market was stretched to the breaking point. For example the Dow Jones had every single component trading above the 50 and 200 daily moving average. And just one stock from the Dow didn’t manage to close above its 10 day moving average.

Other measures of breadth were also unbelievably extreme. For example, at 81%, the NYSE bullish percent was higher than it had been for at least 22+ years!

NYSE bullish percent index Sept 2009

Even more alarming, looking beneath the numbers, the lowest quality stocks were not only participating in the rally, they were leading the charge.

While the S&P 500 managed to peak over the June highs momentarily, its recent action is reminiscent of mid-June. Then, as now, the index managed to eek out a win over the previous swing high (in early May) and then entered a narrow range. Only to break down lower.

Another interesting observation is that while the S&P 500 index was higher in August, the number of new highs did not continue to expand. Since the spring the recovery was supportive of a higher and an increasing number of stocks were making highs but then the music stopped:

Nasdaq new highs Sept 2009

Lowry’s Intermediate Market Call
A few weeks ago I mentioned an important market call from Lowry Research. While at first Lowry’s intermediate buy signal may have sounded as if they were suggesting their clients to go wildly bullish, that wasn’t the case. They were recommending adding exposure after a correction. And that may be exactly what we are about to see unfold.

The S&P 500 has weak support just above 975 and much stronger support at 875. So those are areas to watch. As well, I’ll be looking at how fast we drop as well as looking for specific stocks that will display relative strength by bucking the general tone of the market.

Here is a recent interview with Tracy Knudsen of Lowry Research in which she further explains their recent market call and delves into their analysis of the market. If you haven’t already, I suggest you listen or read Lowry’s intermediate trend buy signal first and then listen to this newer interview.

To listen, press play and then pause to allow the audio file to completely buffer, then fast forward to the 40 minute mark:

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2 Responses to “Market Cracks After Unprecedented Overextension”  

  1. 1 charliek

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    i have the range at 32 points as being the widest since april 20th, i don’t understand your comment of the day having an “extremely thin” range.

  2. 2 Babak

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    charlie, I’m referring to the previous trading days, the thin range bound trading contained within the red lines in the S&P 500 chart above.

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