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Market Treads Water As New Highs Crumble at Trader’s Narrative

A few days ago I mentioned that the market is setting up for a correction in the short term. Since then the market has been going sideways but the S&P 500 index also printed a very bearish upside down hammer candlestick on Monday.

Today I wanted to take a look at the market internals through the lens of the ratio of new 52 week highs to new 52 week lows. The chart below compares the Nasdaq High/Low ratio (to avoid the NYSE breadth data) with the S&P 500 index:

Nasdaq new high low ratio SPX chart Oct 2010

The normal pattern is to see the number of new highs relative to new lows increase as the market is rallying and for the ratio to decrease as the market falls. This makes sense since the more stocks rally, the more we are going to see them make new 52 week highs and less 52 week lows as they are lifted off the floor by bids.

Of course, spikes in either extreme for the ratio also signal major inflection points. I’ve drawn a few of the recent ‘top’ extremes in red circles.

But right now we are seeing the ratio of new highs to new lows decline, even as the market has been continuing to move slightly higher. That is unusual. It is a sign of a lack of a wide participation by the Nasdaq component stocks. And eventually, it will mean that there are less and less leaders championing the market’s move higher.

In recent times we saw a similar pattern in March 2010. The ratio fell, even as the market itself climbed into April 2010. But eventually, the number of new highs spiked higher, catching up with the S&P 500 index and marked the intermediate top.

The S&P 500 index’s cumulative advance decline measure is continuing to be positive but less robust than before.

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5 Responses to “Market Treads Water As New Highs Crumble”  

  1. 1 Peter Jsson

    Disconnect all automated trading systems so the markets starts to develop.

  2. 2 mike purling

    I get the feeling that the current rally is being fueled by the notion that Republicans are gaining strength and more fiscal discipline is coming after the November elections. People are beginning to wake up and do not like the changes that President Obama has enacted. However, once we start to take a new approach and begin to enact more fiscal discipline, there could be some short term pain to realize the longer term gains. There is a huge sum of money that has to be invested. With interest rates at the bottom there are not very many alternatives and the stock market has been a beneficiary. Once interest rates find a more realistic level the stock market will lose some its edge over other alternatives.

  3. 3 PEJ

    Babak, I think you are wrong: the Dow is headed for 38k. It’s obvious.

  4. 4 Tiho

    Nice write up. Also, one observation I would like to point out is that the AAII sentiment is now overly-complacent. Bears came in at only 21.6%. We have to go back all the way towards the good old boom days of January 2006 to see a reading like that. Bull ratio is therefore the highest in four years!

    When one looks at all the breadth measures, technicals and sentient, the obvious conclusion is that the market is really stretched here. We could be setting ourselves up for something more than just a correction, even more so confirmed if Mr. Bernanke (PhD in money printing) disappoints at one thing he is really good at - money printing.

  5. 5 JoeBlow

    The Republicans won’t fix anything. You have to remember, it was McCain, Bush, and Obamas that all approved the first looting of the treasury.

    It won’t stop just because we have more of one type of crook vs. the other. Blue crook, Red crook, what’s the difference?

    The money has already been stolen and is GONE. QE2 will be more of the same. Wall Street bankers trading the FED their worthless holdings for US Dollars that will then be converted into something of value for them while the US Tax Payer is left holding the bag on a debt that can never be repaid.

    After the house of cards comes down, those that stole X Trillions from the USA will be off living the high life while you and I live in sqaulor.

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