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Technical Deterioration In Both Short & Long Term Indicators at Trader’s Narrative

Obviously we are extremely oversold in the short term. How else would you describe a day when 98% of the volume flowed to declining issues on the NYSE? On the Nasdaq, market breadth was slightly better with 94% of share volume declining. The support that has held at 1040 on the S&P 500 is getting seriously challenged as the bears jump on it for the fourth time (February 5th, May 20th, June 8th and June 29th). The difference, of course, is that while the level was previously tested intra-day, it closed there today.

Below are a handful of technical signs that the market is deteriorating not just in the short term but in the long term as well:

S&P 500 Cumulative Advance Decline Line Falls Off The Ledge
The cumulative advance decline line for the S&P 500 was on the ledge last week. Today it jumped off.

The leap off the ledge by the cumulative AD line means that the red we saw across our screens today has wide participation. It isn’t just a few large cap stocks dragging down the index but a plebian sell-off. Technically speaking, the cumulative AD line is still above its February lows so the positive divergence is still in effect. But further deterioration will see that next level taken out as well.

Click to see larger chart in new tab:
S&P 500 compared to cumulative AD Jun 2010 update
S&P 500 cumulative AD fall Jun 2010 update

Percent Above Moving Averages
The oversold condition is clear in the short term, however, there are continuing signs of a change in market tone that should concern the bulls. For example, the percentage of S&P 500 stocks trading above their 50 day moving average has been loitering within historic lows for some time now.

Since May it has been below 50% (with the small exception of a few days). At today’s close, only 8% of S&P 500 index components are above their intermediate average. And as I’ve written before, the longer this indicator remains so low, the more it is telling us of a market that is too tired to rally.

Click to see larger chart in new tab:
percent SPX above 150 moving average Jun 2010

The long term prospects are weakening since the percentage of S&P 500 components above their 150 day moving average are at 25%, the lowest they’ve been since late March 2009 - just as the equity market embarked on a powerful cyclical bull rally. By mid-May, the subtle shift in the balance of power was noticeable. I’ve used this chart several times previously to point out a “box of bullishness” - a persistent state of high momentum that propels the market higher.

The reverse is also true - a persistently weak breadth means that the bears have the upper hand and control the market (see red boxes in above chart). We aren’t there yet, but the important point here is that we’ve seen a shift in the underlying market current market.

The CBOE’s Volatility Index is elevated at 34 but the last time the S&P 500 index was retesting these levels, the “fear index” was significantly higher. This can be interpreted two ways. The argument that you feel more comfortable says more about your inherent bias than provide any definitive edge.

The last time we looked at (an even more pronounced) volatility divergence was in February 2009 just as the market was about to find its footing. Thanks to 20/20 hindsight we now know that the relatively low volatility didn’t keep the bulls from taking control over from the bears.

Head & Shoulders
I’m sure you can see the completed head and shoulder on the S&P 500 - it is so clear that I didn’t bother drawing it on my chart above and distracting you from the pure price action. A measured move from the neckline gives us a target of 900 for the S&P 500 index. If we do get there, with the deteriorating breadth and technicals that I outlined above it is difficult for me to imagine the index not falling lower.

Final Thoughts
More than a few readers have written to me or commented on the blog that I’m a bit too optimistic, being too ready to “buy the dips”. It may certainly be true that I have a bullish bias - after all, I am all too human. I do make a conscious effort to be as agnostic as I can be. And looking back quickly through my previous comments, for example, there is this from late March when I wrote, When the Market Goes Streaking:

Based on this and other indicators (like the options trading activity and the amount of froth from speculative trading), I do think we are at or very close to a top here. The market may move ahead a bit more but like other times, it will quickly give that all back and more. As well, a simple resistance/support analysis of the S&P 500 finds the market very close to major resistance in the area of 1200. A similar resistance level is coming up for the Wilshire 5000 index in the 12,500 range.

If I seem too ready to pounce on a decline, as I did back in February, it is because I try to follow the same methods and indicators that have proven themselves. Of course, indicators react differently under different market conditions but I find that it is not useful to jump at every shadow, fearing that every single wiggle is a shift in the major context of the market.

The result is that, ultimately, I’ll be wrong, but along the way, I’ll be right several times over. As long as one has discipline in money management and risk control this method isn’t all that bad.

How do you approach the market? I’d love to hear back from readers about their over-arching philosophy or approach. Or be as specific as you like.

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15 Responses to “Technical Deterioration In Both Short & Long Term Indicators”  

  1. 1 Bullish bear

    Please keep ur outlook the same. I find it very realistic and like that it isn’t doom and gloom all the time. I think it is balanced. You do a great job and it’s appointment reading 4 me everyday. Thank u and keep it coming!

  2. 2 Babak

    Thanks Bearish Bull, it is difficult for me to be otherwise than how I am. But I appreciate the sentiment.

  3. 3 Oexrex

    As I commented a few weeks back the macro picture was very different at the May top. This one behaved differently than ‘ 04, ‘ 74 or just about every other cyclical bull.

    The historical evidence is/was there but seeing it requires a different perspective.

  4. 4 BO

    ‘’As long as one has discipline in money management and risk control this method isn’t all that bad. ‘’
    Totally agree. It is Holy Grail of Trading at all.

  5. 5 Bull Market Man

    Its the ones who get out there and by dips on nasty days like Tuesday that make money. Buying certain stocks as they have pulled to their 200s is no doubt way to make money. Now we just need a little participation from the markets and we are off to the races. Never be to pessimistic to buy dips. When everyones scared, Be greedy and when everyone is greedy, be cautious.

  6. 6 Babak

    Yes, exactly, the tricky part is finding those points of maximum pessimism/optimism. Not as easy as it would seem in hindsight - but a worthwhile effort.

  7. 7 Declan Fallon


    I love your take on market sentiment. With respect to Percent above MAs in my interview with Charles Kirk I had intrepreted the initial run into the bull-box zone (70-90 range) as the rising-tide-raises-all-ships. The subsequent trading range which emerged in the breadth indicator from 2004 to 2007 represented the sector rotation portion of a cyclical bull market. The cyclical bull market ends with the drop into the sub-20% / market crash zone.

    Current behaviour appears to be more in common with 2004, than either 2002 or 2008; 2004 was a scrappy year for the indices (I remember I got chopped around alot after a prior good year) which fits with the idea of a cyclical bull market from March 2009 lows. This scrap has only just begun so I wouldn’t be surprised to see the market apparently ‘tank’ here only to make yet another quick recovery.

    It’s a traders market and the technical picture is horrible, but too much water has passed under the bridge from last March to suggest it’s going to surpass this low.

    (No doubt I will be proved wrong!)


  8. 8 Babak

    Thanks Declan. I agree that the current market rhymes with 2004, where we had a chop/less gradual ascent. Can you give me what you’re basing that on though?

  9. 9 Kristjan

    The measured move from the H&S should take the S&P way below 1017 - it’s around 170 points from neckline to top of the head. 1040 - 170 = 870. At least that’s the way I see it. If you use some other method, please specify.

  10. 10 Babak

    Kristjan, just testing to see if you’re paying attention (kidding, thanks for catching that - it is corrected now)

  11. 11 Avi

    technicals, valuation, sentiment (surprises, whats the mood) and economics all matter… you’ve got a good grasp on all of them… one not need predict the markets to make money, just make sure you are on the right side sometimes and aviod the big drops

    keep up the good work and forget the haters


  12. 12 Babak

    Thanks Avi, lol for some reason you reminded me of this meme:

    haters gonna hate

  13. 13 OntheMoney

    I too was buying the dips on the way up, Babak - often using your excellent analyses to inform my decisions. Among the various reasons which made me ‘go over to the dark side’ is a combination of two technical factors:

    1. An unmistakeable change in character. The market is now not responding to short-term oversold technicals or pessimistic sentiment readings. In my experience (and as the good professor Jason Geopfert also suggests) that is a dead giveaway of a longer-term shift in trend. (And speaking of the trend, the 200-day MA finally turned down today).

    2. The rare and incredible momentum since March ‘09 has stalled on the long term ROC indicator and, over a century of the Dow, past instances of this paint a sobering and consistent picture: the market simply cannot recover its highs. At best, we’ll be flat over the next year, at worst a crash is coming. I go into this in more detail as part of my post here

  14. 14 Babak

    OntheMoney, thanks for your comment. Very interesting. Sometimes the simplest analysis is best and nothing is simpler than RoC

  15. 15 Rod

    Since you asked … my 2 cents worth:

    I think you are doing well with your strategy. I would only be more cautious when there is an oversold extreme after a big bull market. It usually means that lower prices are coming, and the game of calling the bottom becomes one of looking for divergences.

    Apart from that, great blog!!

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