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Trading Lessons

Stock Market Exhaustion Gap?

Stock-Markets / Stock Markets 2014 Nov 24, 2014 - 05:05 AM GMT

By: Andre_Gratian

Stock-Markets

Current Position of the Market

SPX: Long-term trend - Bull Market

Intermediate trend - While everything technical points to an overbought condition which should require an adjustment, the exact timing of that correction is for the market itself to decide and reveal.

Analysis of the short-term trend is done on a daily basis with the help of hourly charts. It is an important adjunct to the analysis of daily and weekly charts which discusses the course of longer market trends.


Daily market analysis of the short term trend is reserved for subscribers. If you would like to sign up for a FREE 4-week trial period of daily comments, please let me know at ajg@cybertrails.com.

EXHAUSTION GAP?

Market Overview

Just as it was rolling over into a potential minor correction after a period of deceleration, SPX was rescued by an announcement that China's central bank had decided to lower its interest rate. At the same time, the ECB announced that it was prepared to do whatever was needed to stimulate the Eurozone economy. As a result, the index surged at the opening on Friday, tagging on 16 points in the first 10 minutes of trading but, by the end of the hour, it started a decline which continued until it reached the top of its 5-point opening gap where it found support and managed to regain some of the points it had lost. The high of the day did fill a projection target and this could account for some of the profit-taking, but it could also mean that traders recognized this move as a (temporary?) climactic end to the rally from 1821. We'll find out next week if this was indeed, an exhaustion gap.

Momentum: The weekly MACD has now made a decisive bullish cross, but remains in a pronounced state of divergence with price. The SRSI did manage to overcome its former high by a slight margin, but looks as if it is losing momentum. It too exhibits strong negative divergence. The daily MACD has flattened out and its histogram is barely positive. The hourly MACD turned up just before going negative and is in a weak uptrend and has flattened.

Breadth: The McClellan Oscillator had a small bounce off the zero line, thereby creating strong negative divergence. This has moved the Summation Index slightly higher.

Structure: With the continuation of the uptrend, Tony Caldaro now believes that we are extending primary wave 3, while other EW analysts are leaning toward this being wave 5.

Accumulation/distribution. Short-term: The small congestion pattern turned out to be accumulation with a count which took the SPX exactly to its projection target on Friday. Another congestion pattern may now be forming; or a correction could start.

Long-term: There are no signs that serious distribution is taking place.

XIV: This index now shows both intermediate and short-term divergence to the SPX.

Cycles: Eric Hadik, a well-known cycle analyst, believes that we are at an important cyclical top.


Chart Analysis

We start wih the weekly SPX (chart courtesy of QCharts, including others below) with the McClellan Summation Index posted underneath it.

 

The SPX is approaching the top of its intermediate term channel where it should meet with the resistance that this line has provided on prior occasions. Since it came within about 5 points of it on Friday, and all the indicators are showing divergence, this may be close enough to cause a pull-back. Note that NYSI has a two-fold problem: the first is that the oscillator itself is beginning to round over as it approaches its 200-DMA (while remaining well below its previous highs going back to early 2012), and the other is that its RSI is flattening after reaching an overbought 84.

Both MACD and SRSI are in a so-so uptrend which remains well below their potential upward limits while price closed at a new high this week. This has created severe negative divergence.

The daily SPX chart shows how the index created a little ledge before pushing higher. Support which kept it from going lower came from the 8-DMA (pink) which contained all attempts at breaking through it. We will not have a reversal, even minor, until it is breached.

The extreme overbought condition caused by the move from 1821 (without any kind of correction or even consolidation), the approach to the top trend line (which should discourage wholesale buying), and trading outside of the original channel all render the index susceptible to a short-term reversal. In addition, when a price gap occurs under such conditions, it is very likely to be an exhaustion gap and, since one was formed on Friday, it will be interesting to see how the market follows this occurrence. The worst that could happen would be an island reversal, indicating that an important top has been reached. Next would simply be the beginning of a decline which continues below 2040 (red horizontal line) and then continues below the 21-DMA (blue).

Or, SPX could hold above 2040, in which case nothing significant will happen -- probably only a consolidation followed by more uptrend. But this uber bullishness cannot continue forever without a normal correction occurring. Bearish technical signals are not only in place but appear to be increasing their warnings week after week as, for example, the following daily chart (courtesy of StockCharts.Com) which continues to trend in a direction opposite to the SPX.

This is not the only one. There are others which have the same intense bearish divergence. And yet, until the index actually reverses and begins to decline, that's all it is: a warning which should keep us on our toes!

SML:SPX Daily Chart

The hourly charts hows in greater detail what happened on Friday. The strong opening created what is a possible exhaustion gap made credible by the deep pull-back, although the bounce at the end somewhat curbs that possibility. A much more bearish sign would have taken place if the index had closed on its low of the day without rallying. Several trend and channel lines converged at the high point to form resistance coinciding with a P&F projection and the lower range of a cluster of Fibonacci targets.

The oscillators have turned but could be in a worse condition relative to price. In order to have a strong hint that we are starting a correction, prices should break both trend lines and drop below 2040. This would represent a decline of over 20 points and would argue for continuing weakness. But there is also strong support between 2030 and 2040, so both camps will have plenty of occasions to prove themselves.


Sentiment Indicators

In spite of the new market high, the SentimenTrader (courtesy of same) long term indicator only advanced from 57 to 58. That's hardly conclusive evidence that the market is at an important top.

Weekly Sentiment Readings


XIV (Inverse NYSE Volatility Index) - Leads and confirms market reversals.

XIV has maintained its long-term divergence to SPX and has created short term divergence as well by trading sideways, while SPX made new highs. The timing is up to the market, but this relative weakness is increasing chances that a reversal is about to take place.


IWM (iShares Russell 2000) - Historically a market leader.

The relative weakness of IWM to SPX has also increased with last week's action when the latter surged to a new high but IWM could not move above its previous short-term top. Unless there is a radical change in the behavior of IWM, this divergence (similar to that of XIV), indicates that a market re-adjustment is both necessary and imminent.


TLT (20+yr Treasury Bond Fund) - Normally runs contrary to the equities market.

There is little change in the action of TLT this week, except that it appears to be a little closer than it was last week to resuming its uptrend.


GLD (ETF for gold) - Runs contrary to the dollar index.

Once again, the intermediate behavior of GLD has proven that it is guided primarily by its 25-wk cycle. Pretty much on cue, GLD started to improve around the time that the cycle low was due. Although the index is unlikely to be starting a major reversal at this time, the upward pressure from the cycle should allow it to make more upside progress.


UUP (dollar ETF)

UUP appears ready to complete its wave 5 from the May low. If so, it shoud be followed by a minor consolidation before this index can move much higher.


USO (US Oil Fund)

USO may be giving us an inkling that it is ready to moderate the decline which has lost it about 30% of its value since June. With the long-term downtrend firmly established, all we can probably hope for is some form of consolidation and an oversold bounce before even lower prices are seen.


Summary

After a 250 point advance without even a minor correction, the gap which was produced by Friday's strong opening can only logically be labeled an exhaustion gap which could lead to the first normal correction of the entire uptrend from 1820. But human logic is not the market's strong suit.

Even under severely adverse technical conditions, SPX continues to make new highs. This is a situation which cannot continue much longer but the exact timing of the reversal is for the market itself to decide.

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Disclaimer - The above comments about the financial markets are based purely on what I consider to be sound technical analysis principles uncompromised by fundamental considerations. They represent my own opinion and are not meant to be construed as trading or investment advice, but are offered as an analytical point of view which might be of interest to those who follow stock market cycles and technical analysis.

Andre Gratian Archive

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