Tuesday, March 31, 2009

Catching Market Turns: When One Index Does Not Confirm Another

OK, so here's a little lesson for you developing traders out there. Was yesterday a weak day or a strong day in the stock market? Of course, it was a weak day, because many more stocks declined than advanced on the day and there was net selling pressure on the day, as measured by the Cumulative NYSE TICK. Indeed, the day was so weak, it toppled many stocks off their (up) trending perches. If you take a look at this morning's Twitter posts, you'll see that the ratio of stocks closing below their volatility envelopes (Supply) exceeded those closing above their envelopes (Demand) by over 25:1.

Look, however, at my 2:16 PM tweet yesterday, indicating that small cap stocks were not confirming afternoon weakness in the large caps. Even the large cap NASDAQ stocks (NQ futures) were not confirming the weakness in the S&P 500 Index. If you review the recent post on indicator non-confirmations, you'll see that, in the most durable trends, sectors will tend to move in unison. When important segments of the market can't hold their weakness, it's a sign that the downtrend does not have good legs. Now, this morning, we're seeing the result: much of Monday's decline has been reversed in overnight trade.

If you click on the chart above, you'll see how the Russell 2000 Index (IWM) did not confirm weakness in the S&P 500 Index (SPY) at point 2. You'll also see that the Russell actually closed above its opening price--hardly an indication of weakness on the day time frame!

Note, also, that at point 1, the Russell had not only begun outperforming the large caps, but had actually retraced its decline from the open. That was actually our first indication that not all stocks were tanking in the day session. Yes, Monday was a weak day, but the weakness became less broad over the course of the day. And that emboldens the bulls for the next day.

I will be providing decision support on some of these trading patterns with intraday Twitter posts on days I'm not working with traders. Subscription is free, or you can pick off the last five tweets on the blog page under "Twitter Trader".