Thursday, March 26, 2009

What We Can Learn From Indicator Non-Confirmations

We refer to non-confirmations when price makes a new high or new low, but one or more market indicators fail to follow suit. A good example came between 12 Noon and 13:00 PM CT, when the ES futures (top chart) broke out of their morning range and made fresh highs for the day. Those highs also took out multi-day highs and thus raised the prospect of a major breakout to the upside.

Notice, however, that the number of advancing stocks minus declining ones ($ADD; bottom chart) actually was weaker during the breakout than it had been early in the day. As my intraday Twitter posts noted, at the breakout, we had 25 stocks from my basket trading above their opening prices and 15 trading below--much more mixed action than one would normally expect for a breakout move. Moreover, as the Twitter posts noted, the new highs were not confirmed by several S&P 500 sectors and the 1945 new 20-day highs at the time, while impressive, fell short of Monday's level of over 2600. That is why I had my eye on a reversion to VWAP, rather than a moonshot to R3.

In a good trending market, the vast majority of stocks and sectors will move together. Non-confirmations tell us that the rising tide is not lifting all boats, at least at that juncture. Those are often occasions when breakouts turn into false breakouts, setting up nice reversion trades back into the range. One potentially valuable application of Twitter is to alert traders to these non-confirmations, so that they can think twice before chasing strength (free subscription here). Another application is identifying choppy, range market conditions, so that traders can refrain from overtrading.