History repeating?

I must admit, I believed the markets were on the way down back during the summer. I thought for sure that the next wave down in an ongoing secular bear market was unfolding. All signs seemed to point lower. Apparently not.

Now, months later while hitting new bull market highs, the question is: Do I still believe in the secular bear market case? Do I still believe that this almost 2-year bull run is just a bear market rally? Yes, and yes. Picking tops and/or bottoms is a difficult, if not impossible, thing to do. Generally, we do not know we’re right until long after the top or bottom is in. That being said, when we look back, there were always signs. Could the market be giving us signs now?

Below is a 2-year chart of the S&P 500 from the all time bull market high in 2007. If one believes in the bear market case, then the 2007 peak was the beginning, or the end depending on how you look at. Please review the chart with my added notations.

Now, interestingly enough, please review the next chart, which is the current 2-year chart of the S&P:

A picture, or 2, is worth a thousand words. Is it possible that history is repeating itself? Only time will tell. However, there are other factors that I believe are worth considering:  For example, momentum.

Although there are literally hundreds of momentum indicators, let’s look at a very popular, useful one in the RSI (Relative Strength Index). The RSI compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of a security.

The RSI can be helpful in many ways, but one of the most telling is when the RSI diverges from price. In other words, as the price of a security hits new highs, one would expect the RSI to hit a new high also. If a security hits a new high, but the RSI forms a lower high, this would be called a divergence.  Momentum usually leads price and this divergence simply implies that momentum is waning. Imagine it as if you threw a ball in the air. Although the ball continues higher, the momentum of the rising ball starts to decrease. Eventually, the ball will follow the decreasing momentum.

With all that being said, please review the following 1-year chart of the S&P with the RSI:

And there is the textbook definition of a momentum divergence on the RSI. HOWEVER, if the S&P were to continue to rally, thus pulling the RSI higher, this divergence could “work itself out”. Time will tell.

So, we have history sending a message and momentum seems to be waning. Is there more? Well, of course!

At major market tops and bottoms, investor sentiment tends to reach extremes. Keeping it simple, if everyone is bullish, who’s left to be bullish? The same would hold true on the bearish side. Although sentiment readings do not pick exact tops or bottoms, they certainly can tell us that the market environment is ripe for a reversal. With that in mind, please consider the following sentiment readings:

  • The 10-week moving average of the percentage of bulls reported in the AA II (American Association of Individual Investors’) weekly poll is at 49.3%, which is the highest level in 6 years. Higher than sentiment at the all time 2007 high.
  • The percentage of bulls among advisors, as reported by Investors Intelligence, is 56.8%,. This is the highest since the 62% reading of October 2007, the very week of the all-time high in the Dow.
  • The DSI (Daily Sentiment Index) at trade-futures.com reached a peak reading of 94% bulls in November. This is t he highest reading since the same measurement was reached in January 2007, almost 4 years ago. Just to contrast, there was a record-low 2% bulls reported on March 2, 2009, the start of the current bull run.
  • Mutual fund managers’ cash-to-assets ratio for November is at 3.6%, just 0.2 above its all-time low of 3.4% from July.

The Tale of the Tape: Be cautious. Protect your assets. Could I be wrong, you bet, but as I said earlier: There are always signs.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT

Silver update

I just wanted to do a quick follow-up on silver. A few weeks ago silver appeared to be reversing lower only to rally back up to resistance. Presently, it seems that silver has reached a point of reversal again.

Please review the following chart of silver with my added notations:

The first thing you will notice is the up-trending resistance line I have drawn. Silver had hit an intraday high of $29.34 a couple of weeks ago, which was at the trend line, but silver actually closed at the trend line on Monday. If silver’s history holds to form, a reversal in silver is to be expected.

If you are looking for a possible re-entry point for a long position on silver (or SLV), please analyze the next chart:

In the short term, silver has been bouncing along the up-trending support line I have drawn. You will also notice the large Bearish Engulfing candle pattern (please review http://www.themeshreport.com/2010/11/are-silver-and-gold-done/ if needed) that formed yesterday. If silver meets the up-trending support line again, might that be a point of entry? What if that trend line were to break?

The Tale of the Tape: Silver appears to be showing signs of a reversal again. The silver commodity has approached a long-term resistance, while forming a common reversal candle pattern in the process.  Silver should be expected to move lower and probably approach the short-term up-trending support line. If/when that support line is met, entering a long position on silver or the SLV could be considered. However, if silver were to break that up-trend line, taking a short position on silver or SLV would be the higher probability trade.

Waiting for the most opportune times that I have outlined above could provide you with higher probability entry points. No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.

Good luck!

Christian Tharp, CMT

Small caps lead the way?

Last week I wrote a newsletter focusing on the key levels for the S&P and Dow that we would need to watch in order to get a sign of the next move in the overall stock market. For review, please go to http://www.themeshreport.com/2010/11/where-are-we-going/ The resistance level on the Dow seems to be around 11,200 – 250 and the corresponding resistance for the S&P is around 1200.  Although earlier this week it appeared that support might be breaking instead, the markets have rebounded nicely today.

Please look at the current position of the S&P and Dow below:

You can see the resistance levels above and also the brief break of support on the Dow. However, the S&P did hold support and both indices have now rallied back up to resistance. So, can we break higher?

Maybe small cap stocks, as measured by the Russell 2000, can give us a potential hint? Please review the chart of the Russell below:

The Russell seems to be breaking higher today. If the Russell can hold its gains, and even move higher, it could be a sign that the larger caps will follow. When investors are in the mood for risk, it is not uncommon for the Russell to reflect that mood. Small cap stocks tend to be the riskier plays, thus the potential for greater gains.

The Tale of the Tape: Seeing the Russell break higher today should be a sign that the Dow and S&P will follow, but I would urge caution until that actually happens. Remember, the Russell isn’t going anywhere without the “big boys”. If the broader market can confirm the Russell’s breakout, this should provide an excellent opportunity to enter various long positions as long as the breakout holds.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT

Where are we going?

The past few weeks in the market have been somewhat choppy, to say the least. I must admit that there has to be some concern that the stock market could not hold the recent break above their April high. It reminds me of the 2007 all time high in the Dow. Please look at a chart of the Dow from back in 2007:

See how we briefly broke above the July high in October, only to quickly fall right back below it. Well, we all know what happened after that!

Although I will not go as far as to say that same scenario is unfolding now, it does put recent moves into some context. Please look at a recent chart of the Dow:

Sure looks familiar doesn’t it? Regardless, since breaking back below he April high, the Dow seems to be stuck in a very tight range between the 11,200/250 resistance and the 11K support. The S&P equivalents would be 1200 resistance and 1175 support. At some point, the markets will have to break one of theses levels, either higher or lower. Keep tabs on them for some insight into the next market move.

The Tale of the Tape: After breaking back below the highs from April, the stock market seems to be congesting within a very tight range. The break one way or the other should dictate the next significant move in the market. Trading within this tight range could be very choppy and difficult. Don’t be afraid to sit it out and wait for the breakout or breakdown. When the break comes, you will be better able to decide what side of the trade you want to be on, trade accordingly and with higher probability.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT

Dollar up, Euro Down?

As I’ve often discussed in my Chart School newsletters, there is an inverse relationship between the dollar and the euro. In addition, as the dollar goes, the stock & commodities markets have been going in the opposite direction. So, analyzing the dollar can give you some insight into the possible direction of assets such as the euro, stocks and commodities such as gold and silver.

First, let’s review the long-term chart of the DXY dollar index.

As you can see, the DXY bounced on its long-term uptrend line (black), as we would expect. Had the DXY broken lower, I would have expected the dollar to move lower, thus the stock market, euro and commodities to move higher. However, the DXY having held that support and moved higher, it is not a surprise that the euro, stocks and gold/silver have moved somewhat lower. So, what next?

Let’s take a look at the UUP next. The UUP is an ETF that “tracks” the movement of the dollar. If you wanted to profit from a move higher in the dollar, but didn’t want to trade currencies, you could buy the UUP.  Please review the chart below of the UUP:

Taking a closer look, you can see that the UUP has broken through its down trending resistance line. It also quickly came back down and retested that old resistance as a new support. This seems to validate the importance of this level. So, having broken through resistance, one would probably expect the UUP (dollar) to move higher.

What about the euro? Take a look at the FXE, which is the ETF equivalent of the euro:

You will first notice how the FXE and UUP look like mirror opposites of one another. More importantly, the FXE is currently sitting on its up trending support line. If the dollar continues higher, wouldn’t you expect the FXE (euro) to break lower?

The Tale of the Tape: The DXY has tested its long-term support and started to move higher. The UUP has broken through a key resistance level. All signs appear to point toward a higher dollar over the short-intermediate run. A long position in the dollar/UUP could be a great play. This might also be a bad sign for gold/silver, stocks and the euro.

If you choose to trade other assets based on this information, wait for a breakdown in the market you will be trading. For example, if the FXE were to break its key support, you might want to short the euro/FXE. The same could be applied to stocks or commodities like gold and silver.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT