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Technical Indicators Support the Market



Technical Indicators - The Climax of Stock Selling May Prove Good for the Market!

Growing Buzz over Bearish Chart Patterns

Don't Be So Quick to Buy the Head-and-Shoulders Hype

Priceline.Com (PCLN) Should Continue Its Earnings Dominance This Week!


By Ian Harvey

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May 7, 2012

Introduction

It was a rough week for U.S. stocks, as the month of May wasted no time in living up to its bearish reputation. Friday's report of weaker-than-forecast nonfarm payrolls growth was the last straw for traders, even though the unemployment rate unexpectedly backpedaled. So the market's range-bound chop continued, with equities settling near the low end of a sideways channel that has been in place since March.

Will the investors fear turn to panic or will commonsense win out?

With Wall Street heading into a seasonally weak period, and the conditions of last week fresh in investors’ minds, panic could be a major concern for the market. However, even though the technical indicators provide an outlook that remains cloudy over the near term, there are still many aspects of the market in good shape, and there is encouragement from the growing buzz over bearish chart patterns, therefore, stocks could be back to a move forward in the week ahead.

Choppy Market Action

".....Nevertheless, after two-plus years of improving price action, naysayers continue to find reasons to doubt this rally. Therefore, there are many alleged sell signals available to determine whether we should brace for an imminent pullback -- and an option-based indicator that needs to be kept an eye on.....In fact, a theme that has been discussed for the past few weeks has been the fact that many technicians seem to be short the market.....”
-Sell Signals for the Stock Market, March 19, 2012

".....Tuesday’s sell-off has the markings similar to the market's late-January pullback – but with skepticism still surrounding the three-year-old rally the analysts and technical groups recent sell signal will be put to the test!..... Did the pullback achieve its’ goal according to the technicians – and was the pullback enough? Did those on the sidelines waiting for a pullback miss an opportunity, with the SPX quickly snapping back to its February highs?..... Moreover, if the excerpts above represent the group’s opinion, it is easy to believe that many investors are still on the sidelines waiting for a pullback of greater magnitude --somewhere in the order of 3% to 5%, or even 10%.”
-The SPX and the Latest Technical Sell Signal in the Week Ahead, March 12, 2012

It was first pointed out in mid-March that the odds were high for choppy market action, see excerpts above -- and that's exactly what we've seen over this time period, as the S&P 500 Index (SPX - 1,369.10) is right where it was eight weeks ago. Turning to the current outlook, we're hearing a lot of talk about how the market peaked in late April in each of the past two years, followed by a very rough summer and fall, and that this could occur once again.

Pullback Wariness

".....The holiday-shortened week seemed to be a case of the bulls going on holidays early! By the time the market closed on Thursday, a few of the favorite major equity benchmarks pulled up just short of psychologically significant round-number levels. There are many theories floating around as to why this occurred.....such as.....it appears that hedge fund managers have pulled back from equities, as analysis of the options market suggests that the hedging activity typically associated with accumulation of equities among these market participants has drastically slowed.”
-Market Risk Aware Investors, April 08, 2012

".....This article looks at three major signs that skepticism is mounting, despite the market's technical feats.....The build-up in skepticism, which was mentioned earlier, is evident on a few fronts, including.....as the SPX challenges 1,400, the MID toys with the 1,000 mark, and the Russell 2000 Index (RUT - 830.30) closes in on all-time highs and former resistance points -- may account for the frustrating situation we have seen in recent weeks.”
-The SPX Crucially Positioned – Skepticism is Rampant, April 02, 2012

In early April, I wrote about several reasons to be wary of a pullback of some sort -- as noted in the excerpts above. However, there continues to be more positives than negatives, particularly looking at the technical indicators, and therefore, don't expect a major sell-off this summer -- but more choppy action, and sideways movements, could be very possible.

As has been widely noted in the media, a generally bearish six-month period seems to be the road ahead at present. Going back to 1950, the Dow Jones Industrial Average (DJIA -13,038.27) has been virtually flat during the May-to-October time frame, versus a more than 7% gain during the November-to-April period. Of course, that doesn't mean the next six months will be flat.There could very well be seen some gains according to technical indicators, but this historical trend is something to be aware of going forward.

050712-technical indicators 1


Markets Trending Higher

The significance of what it means if the market is trending higher coming into this historically weak season is apparent by taking this study one step further. To differentiate these returns it is a matter of looking at whether the Dow was above or below its 200-day moving average at the start of the May-October period. The average return gets a little better when the Dow is above this trendline, but it's still not very significant -- again, confirming how tough this timeframe has been.

050712-technical indicators 2


The Technical Indicators

On the technical front, there has been a lot of talk about how various head and shoulders topping patterns have been forming on several indexes. These technical indicators, of course, are rather bearish patterns, and can lead to significantly lower prices should the neckline be violated. Below is a current example on the iShares Russell 2000 Index Fund (IWM).

050712-technical indicators 3



However, it's very important to remember that, while these technical indicators produce patterns like this which can be very powerful, it is noticeable over the past few years that when everyone is talking about a pattern, it rarely plays out the way it's supposed to. In fact, it has been amazing at how many times emerging bearish patterns have been picked up on and discussed by everyone, yet the bullish patterns -- which have tended to play out more reliably over the past three years -- are simply avoided. Well, this scenario is back once again, and various technicians, with their technical indicators, are noting the bearish patterns out there as reason for concern. If the various doomsayers are wrong again, a reversal of that skepticism could fuel the next move higher.

Technical Indicators - Climaxes

One of the technical indicators that can be useful looks at buying and selling climaxes.

A 'Climax' is a technical indicator that follows a protracted period of selling or buying, a point wherein market trends are retarded or discontinued.

At a selling climax, the market is characterized by a trend reversal whereby the market begins to buy stocks and prices rise. Simply put, a selling climax occurs when a stock makes a new 52-week low, and then closes higher on the week.

For a buying climax, the opposite occurs, and the market begins to sell, resulting in lower prices. A buying climax is the opposite: a new 52-week high, and then a close lower on the week.

The climax is merely the highest point of selling or buying and can be followed by many trend reversals.

If you see a surge in selling climaxes, it could be a sign of strong hands accumulating shares. Although it's not perfect, these technical indicator have done a solid job of finding some bottoms over the past year. For the week ending April 27, it has been noticed 65 selling climaxes out of all optionable stocks. As can be seen below, this was the highest number so far this year. Although 65 doesn't sound like a lot, when you consider the overall market is still very close to multi-year highs, this development could actually be much more significant than it seems on the surface. If you're bullish, then these technical indicators are producing some very positive signs!

050712-technical indicators 4



Stocks and 52-Week Highs

Another of the useful technical indicators is the number of stocks hitting new 52-week highs. The number of new 52-week highs is quite significant -- the more highs you have, the better chance of winning the trade. If you have more and more stocks forming new highs, then there's a very good chance the market remains strong.With that said the cumulative new highs versus new lows at the New York Stock Exchange (NYSE) reached yet another new high recently. Below is a three-year chart of this technical indicator. It's tough to get extremely bearish when you have this much underlying strength from this type of indicator.

050712-technical indicators 5



Evidence of Big Money

“.....it is very probable that activity on CBOE Market Volatility Index (VIX) futures and major equity-based ETFs is hedging-related. In other words, this activity could suggest institutions are in the process of making either bearish or bullish bets. Back in March, this option activity was a cause for concern, but now we're seeing signs that deep-pocketed players are putting their cash back to work.....Also, the VIX is also seeing a rebound in call buying. As the chart below shows, when the VIX's 20-day buy-to-open call/put ratio has turned higher from similar lows, it can be a very bullish signal for the overall market.”
-Bullish Risk – Investor Anxiety Spikes, April 16, 2012

“.....A big theme at the time was that the CBOE Market Volatility Index (VIX) was "cheap," and various VIX products -- such as VIX options -- were ideal instruments for hedging equity portfolios.....VIX options are most often used as hedging tools. When VIX call volume surges, so do equities, as VIX calls are frequently purchased as hedges by fund managers when they are accumulating stocks….On the other side of the coin, VIX put buying surges and call buying falls off a cliff during periods of market weakness, as hedge fund managers begin to build their short exposure through increased equity shorting and decreased stock buying.”
-VIX Options and Bullish Bets, May 01, 2012

Another positive sign is that there continues to be seen evidence of big-money investors moving into equities. As mentioned last month, as in the excerpts abovecall volume was picking up on the CBOE Market Volatility Index (VIX - 19.16), and this has historically been bullish. It is quite probable that this activity is a sign institutions are in the process of making bullish bets (see excerpt above "VIX Options and Bullish Bets") on stocks, and using the VIX call options as a hedge.

050712-technical indicators 6



Not to be outdone, the 20-day buy-to-open put/call ratio on the SPDR S&P 500 ETF (SPY), PowerShares QQQ Trust (QQQ), and iShares Russell 2000 Index (IWM) also broke out to new highs -- yet another sign of institutions looking to hedge their bullish equity positions. What is good here is that these technical indicators are showing that the ratio still has plenty of room to move higher before the market gets near past major peaks.

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Conclusion of Technical Indicators

All in all, it is quite obvious that the bull market is alive and well, and will eventually resolve to the upside. In the intermediate term, though, there are definitely mixed signals being produced, particularly with the technical indicators. As traders, it is important to take what the market gives -- and for this reason, it makes sense to be hedged, or look for both bearish and bullish setups here. It would be advisable to continue to look at housing and consumer discretionary names as potential longs, while select big banks and materials look weak.

Below are some observations that seem to be occurring in the market:-

1. A lot of retail names and apparel names look good, but it is difficult to find anything on the short side to pair them with.

2. Homebuilders are looking stronger and stronger every day and many are trading near multi-year highs. If you aren't in them already, it's a little tough to enter right here.....there's still a lot of skepticism toward the builders, though.

3. Some of the building materials stocks also look decent, if you don't want to jump on the homebuilders directly. Owens Corning (OC) is one stock that has stood out recently.

4. Regional banks that have solid chart set-ups seem a buy, while larger financial firms don't look so hot. Names like U.S. Bancorp (USB), Comerica (CMA), and Northern Trust (NTRS) all look intriguing, while Citigroup (C) and Morgan Stanley (MS) provide jitters for the investor.

5. Coal stocks also are on the scare list. In particular, Peabody Energy (BTU) looks vulnerable right here.


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