Does Momentum Favor the Bulls or Bears?

Momentum can be an excellent tool for understanding the movements in the market and the ‘health’ of a trend. I like to see momentum for a market reflect the price action – hitting new highs and staying in its own version of an up trend. I often look for divergences in momentum, signs where price is heading one direction but momentum is going the opposite direction as warning signs of a potential change in trend for price.

Each Weekly Technical Market Outlook post I write shows the daily chart of the S&P 500 ($SPX) and three momentum indicators, the Relative Strength Index (RSI), MACD, and the Money Flow Index. However understanding what’s happening on higher time frames can be just as important, if not more so, when analyzing the market. With that, lets check in on the weekly and monthly charts.

First up is the weekly chart of the S&P, along with the RSI and MACD indicators. Since the 2011 near-bear market the Relative Strength Index (RSI) has been in a bullish range. We’ve seen this measure of momentum continuously hit ‘overbought’ levels while holding above 40 on downturns. This tells us that momentum is strong and the trend in price should remain intact.

Recently the RSI and began making a series of lower highs as price as continued to advance. The first lower high was followed by a near 10% drop in the S&P back in October. Since then, the market has rallied and hit new highs and the divergence has steepened. While this bearish divergence is considering, the indicator remains in a bullish range as holds above its prior lows.

When looking at the MACD indicator, which is another well-known measure of momentum, it also has been experiencing a bearish divergence. The difference between the RSI and MACD divergences is the MACD downturn has been with us for all of 2014. So far the S&P has seen 3 distinct lower highs in the MACD, which is more than we saw going into the 2007 peak.

SPX weekly

The monthly chart of momentum for the S&P 500 can cause confusion for some traders. Many will look and see that we’ve been ‘overbought (over 70 on the RSI) for almost the entire year and point to that as a reason to be bearish. But we know better! being ‘overbought’ just means that momentum is strong, it doesn’t require the price to go down substantially. Going into the 2007 peak, the monthly RSI began making a lower high. We aren’t seeing that type of bearish action in the latest set of data. While the peaks in the momentum indicator are not all exactly to the same level, in my opinion they are still showing strong signs of positive momentum. I’m currently watching to see if a break under 70 falls under the prior August 2013 low and if it’s then followed by a clear lower high on any rebound we see soon follow.

The MACD indicator has done a nice job highlighting the slow grind higher in momentum. With the recent weakness in December the fast line (black line) is close to crossing below the slow line (red line) which many traders view as a bearish signal. While I’m not overly concerned with the absolute level of the MACD, it’s interesting to note that we are currently seeing stronger momentum based on the currently monthly reading than at the 2000 and 2007 highs.

SPX MonthlySo what is momentum telling us? In my opinion, the weekly and month charts have continued to confirm the bull market and the up trend in U.S. stocks. While the divergences that are taking place in the RSI and MACD on the weekly chart are concerning and could lead to a protracted downturn, the fact that the Relative Strength Index remains in a bullish range is a positive sign in my eyes. We’ve yet to see a breakdown on the monthly chart, which would likely occur, but of course is not a requirement, ahead of a major market high.

Understanding what’s taking place on the higher time frames can give us clarity and a break away from the noise that takes place on the intraday and even the daily charts.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Weekly Technical Market Outlook 12/15/2014

After a seven week run up to new highs it appears sellers woke up from their winter naps and turned on their trading terminals. The S&P 500 ($SPX) fell 3.52% last week while small caps ($IWM ) dropped 2.53%, International stocks also finished in the red by 4.66%. Of course we can’t forget the oil market which stumbled 12.4% over the last five trading days.

Trend
While the trend for the U.S. equity market remains positive, I did not like seeing price fall under the prior September high in the final hour of trading on Friday. Because of its round number status no doubt we’ll hear a lot about 2,000 for the S&P this week and why it ‘matters.’

trendBreadth
While breadth had been improving we still have yet to see the NYSE Common Stock Only Advance-Decline Line break back above its prior high. Two weeks ago I discussed how the other A-D lines had confirmed the most recent high but the broader, NYSE equity only has yet to do so. The Percentage of Stocks Above Their 200-day MA has continued to hit new lows which has only been intensified after last weeks selling.

breadthDecrease in New Low-High 
One of my favorite follows on Twitter is Dana Lyons. Dana does some really interesting analysis and produces some great charts that he also shares on his Tumblr.  Below is a chart Dana recently shared that shows the data points where the S&P 500 has been near a 52-week high but the breadth, as measured by the number of new lows minus new highs is greater than 2%.

Dana notes that we last saw this occur in August of last year, which as we know did not put a stop to the up trend in stocks. However, the previous instances are hard to ignore.

Dana chart

LIBOR
Over the last several years the 3-month LIBOR rate has been fairly uneventful in its decent. In its simplest form, LIBOR is the international rate that banks charge each other for short-term loans. When the trend in LIBOR begins to rise that often means banks are growing nervous and are charging a higher premium for loans to one another. During previous dips in the U.S. equity market we haven’t seen a noticeable rise in LIBOR.

However, this last week has been difference. While the market is off just a couple of points LIBOR rose 3.10% which is the largest 1-week increase since 2011 when the S&P downgraded the U.S. and politicians were debating whether they should do their job keep the government open.

A one week move is not something to ring the siren over but I don’t believe it’s something to simply ignore either.

LIBORMomentum
Many traders will point to this chart as a reason for last week’s selling. While the S&P made a new high the Relative Strength Index put in a small bearish divergence. Two weeks ago I highlighted the divergence in the MACD histogram as a sign of potential weakening momentum. This lower high in the RSI helped confirm that.

momentum

Gold
It seems Oil has gotten most of the attention recently but before that it seems the focus had been on the slide in Gold prices. As Gold broke through its 2013 lows I think many traders wrote it off as a dead asset. But those lows have once again been breached and the bulls have been putting bids under gold over the last two weeks. We now have a sign of a possible false break which is being accompanied by two bullish divergences in momentum: the RSI and MACD indicators.

It appears the bears just didn’t have enough left in the tank to keep driving Gold prices lower. Or many they shifted their focus from the shiny metal to the black gold market, oil, to tickle their fancy. Nonetheless, spot gold prices are back above their prior low and with these weekly bullish momentum divergences, this asset may become interesting to some. However much work is to be done to regain the trust of the market and see the down trend broken. Two weeks of gains is hardly enough to base a complete turnaround on.

gold60-Minute S&P 500
It seems the fairly long divergence on the MACD is finally getting its day in the sun as price begins to follow its lead. The Relative Strength Index also started putting in a series of lower highs near the intraday top for the S&P 500. Which was soon followed by multiple ‘oversold’ readings which as I wrote about last week, doesn’t mean a bounce has to be produced.

60min

Last Week’s Sector Performance
As the major indices sold-off last week traders sought the ‘safety’ of the defensive sectors, most notably Utilities ($XLU) and Consumer Staples ($XLP). Relative to the S&P 500, Energy ($XLE)  was the worst performing sector followed by Materials ($XLB).

last week sector

Year-to-Date Sector Performance
The trend continues another week of Health Care ($XLV), Utilities, and Technology ($XLK) in the top spots of relative performance YTD. Energy, Materials, Consumer Discretionary, and Industrials remain under-performers with just a couple of weeks left of 2014.

ytd sector

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Being ‘Oversold’ or ‘Overbought’ Is Often Not Good Enough

One of the first mistakes many new traders make when using technical analysis surrounds the words ‘overbought’ and ‘oversold.’ While the Relative Strength Index (RSI) is one of the most popular technical indicators, it’s often used incorrectly. Stocks and markets that become ‘overbought’ or ‘oversold’ can often become more overbought and oversold.

While this applies to many momentum indicators, I’m going to focus this discussion on the RSI. Momentum is often thought of as a mean-reverting indicator. It’s believed that something cannot rise or fall forever and the momentum of the trend will likely correct itself. While 70 and 30 are often the ‘trigger’ lines for the idea of being ‘overbought’ and ‘oversold’ respectively, this ignores the whole notion of momentum.

A break above these numerical levels just tell us how strong or weak momentum actually is. It does not mean momentum nor the RSI indicator has to revert. This is why I often look for bullish or bearish divergences as signs of changing momentum. Which involves price continuing a trend after a brief decline but does not receive confirmation in momentum as the indicator begins to diverge and change direction. The chart of Crude Oil does a great job at showing why a break outside an ‘overbought’ or ‘oversold’ level is not good enough to forecast a change in trend.

Oil saw its first reading under 30 on October 9th on the daily chart and while the next day the price of Crude rose, it did not put a stop to the selling within this commodity. However, it did tell us how weak momentum was and the price of a barrel of crude oil has continued to fall over 20% since then. During this time the RSI indicator has broken under the ‘oversold’ level six additional times. Sellers have been relentless in pushing oil prices lower and momentum has shown us this by staying consistently weak.

WTICOne caveat to the idea that being ‘oversold’ or ‘overbought’ in momentum is not good enough to begin expecting a change in trend is the time frame. The above example in Crude Oil is a daily chart but there can sometimes be interesting setups in a weekly or monthly chart when momentum gets extended in one direction and quickly reverses course. This is not to say that when coupled with other forms of analysis that over-extended momentum can not be a good tool. But by itself, in my opinion, it is often signaling the opposite of what many traders believe and the trend in price continues.

 

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.