Driving a “wedge” between bulls and bears

While I was analyzing the charts of the S&P 500 and the Dow yesterday, I noticed a common price pattern know as a Wedge. It is simply a technical chart pattern composed of two converging lines connecting a series of peaks and troughs. Wedges can take the form of a rising wedge or a falling wedge.

Falling wedges form during a temporary pause of upward price rallies. Rising wedges will typically occur during a falling price trend and usually hint to a break lower. Even though a falling wedge is seen as bullish and a rising wedge as bearish, technical analysts such as myself look for a ‘breakout’ of this wedge pattern as bullish on a breakout above the upper line or bearish on a breakout below the lower line.

Please look at the chart I have below:

You can see that I have highlighted the rising wedge that seems to be forming on the S&P 500. If you looked at the Dow you would see the same pattern. Since we are currently in an overall down trend, the rising wedge should be looked at as bearish and a breakdown of the rising support is expected. However, this is not a sure thing. The markets could just as easily break higher and resume the short term up trend.

The Tale of the Tape: The markets are forming a common technical pattern know as a rising wedge. This would appear to signal an impending breakdown. However, this pattern should not be acted on without confirmation. The confirmation would be the break of the up trending support. Assuming this happens, entering short positions would be favorable. On the flip side, if you are bullish on the market, one might enter long positions on a pullback to the up trending support or on a break above the up trending resistance.

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

S&P above 200-day MA: Sure thing?

After last week there has been a lot of talk about the S&P 500 breaking back above its 200-day moving average (MA). On one hand, I’d agree that’s a good thing and could be promising. On the other hand, there seems to be a belief that the market is definitely headed much higher from here on out now that we’re back above the 200-day MA. Is that true though? Is the break back above the 200-day a sure-fire thing?

In one of my more recent newsletters I covered a very common, long-term buy/sell signal in the form of the 50-day MA crossing the 200-day MA. (Feel free to go to http://www.themeshreport.com/back-to-the-bull-or-still-a-bear/ for a review of this topic.) In short, the 50-day MA crossing above the 200-day tends to be a good sign of a trend change from down to up within the market. The opposite would apply when the 50-day crosses below the 200-day MA: a change of trend from up to down. One of the reasons I believe the markets will be heading lower overall is because of the 50-day MA recently crossing below the 200-day MA on the S&P 500.

Well, does this past week’s S&P move back above its 200-day MA change my view? Should it? Take a look at the following chart:

 

What you are seeing on the chart above is that last time the S&P had its 50-day MA cross below its 200-day MA.  This was back at the end of 2007, and as we all know, that was the start of the bear market.  You will also see that I have highlighted in blue (2) instances where the S&P rose back above its 200-day MA, one of which was after the crossover. So, it does appear that a rise back above the 200-day MA after a 50/200 crossover can happen, yet not change the overall direction of the main trend.

Now, I’m not trying to rain on anyone’s parade. Rather, I just want traders and investors to be cautious and on their A game no matter what. We don’t want to get lazy now that a few talking heads claim that the coast is clear. And hey, who knows, maybe some of those talking heads are right and we are going back up to new highs. Anything can happen, right? As a matter of fact, I recently noticed a subtle glimmer of hope for the overall trend. Please look at the next chart:

The above chart is obviously a current chart of the S&P 500 showing the recent 50/200 crossover that I mentioned earlier. You can also see the S&P’s recent rises above its 200-day MA. If you reviewed my previous newsletter on the 50/200 crossover, you know that sometimes a crossover can just be a fake-out and the 50-day MA can pull back above the 200-day MA, thus putting the up-trend back in force. Well, over the last week the S&P 50-day MA has started to rise back up towards the 200-day MA. Might the 3-month sell-off in the markets just have been a rough correction that is now ending? Stay tuned!

The Tale of the Tape: With the S&P 500 moving back above its 200-day MA, it can be easy to get a little giddy and somewhat complacent. History shows that there can be false alarms with all “signals”. The S&P could very well be heading to higher-highs, but be on guard for whichever way the market may turn.

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

What’s next?

As you may have noticed, the past few days seem to have increased in volatility. With that, a lot of the students that I coach have wondered what the near-term direction of the market is. It seems that we either go up nicely only to have the gains erased, or we go down hard only to fight our way back into the green. So, which is it: up or down? How might one gauge the short-term direction of the market?

As you may have noticed in my other Chart School articles, as often as possible I like to keep things simple.  Below is my very simple, straightforward answer to the above question:

As you can see, I have added the 200-day simple moving average (SMA) to the S&P 500, as well as its current trend line support (blue).  As commonly happens, the S&P is reacting to its 200-day SMA as a resistance area on each rally we’ve had over the last few months. In the meantime, the S&P has created the up-trending support, which we have tested a couple times as of late. At some point one of these levels will have to give.

The Tale of the Tape: The S&P is stuck between its up-trending support and its 200-day SMA, which is currently at 1114. A break of either of these levels should dictate the near term direction of the market. A break above the 200-day SMA would be a great point at which to enter new long positions or add to current ones. On the other hand, if the support we’re to break, short positions might be entered.

Waiting for the most opportune trading times, like I have outlined above, could provide you with the higher probability trading 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

As rates go, the rally goes

There are plenty of correlations between the various markets. Sometimes these correlations are direct, and sometimes they are inverse relationships. Believe it or not, sometimes correlations can switch from direct to inverse. There are correlations between interests rates and the dollar, the dollar and the euro, bonds and stocks, commodities and rates, etc. etc. etc. Sometimes these correlations are always in effect, sometimes they are in effect off and on, and sometimes they are only in effect from time to time. Obviously, it can be helpful to recognize when important correlations are in force that may give you a  “heads up” to a trend change or continuation. So, let’s look at one correlation in particular: stocks vs. interest rates.

For this exercise I have chosen to use the S&P 500 to represent the markets and the 10 Yr. T-note for interest rates. Please analyze the 1-year chart of these below:

With the S&P above and the 10 Yr. below, you will notice that I have highlighted in blue some of the noticeable peaks in rates.  You will notice that whenever rates turned down the S&P followed. More often then not rates led the market, with the market only leading once. So, why might this happen? Well, the simplest reason might be due to investors becoming fearful in their outlook on the economy. When this happens they tend to jump out of stocks in a “flight to safety, thus buying bonds. When the demand for bonds rises, so do bond price, which in turn pushes rates lower. In short, it could be useful to keep an eye on rates.

Below is a chart of the 10 Yr. T-note by itself with some key notations:

The red line denotes the down trending resistance for the 10 Yr Note. The green represents the key 3.10 level that is currently a resistance after being a long-term support. The blue support line at 2.90 is also a key level for the 10 Yr.

As of the time of this writing, with the markets moving slightly higher, the 10 Yr. has made its way through the down trending resistance. Since we have seen that there is a correlation between rates and the market, this resistance break would appear to make sense considering the market has also moved higher. Now the focus will be on 3.10 and 2.90. Remember, more often than not, rates on the 10 Yr. led the market. Regardless of which leads, paying attention to the 10 Yr. could help to confirm a higher or lower move in the market.

The Tale of the Tape: After breaking through its down trending resistance, the 10 Yr. T-Note is between its 3.10 resistance and 2.90 support. Watching these two levels to see which way rates break could help to confirm the future direction of the market. This in turn will help you know which side of the trade to be on and when to make those trades.

Waiting for the most opportune trading times, like I have outlined above, could provide you with the higher probability trading 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

Gold go bye-bye?

A few weeks ago I published a Chart School newsletter in which I discussed the prospects for gold. At that time, I recalled hearing about what a great buy gold was seemingly every time I turned on the TV or even went to a mall. “Buy gold”, or “We buy gold”, it was always one or the other. Well, should I?

So, I decided to take a look at gold myself to see what I could see. To do that, I decided to look at the GLD, which is the ETF that tracks gold and allows you to profit from gold without having to physically go out and buy a bar! Below is a similar chart to the one I presented in my previous newsletter:

At that time, you can see that the GLD was trending higher, while volume was contracting. This is what’s known as a divergence. Think of it as less and less interest as the price goes higher and higher. It’s as if there is nothing holding the ETF up and it could fall on it’s own weight. Although this divergence is not an immediate “sell” signal, it did tend to make me skeptical of gold’s recent rise. Well, it was not a surprise to see what happened next:

Not only did the GLD break it’s up trending support line, but when it broke, it did so on a pretty nice increase in volume. In other words, we didn’t just casually break that support. There was a heavy interest in getting out and the “big” money was making a move out of gold/GLD. Although we don’t necessarily need a pop in volume to go lower, it does add validity to the breakdown. Afterwards, the price of the GLD did exactly as expected after a break of support, it went lower. Recognizing that support break and increase in volume would have been a great short opportunity, yes? Well, please look at my updated chart:

You will see that the GLD had created another strong support, but this time at the $115 level. Again, the GLD breaks support and yet again on a heavy increase in volume. Based on what you know about support breaks, volume and the charts above, what might the GLD do next? More importantly, what might YOU do next?

The Tale of the Tape: The GLD has broken down again. Regardless of what all the talking heads may say, the GLD is telling me that it is going lower. This would appear to be a great time to:

  1. Short the GLD
  2. Buy the ETF – GLL, which goes up when gold goes down
  3. Short gold related stocks that also break support. Stocks to watch may be ABX, AEM, GOLD, RTP, FCX, AU, GG, etc

Waiting for the most opportune times that I have outlined above could provide you with the highest probability trading 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