MAILBAG QUESTION:

"you wrote in ur weekend wrap that you were concerned about a correction coming up. what are all factors that got you cautious about the market ahead of the sell off today after forecasting higher prices? also why do you think traders dont act on technical factors more than they appear to?"

MY RESPONSE:

TECHNICAL 'VERSUS' FUNDAMENTAL ANALYSIS:

Taking your last question first, about why more traders/investors don't act more on technical factors and act AHEAD of price breaks which is what I try to teach. It's a stretch for many to believe that price and technical indicators can FORECAST 'events'. Most people can mostly only get their heads around the idea that 'events' such as economic reports, earnings announcements, Fed action, etc. DETERMINE when and if trends reverse or slow down. Market participants generally think that the Market is more 'random' in its price swings than is actually the case; e.g., the market moves higher UNTIL some news comes out that calls into question bullish assumptions.

The concept of Market action spotlighting future economic trends goes back to Charles Dow's observations that changes in the two key Dow Averages 'forecasts' upcoming changes in the economy. For example, the Dow Industrials (INDU) makes a new monthly Closing high, which the Dow Transportation Average (TRAN) fails to do, thereby not 'confirming' INDU's move. If this divergence goes on it 'sets up' a forecast for a possible Market top and economic slowdown. For example, the Industrials have been going up on more production but also with a build up of inventory. A lagging Transportation stock Average suggests a less shipping of those goods out to customers, which in turn can forecast an economic slowdown.

The foregoing example is a bit simplistic but I'll go on and show the chart and indicator factors that suggested that we could have a correction/pullback coming very soon when I wrote my most recent Index Wrap.

My main theme voiced in my most recent weekly Index Wrap was that implied volatility had gotten so low that I thought something had to give. This facet of an unusually low level in VIX and VXN was more of a 'feeling' and I don't have a very precise way to measure tops based on such low levels of what the media love to call (re VIX) the Wall Street 'fear' index.

This facet of the Market DOES dovetail with one of my key (technical) indicators that is better at forecasting upcoming trend changes: that of bullish bearish sentiment, which I plot daily based on the CBOE equities daily total call to put volume ratio. You'll see in my second chart (daily S&P 500) below that my 'CPRATIO' sentiment indicator shot up to a very HIGH level recently, indicating what I consider to be an unsustainable EXTREME in bullishness. Such peaks are another way of seeing an 'overbought' situation such as is the case when the 13-day Relative Strength Index (RSI) has advanced to a high level; e.g., 70-80 or higher.

I wrote this in my most recent Index Wrap, as seen at the above web LINK:

"No 1-2 (technical) indicators are conclusive in a strong bull move like reversal type price action (is). When a pullback is signaled by topping out at prior highs, key downside reversals, etc. the 'ground' was simply set so to speak in that various (technical) indicators suggested increasing risk for a pullback."

Indicator patterns are NOT conclusive for forecasting trend reversals until price action 'confirms' it. What we saw today WAS a trend reversal pattern I was suggesting to be on the alert for; in this case, a "key downside reversal" which I'll highlight first. A second part and I may write on this later in the week in a 'part 2', is some background on what I was also seeing in some key long-term index charts that ALSO suggested that the S&P and the Nasdaq were hitting potential technical/chart resistance.

KEY DOWNSIDE REVERSALS:

What I call a 'KEY' downside reversal typically happens when an uptrend has been underway for a lengthily period and there's a move to a new daily (or weekly) high for the move, often a decisive new high, followed by a collapse in prices and a CLOSE below the prior 1-2 days (or weeks) LOWS.

We see the above conditions met in my first chart, a close up view of recent price action in the S&P 500 (SPX). How much further downside we'll see after today is still unknown, but corrective pullbacks are often substantial after a key downside reversal pattern occurs. (A key upside reversal is the reverse situation in that there's a move to new low, followed by a strong rebound that takes the Close above the prior 1-2 days' Highs.)

The daily SPX chart is shown next and includes the RSI and my CPRATIO (sentiment) indicator, which as discussed spiked to a very high extreme last week in terms of historical tendency. It quite unusual, even in strong bull markets, for CBOE daily equities call volume to be as much as 2.6 times greater than total daily put volume. I have seen it spike to nearly 3, but only in very rare instances and near a significant top. Anyway, while I couldn't yet forecast a possible top in terms of PRICE action I was primed for it to occur. I didn't have to wait long until today, reversal-Tuesday (6/24/14), to see it as seen close up in the chart above.

The low volatility registering lately (e.g., below 12) in the S&P 500 VIX index does encourage more buying of relatively cheap calls as risk premiums (for volatility) are low. This adds to call volume. Still, a 2.6 number shows a big call/put trade imbalance and implies galloping bullishness. The red down arrow on the daily SPX chart below points to the 2.6 peak in the CPRATIO graph below; i.e., total daily CBOE equities call volume was 2.6 times that of total daily put volume.

Sandwiched in the middle of the chart below is the 13-day RSI and I've highlighted its bearish price/RSI divergence as prices were climbing on declining 'relative strength'. All very interesting and telling in terms of trading but I want to emphasize again that price, not indicator, action is pivotal in suggesting a tradable top or bottom. Indicators are at most pointing to what MAY lie ahead and increasing reversal risk.



THE DOW DIVERGES:

The Dow 30 Average (INDU) pattern and performance was another reason that I was cautious on the ability of the broad S&P 500 or big cap 100 (that and the Nasdaq upside momentum slowdown) to advance to decisive new highs. This because the Dow was lagging SPX and OEX and it didn't look to have enough of the 30 stocks in bullish mode (only about 8) to push on to a decisive new high. Today's INDU price action shows the Dow topping out yet again at its recent line of resistance as highlighted on my next chart. This sets up a minor double top in the Dow. Stay tuned on where prices go from here.

ANOTHER KEY REVERSAL PATTERN: NASDAQ

The same decisive new high for the Nasdaq Composite (COMP) as seen with SPX, is followed by a collapse in prices and a Close that's BELOW the prior 1-2 (or more) days' highs, making for a 'key' downside reversal. You might well wonder about any significance of the reversal from the 4400 level, beside it being at a new next '100' level increment which can invite profit taking selling. But, looking at OTHER time frames, such as with the COMP hourly chart seen following the COMP daily chart here, technical resistance becomes more apparent.

The Nasdaq Composite, as with all the major indexes, should be looked at on an hourly and daily chart basis if your trading outlook is more than 2-3 days, such as 2-3 weeks, which is my typical time horizon. Hourly charts are also important in showing the 2-3 week trend outlook IF you can get more than 10 days or so of hourly price data as is typical with some 'basic' charting programs.

See the broad COMP uptrend channel on my longer range hourly chart below. 4400 in the Composite was a second time that the Index hit resistance at the top end of its uptrend price channel. The first time led to a minor dip but a slow rebound. This time, there's greater downside risk for the bulls given daily chart action.

I also made a point of highlighting a prolonged bearish price/RSI pattern on the hourly COMP chart below that suggested a bearish outcome at some point ahead. Such divergences are not precise for 'timing' a top but when you see the divergent pattern coupled with a key daily chart reversal, the hourly trend channel pattern and the daily chart reversal pattern together suggests a possible good-sized pullback; one, that those with bullish positions might not want to ride lower. Interestingly and tellingly, bullishness is still relatively high today according to my sentiment model. This is a dynamic of bullish/bearish sentiment: when it gets stubbornly high, traders don't give up their convictions (of higher prices ahead) easily.

I had some long-term weekly S&P chart pattern concerns, including even the monthly Nasdaq 100 chart, that provided a 'background' to some bearishness that was creeping in for me this past weekend that I'll likely go into in a follow up Trader's Corner at the end of the week. This, after we see a few more days price action. It's still early in the mystery of today being the start of more than a downside 'blip' or, something more substantial.


GOOD TRADING SUCCESS!