Spotting Tops: Posted February 9th, 2013: Updated 06/02/2013

June 2nd, 2013:

Once again the market is making it tough on those who try to divine its movements, but there are now some additional clues to work with and the biggest clue may have come from Bernanke two weeks ago. At that time, as I’m sure you know, Bernanke hinted at tapering bond purchases in the fall. If you’ve been paying attention then you know that this entire rally off the March 09′ lows has been fueled with Fed money and if Bernanke starts to turn off the spigot, then where’s the money going to come from to buy every dip and pump the market back up? It ain’t gonna’ come from Uncle Ted and Aunt Alice.

So, have we topped out? Well, I have to tell you that if the market had topped every time I thought it should have over the last several months then it would have topped out back in late February and early March when the ADX on the daily $SPX chart rolled over after rising up close to 40. But that didn’t happen. We did have a pull back then but that pull back stayed above the rising trend line. Now we have some more signs of a top and some of these are pretty convincing, but the market makes the final decision in all this and the market may want to go higher. Even so and based on a few things that have happened recently, this is a time to be hypervigilant.

On the daily chart below, I’ve labled the candle from May 22nd as an upthrust. Per Richard Wyckoff, an upthrust occurs when the markets rally hard intra-day on heavy volume and then fall back and close near the open and then this candle, which is just a shooting star, needs to be confirmed the following day with a lower close. Obviously that isn’t exactly what happened on the 22nd as $SPX closed down 13pts when Bernanke hinted at the possibility of tapering his bond buying, but we did get the confirmation the next day with a lower close.

Back on October 11th, 2007, we had a similar candle on 3billion shares when average volume at the time was around 2.3billion. This candle didn’t get confirmed until October 13th, two days later. Still, the out-of-the blue high volume and the long wick of the candle from the 13th were red flags. In no way did that candle from October 11th, 2007 foretell a drop of nearly 1000 $SPX points. All that it did at the time was warn of the potential for a top of one degree or another.

These kinds of candles appear all the time. Most are just one day events that never get confirmed, but this one from May 22nd has been confirmed and if nothing else it is a red flag. Since the appearance of this upthrust candle, the $SPX has only dropped about 2% and after such a huge rally off the November lows this is really nothing more than a hiccup. But, as you can see on the chart, we’ve already had the first phase of a sell signal and the trend line is just a few points lower right with the 50MA at 1599. Also note on the chart that the ADX line has peaked and has been rolling over since the 24th.

All of the above suggests that the market has topped out for now and that one should prepare for a down turn of one degree or another. The wild card is going to be how the market deals with the threat of a throttle down of the Fed funds that have supported and pumped this market since March of 09′. I am currently of the opinion that the market is going to drop considerably and that it will enter Bear Market territory in the next few months. I am concerned that we could witness a long drawn out top similar to the ones that started in early 2000 and late 2007. But I don’t have a crystal ball and I could be and probably am wrong in worrying about any kind of major decline. Even so, I will worry until events prove my worries to be unfounded.

Also, this signal would be negated and proved false should $SPX close above 1669.16, the close from May 21st, 2013 before it makes any more new closing lows below the most recent closing low of 1630.74. So, if $SPX 1669.16 is taken out on a closing basis, then that would prove that the market can and wants to go higher. On the other hand, a close below 1630.74 will show that the market can and wants to go lower as this would set up a scenario where we have a series of lower highs and lower lows, essentials of a down trend.

Chart courtesy of Stockcharts.com

Stock market history doesn’t always repeat, but it always catches up.

GL and be careful in the next few days and weeks.

February 22nd:

Removing chart of $NYA and replacing it with chart of $SPX.

At this point, everyone must be wondering if the market is ever going to top or if it’s just going to head north into the stratosphere. I don’t have any idea, however, we should get a much better idea about what’s going to happen next in the market by the end of trading on Friday, March 1st. If we get new closing highs in the $SPX with corresponding new highs in the RSI, CCI and the ADX, then we’re headed higher. On the other hand, if we get new closing highs in the $SPX but not in the RSI, CCI, and ADX then we are probably going to see the $SPX and other indexes roll over for a pull back of one degree or another.

*     *     *

The following information is based on data available as of February 8th, 2013:

Spotting market tops is the hardest job on Wall Street. I’ve seen so many people, including myself,  call tops only to see the market go significantly higher in the following days, weeks, and months. I heard Friday morning that Doug Kass, who I think is a perma-bear, added to a short position in the SPY Friday, February 8th, before the open. I don’t know much about Mr. Kass but I’m sure he has a newsletter and charges for his services so I have to think that several hundred other people added to their short positions right along with Mr. Kass. With $SPX up 6% so far this year, others may be thinking the rally can’t last and are going short, as well. And, of course, the market needs the shorts because it is their ‘forced’ buying-to-cover that often fuels the market higher.

Belief without evidence is a crippling handicap that most humans suffer from. People believe all kinds of things for which they can provide no evidence and yet they will fight to the death to defend these beliefs. When it comes to putting money at risk in the stock market, belief without evidence can blow up your account in nothing flat. In order to survive in the market, one must set aside ‘belief without evidence’ and replace that with as much objectivity as is possible so that charts can be viewed in the proper light. But I digress.

The point of this page is to offer up some things to watch for when the markets seem to be getting a bit too frothy. But a frothy market is an exciting market and becomes its own self-fulfilling prophecy as money on the sidelines is drawn in by those fearful they’re missing out on an easy money situation and this new money can extend a rally long past its due date. Still, there are always clues to watch for.

On the $SPX daily chart below, you will see the RSI 14, the CCI, the 20,20 Stochastic, and Wilder’s ADX. For the purposes of this discussion, I will will only be referring to the RSI, CCI, and ADX.

What I’m looking for is negative divergence in the RSI 14 and the CCI. This is what Welles Wilder refers to as a ‘failure swing’. By this I mean that $SPX makes a new closing high but this is not confirmed by the RSI 14 and/or the CCI. Next, I’m watching the ADX line for a turn south from a level above 30 as this would indicate that the current trend is over.

I have noted the closing price on $SPX for January 29th and February 1st. Below those closing prices I have noted the closing values for the RSI 14, the CCI, and the ADX.

It’s pretty easy to see that while the $SPX has made two new closing highs since January 29th, neither the RSI 14, nor the CCI are confirming. This seems to be a cut and dry case for a market top of one degree or another, but it is never that simple. However, this is definitely a red flag warning for now and can only be negated if the RSI and CCI rise to new highs above those of January 29th as the $SPX continues to rise. But if that does not happen in the next several sessions, then a high probability for a market top exists.

The ADX line peaked at 37.02 this past Wednesday, the 6th. It has since rolled a bit, though it is not decisive. Now it’s important to track the ADX to see if it reverses and goes to new highs or if it continues south. If it should continue south then it is warning that the trend for $SPX is changing. For more on ADX, watch this You Tube video.

Click on the chart to open a larger version in a new window.

Stealth Distribution: Even as the $NYA added 41pts on Friday, February 8th, the $TRIN closed at 1.17 in an instance of Stealth Distribution. One instance of Stealth Distribution is not enough to turn the market but should we get another instance during the first three sessions in the week of Februaray 11th, 2013, then that would have to be seen as another major red flag, especially in light of the negative divergences evident on the chart above.

But the market is full of tricks which is why calling a top is the toughest job on Wall Street so until you see the whites of the eyes of a reversal then all of the above is nothing more than pure conjecture. Still, until proven otherwise, you should be aware of and concerned about the negative divergences in the market at the present time. Also be aware of the fact that these negative divergences have a pretty good predictive history and that millions of other chartists around the world are watching this same set up. That in itself could lead to a sell off/self-fulfilling prophecy as market participants become more and more defensive ahead of what they believe is unavoidable DOOM.

Regardless of what does unfold during the week of February 11th, right now one should be cautious and avoid adding to existing long positions or initiating any new long positions because money in the market is money at risk and only the paranoid survive. This current situation will resolve itself some time in the week ahead and a better view of market direction will emerge. Once the dust settles and the smoke clears, you and I and everyone else will have a better idea about which way the market is going to go in the weeks that follow.

*     *     *

The above is meant to be used as a template for spotting market tops. The market will give us many more market tops in the future and so the parameters that I’ve outlined above can be applied to those future situations. You might want to set up a chart with the above indicators and go back and look at the September through November triple top as it is a text book example of how these negative divergences play out. Then go back and look at the March/April 2012 top for another example about how these negative divergences factor into market tops.

GL

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s