Last week here I discussed how the start of the week would likely determine the next short term move. On Monday after failing to move higher and based on the instances I highlighted in that post, we were able to determine the risk/reward favored a further pullback. On Monday I tweeted out: 
In that case things worked out nicely as we did end up going lower last week. Rarely do we find ourselves again in a similar position where the next move will likely be determined by the Monday or Tuesday trading session. It can be a bit unnerving to not know or be able to determine the short-term trend; however, it also allows us more short term trading opportunities if we know what to look for to catch onto the next move early on. The following will provide correlations over the past two years that can help us find that next move.
Oversold Readings: Below is a chart that shows how oversold we got when looking at 20-day highs in comparison to other dips during the last year. 
As you can see above we recently had several days where less than 5% of stocks in the S&P 500 were trading at 20-day highs. This shouldn’t come as a surprise, as it is nothing new to see breadth deteriorating to such extreme levels. Below is a chart that displays all the times that 20-day highs went to or below 5% (green dashed lines) in the last year. Even more extreme measures where 20-day highs registered at less than 2.5% are shown in grey. Only once in the last year (January) did we get three readings below the 2.5% reading within the same dip. We have already had two in this most recent dip of -2.6%, whereas the January dip that had three sported a correction of 6% (the second extreme reading in January was after a 4.2% correction). On the surface we can see that each correction seems more shallow in price yet deeper in breadth readings.
Furthermore, all corrections in the last year have never had more then five 20-day high readings beneath 5%. We have already had four in this most recent pull-back. Thus, unless a real change in character is taking place, the risk reward favors either upside from here or one more lower low that will likely set up a great long opportunity to new highs. 
The Importance of the 50-Day Moving Average: In the chart below I marked every occasion that price closed above the 50-day MA after a pull-back since November of 2012. As a reminder, the reason I focus on examples in the last two years is because the last two years have continually been a buy the shallow dip market. Until that changes, taking clues from similar situations has worked in determining the next move. In every instance that the market dipped below the 50-day MA, once it moved back up and closed above it, the market went on to make new highs (green lines). The exception was in November of 2012 where price closed back above the 50-day MA three times (grey line) before staying above it and then moving on to new highs.
The Takeaway: The S&P 500 has already registered four readings with 20-day highs being under 5% and two extreme readings being under 2.5%. Furthermore, price closed above the 50-day MA on Friday after a dip below that only lasted a day. Given the most recent examples that look similar to the recent pull-back (albeit the actual percentage of the pull-back) the risk/reward favors continued upside. However, before getting ahead of ourselves and assuming next week will be bullish, the best approach is to gauge how price acts at the start of the week. If we remain above the 50-day moving average then it’s possible seasonality (typically not bullish till mid-October) kicks in earlier this year. If, on the other hand, we drop back below the 50-day or stay very close to it and vacillate from over to under it then the odds increase that we will make a lower low before continuing back higher.
Longer Term Implications of Breadth: The long term implications of breadth continuing to deteriorate more profoundly with less shallow retracements in price can be argued from both the bearish and bullish case. The bearish case is that price will not be able to sustain itself with constant extreme breadth readings that are getting worse. The bullish case is that the market is correcting under the surface so that it doesn’t have to in price. You have probably heard “correcting through time, not price” before. The longer term bullish case would suggest we are “correcting through internals, not price” (can I trademark that if it works out?)
Good luck next week!
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Determine Your Next Market Move
In that case things worked out nicely as we did end up going lower last week. Rarely do we find ourselves again in a similar position where the next move will likely be determined by the Monday or Tuesday trading session. It can be a bit unnerving to not know or be able to determine the short-term trend; however, it also allows us more short term trading opportunities if we know what to look for to catch onto the next move early on. The following will provide correlations over the past two years that can help us find that next move.
Oversold Readings: Below is a chart that shows how oversold we got when looking at 20-day highs in comparison to other dips during the last year.
As you can see above we recently had several days where less than 5% of stocks in the S&P 500 were trading at 20-day highs. This shouldn’t come as a surprise, as it is nothing new to see breadth deteriorating to such extreme levels. Below is a chart that displays all the times that 20-day highs went to or below 5% (green dashed lines) in the last year. Even more extreme measures where 20-day highs registered at less than 2.5% are shown in grey. Only once in the last year (January) did we get three readings below the 2.5% reading within the same dip. We have already had two in this most recent dip of -2.6%, whereas the January dip that had three sported a correction of 6% (the second extreme reading in January was after a 4.2% correction). On the surface we can see that each correction seems more shallow in price yet deeper in breadth readings.
Furthermore, all corrections in the last year have never had more then five 20-day high readings beneath 5%. We have already had four in this most recent pull-back. Thus, unless a real change in character is taking place, the risk reward favors either upside from here or one more lower low that will likely set up a great long opportunity to new highs.
The Importance of the 50-Day Moving Average: In the chart below I marked every occasion that price closed above the 50-day MA after a pull-back since November of 2012. As a reminder, the reason I focus on examples in the last two years is because the last two years have continually been a buy the shallow dip market. Until that changes, taking clues from similar situations has worked in determining the next move. In every instance that the market dipped below the 50-day MA, once it moved back up and closed above it, the market went on to make new highs (green lines). The exception was in November of 2012 where price closed back above the 50-day MA three times (grey line) before staying above it and then moving on to new highs.
The Takeaway: The S&P 500 has already registered four readings with 20-day highs being under 5% and two extreme readings being under 2.5%. Furthermore, price closed above the 50-day MA on Friday after a dip below that only lasted a day. Given the most recent examples that look similar to the recent pull-back (albeit the actual percentage of the pull-back) the risk/reward favors continued upside. However, before getting ahead of ourselves and assuming next week will be bullish, the best approach is to gauge how price acts at the start of the week. If we remain above the 50-day moving average then it’s possible seasonality (typically not bullish till mid-October) kicks in earlier this year. If, on the other hand, we drop back below the 50-day or stay very close to it and vacillate from over to under it then the odds increase that we will make a lower low before continuing back higher.
Longer Term Implications of Breadth: The long term implications of breadth continuing to deteriorate more profoundly with less shallow retracements in price can be argued from both the bearish and bullish case. The bearish case is that price will not be able to sustain itself with constant extreme breadth readings that are getting worse. The bullish case is that the market is correcting under the surface so that it doesn’t have to in price. You have probably heard “correcting through time, not price” before. The longer term bullish case would suggest we are “correcting through internals, not price” (can I trademark that if it works out?)
Good luck next week!
For daily analysis, stock and options ideas check out my subscription.
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