Panic Selling - Oversold Levels

Starting from the middle of July (see my DJI post on July 20, 2008) I have been accepting the high volume surges during the June-July 2008 market crass as extremely high panic selling that pushed the stock market into the heavily oversold stage. As a result of this heavy oversold level we had the recovery, yet, the recovery was not as strong as I expected. It's one and half month since the market hit the bottom and because of that I pushing myself to take another look at my longer term charts to see if there are any changes in the stock market sentiment.

By analyzing the S&P 500 and DJI indexes we may see a lot of similarities, yet, the Nasdaq 100 1-year chart has completely different picture.  No wonder that over the last month we had a lot of trading session when the Nasdaq 100 index was trying to push the market in one direction while the S&P 500 and Dow Jones Industrials were struggling to run in opposite direction.

The technical indicators on the Nasdaq 100 chart (see my set of indicators in the "New Highs/Lows" post on August 12, 2008) are not very optimistic at that point of time. Because of the last two weeks, the technical analysis of the Nasdaq 100 index gives the Bearish outlook. Taking into account that in July 2008 the Nasdaq 100 companies were not as oversold as the S&P 500 and DJI stocks it make the picture for the Nasdaq 100 even more Bearish.

At the same time the S&P 500 and DJI technical analysis still points to the higher odds of the Bullish market. In addition to the technical indicators, if I start to compare the January and March 2008 S&P 500 volume surges (panic selling) with July 2008 volume I clearly see that panic selling in July was far more extreme than in January which leads me to assume that in July the stock market reach stronger oversold levels than it was in the beginning of the year. As a result of the January and March oversold levels we had strong recovery where the S&P 500 run more than 10% up. Now, when I saw several times stronger oversold levels the S&P 500 recovered only around 7%... For me it's difficult to accept that this is over and overall, I still believe that the market has more room for recovery, and my longer term mood is still bullish. Yet, the further we go from the middle of July (bottom of the stock market crash) without recovery, the more often I will be looking at the longer term charts to see if there is any changes in the market sentiment.

DJI Chart

Nice week. From y last "S&P 500" post you may see that I expected some correction and we had it. Yet, the longer-term up-trend pushed the stock market higher by the end of the week. (refer to my 1-year technical analysis in my "New Highs/Lows" post on August 12, 2008 and my "DJI" post on July 20, 2008).

My outlook over the longer-term stays unchanged. The same as before I believe that the high volume surges in June-July 2008 have power to push the Nasdaq 100, S&P 500 and DJI indexes and the whole market much higher.

With shorter-term, I only may give one advice to monitor charts on the daily basis. For those who analyze charts, the Monday-Tuesday slide should not be a surprise, as well as Thursday-Friday recovery was clearly defined by the technical indicators. If today my 60-day technical analysis points to the higher odds of the further recovery (see chart below), it does not mean the the same technical indicators will be bullish the whole next week. The technical indicators on the 60-day chart can turn from bullish into bearish any time during the week. That's why I always say "do not trust my judgment, do your homework yourself and do it on regular basis. You skip it, you lose it. If you skip and did not lose that mean that you were lucky and next time you may lose even more...".

Ok, back to the 60-day chart I may say that all three indexes S&P 500, Dow(30) and Nasdaq 100 have almost similar sentiment on all technical indicators:

• SBV - Bullish - The SBV is moving up;
• MVO - Bullish - the last high volume surge is red - during the price decline;
• Advance-Decline Issues Oscillator - Bullish - The AD Oscillator is on up-side;
• RSI and Stochastics - Bullish - The RSI and Stochastics are above70 and 80 levels respectively;
• MACD- Bullish - The MACD is advancing;
• McClellan Oscillator - Bullish - The McClellan Oscillator is on its way up.

Chart 1: DJI 60-day chart with elements of technical analysis

S&P 500

In my last "New Highs/Lows" post on August 12, 2008 I have reviewed my longer term outlook based on technical analysis of 1-year index charts with mentioning that over the shorter term I see oversold levels on Nasdaq 100, S&P 500 and DJI indexes - we saw a dive on the market on August 13 with some recovery by the end of the week.

In majority cases the reversal point after down trend (support) is very sharp and sudden. In opposite a reversal point after uptrend (resistance) is not as volatile and as a rule spread over the time when we may see almost flat market. We had up-move after August 1st and then some decline with Flat market after August 11th.  Now, my shorter-term main question is "Does the market released the oversold pressure over the last week and now it's ready for go further up? or the stock market levelled the indexes before deeper slide?". Keep in mind that I'm referring to the shorter-term trends. My longer-term technical analysis is basically unchanged and I still in Bullish mood and believe in higher odds to see the indexes higher than they are today (refer to my 1-year technical analysis in my "New Highs/Lows" post on August 12, 2008 and my "DJI" post on July 20, 2008).

Chart 1: 60-day S&P 500 Chart technical indicators

From the chart above I may see that my S&P 500 technical indicators are bullish, yet, some of them close to become bearish:

• SBV - Bullish - The SBV moves up pointing to the positive sentiment;
• MVO - Bearish - The MVO shows high volume surges during the recovery in the period from July 22, 2008. Each time after such volume surge we saw small correction, however, we did not see high volume surges during these corrections (absence of red MVO). From one side it tells us that high volume surge during the up-move is needed to push the S&P 500 index down, yet much smaller volume is needed to reverse the S&P 500 index back into up-trend and this fact confirms my longer term outlook. Yet these volume surges are making an input into moving the index into oversold levels which may push the market into stronger correction;
• Advance-Decline Issues Oscillator - Bullish/Bearish - The AD Oscillator is at high positive level, yet it started to move down by pointing to the possible beginning of the changes in the sentiment towards the declining stocks;
• RSI and Stochastics - Neutral - The RSI and Stochastics are on the edge of 70 and 80 levels respectively. Should they start to move down it may point to Bearish trend. Should they go back above their critical lines it would point to the possibility of further Bullish trend;
• MACD- Neutral - The MACD is flat and basically neutral;
• McClellan Oscillator - Bullish - The McClellan Oscillator is on its way up and is Bullish at this point of time.

The DJI 60-day chart looks similar to the S&P 500 chart above. Yet, the Nasdaq 100 60-day technical analysis is more negative by pointing to the higher odds of a possible slide into correction. For the Nasdaq 100:

• SBV - Bearish - The SBV moves down;
• MVO - Bearish - The MVO shows absence of red (high volume during the price drop) and shows a lot of green (high volume during the price rise);
• Advance-Decline Issues Oscillator - Bearish - The AD Oscillator is on its way down;
• RSI and Stochastics - Bearish - The RSI and Stochastics dropped below 70 and 80 levels respectively;
• MACD- Bearish - The MACD is on the down side;
• McClellan Oscillator - Bullish - The McClellan Oscillator is on its way up, yet it is still below zero line.

Overall, by analyzing 60-day technical indicator I may say that I see the possibility of the correction down, yet, at the same time I see the possibility of the scenario when the market can ignore the Nasdaq 100 bearish indicators and move up under the pressure of the Bullish parent longer-term trend. I would say that for me, the shorter term trend is undefined at the current moment and one of the conservative strategies in such situation could be staying in cash until I see the Nasdaq 100 become bullish or the S&P 500 and DJI more bearish.

Technical Analysis - New Highs and New Lows

As I mentioned several times I believe that it is important to understand the nature of the technical studies in order to properly use them in technical analysis. Use of indicators without understanding the principles that move them may lead into situations when a trader starts to blame an indicator for fake signals.

New Highs & Lows indicators are from the group of Breadth indicators and they represent the number of all stocks reaching the new 52-week highs or lows. These indicators are applied to the indexes and exchanges only (to the basket of stocks) - they cannot be applied to an individual stock.

Initially the New High/Lows indicators were applied to the New York Stock Exchange (NYSE). Now many traders started to apply it to the S&P 500 index which is well known as one of the best indexes reflecting stock market sentiment.

So what does New Highs and New Lows show?

I would set 4 basic principles behind these indicators which summarize my understanding of the New Highs and New Lows based technical studies:

1. When we see that the number of new highs increases and the number of new lows decreases during the price advance we have to understand that the bullish sentiment is dominant on the market. Basically we see that the number of stocks making new highs (moving up) increases and it attract investors to play up. Every day we see more and more stocks involved into uptrend and there is a possibility that the index will continue to move up.
2.  When we see that the number of new highs declines and the number of new lows raises during the price drop we have to understand that the bearish sentiment is dominant on the market. Basically we see that the number of stocks making new lows (moving down) increases and it attract investors to play down and possibility of further crash is still high.
3.  When we see that the number of new highs started to decline and number of new lows started to raise while the index price is still moves up we may tell that some stock from the index basket started to drop after being overbought and this change in the sentiment may involve other stocks into declining movement which may lead the index into the recession.
4.  When we see that the number of new lows started to decline and number of new highs started to raise while the index price is still moves down we may tell that some stock from the index basket started to advance after being oversold and this change in the sentiment may involve other stocks into a recovery process which may lead the index and majority of stocks from this index into the new up-trend.

here are 2 popular technical indicators based on the New- Highs and New Lows numbers - New Highs/Lows Oscillator and New Highs/Lows Ratio:

New High/Lows Oscillator = New Highs - New Lows

New High/Lows Ratio = (New Highs - New Lows) / (New Highs + New Lows) * 100

By applying the principles discussed above to the oscillator and ration we may say that:

1. When then the New Highs/Lows Ratio or Oscillators moves along with a price moving average (price trend) it confirms the current trend.
2.  When we start to see the divergence between the New Highs/Lows Ratio or Oscillators and price moving average it could signal about coming trend reversal.

Comparison of the New Highs/Lows to the behavior of the price moving average helps to look beneath the surface and can often warn about coming trend reversals. Yet, investors should be very careful with applying New Highs and New Lows based technical indicators to the basket with the small number of stocks. Such indexes as Dow Jones Industrials (DJI - basket of 30 stocks), Dow Jones Utilities (DJU - basket of 15 stocks) and Dow Jones Transportation (DJT - basket of 20 stocks) may lead to confusion since in majority of the cases we may see only making New Highs (New Lows = 0) or only making New Lows (New Highs = 0) stocks. To simplify the analysis and help with analysis of the small basket indexes, the moving average could be applied to the New Highs/Lows based technical studies.

Another point is that an investor (trader) should understand that New Highs/Lows indicators are based on the daily data and it could be difficult to use them on the intraday level. It would be logical to use them on charts where 1 bar equal at least to 1 day - lower timeframes become less informative.

New Highs/Lows

I missed my weekly post and I do it now. There were not a lot of changes in the sentiment on the market and my bullish technical indications described in my "Short-Term Technical Analysis" on August 5, 2008 post pushed all the indexes (including the Nasdaq 100, S&P and DJI) higher.

Now, looking on the past week you may see that short-term trading strategy based on the longer-term technical analysis could be successfully used if this technical analysis is correct (see my "Simple Trading Strategy" post).

Going back to my longer 1-year charts I do not see any changes in the bullish sentiment. So far, all indicators point to the good odds that we may see the stock market higher.



This time I have added New Highs/Lows Ratio - another breadth indicator that is used in technical analysis to confirm a trend as well as to spot reversal points. The New Highs/Lows Rule tells us that when we see increasing number of stocks that are making new 52-weeks highs (New Highs/Lows Ratio is increasing) we have confirmation of the up-trend and when we see that this number starts to decrease we should be worried about possible changes in the market sentiment and trend. So far, this indicator is bullish as well.

I think a trader should not be afraid to use several technical indicators. The more indicators are used the more informed trading decision could be made. Of course, with many indicators there could be situations when they all point in different directions and some traders could be confused and even desperate by this. I would say in this situation "Stop trading, take a few days vacation until you see a clear picture again". I consider professional traders those traders who knows when to trade and when to stay in cash and who can stay in cash long enough do not make a wrong step.

So, my longer term technical analysis shows me that the stock market still has room for further recovery. Yet, when you look at longer-term chart I would recommend comparing different indices - you may notice that the Nasdaq 100 index is not as oversold as S&P 500 and DJI indexes (see my previous post), on the other hand the Nasdaq 100 does not include financial companies...

Even if my longer-term charts point towards up-trend it does not mean that tomorrow we will see rising market. For tomorrow outlook, when I analyze 60-day chart I see that the indexes are oversold in short term. We already had first day of decline today and it would be nice before making any assumption on what I wrote to take a look at smaller time frames.

Simple Trading Strategy

Nice day. What can I say, see my last "Short-term Technical Analysis" post. Pressure of the longer-term oversold levels pushed the market strongly higher. Today, shortly after the market open all short term technical indicators were extremely bullish and the stock market (all indexes - DJI, Nasdaq 100, S&P 500 and other) recovered in the strong rally.

There is a golden rule "never play against a trend", yet, I have never seen anyone who would explain what does it mean and how it could be used on practice. In my understanding this rule could be used in building a simple trading strategy: ignore signals generated by shorter term indicators if they suggest to trade against the longer term indicators and trade only those shorter term signals which go along with longer term technical indicators.

If based on the technical analysis of 1-year chart a trader have made an assumption that this chart suggest that the market is heavily oversold, then this trader may say that all signals generated by the 60-day chart (shorter term chart) to open a short trade (signals to sell short) should be ignored, while any bullish indication (signals to buy) on the 60-day chart could be used to open a long position. This is my interpretation of the "never play against a trend" rule.

I could be wrong, yet I do not understand those traders who build their trading systems based on one timeframe only. For me it's walking in the "dark room". That is why I analyze several timeframes simultaneously.

Short-term Technical Analysis

Last week in my "S&P 500 post" based on the 60-day technical analysis I have mentioned that the stock market has potential for further slide, yet, not a deep one. The market continued to drop on Monday July 28, 2008 and on Tuesday it is already started its recovery movement.

Now, again by looking at the 60-day chart I am not very optimistic. Again the same as on the last week I may see that over the shorter term I see more overbought indicators that may push the market lower to retest the July 15, 2008 lows. All three major US indices - DJI, Nasdaq 100 and S&P 500 - the 60-day index charts show me that

• SBV oscillator declines,
• McClellan Oscillator declines,
• Advance-decline oscillator declines
• we have high positive MVO on July 23rd and July 30th with absence of the Negative MVO
• Stochastics is below 20

On the other hand I see some positive movement in the MACD and RSI started to advance.

In summary, over the shorter term, the high positive MVO shows that there is a possibility of a slide and now overbought levels are stronger than we had last week.

However, the longer-term charts (1-year charts) still indicate high oversold levels for the S&P 500 and DOW(30) indexes (the Nasdaq 100 companies are not as oversold as the rest of the market). The only negative sign on this chart I see is the fact that the SBV oscillator started to decline.

So, what it is going to be? Will the market slide based on the 60-day technical analysis, or will it ignore shorter term technical indicators and will run higher based on the 1-year oversold levels?

I would put it in the following form: yes, I think the during June - July stock market crash we saw very strong volume surges which indicate extremely panic selling and which tell me that in that period some part of investor (who has enough funds to satisfy the panic selling demands during the crash) were buying. Based on this, I would assume that even if the market slide down towards the July lows, it still has a potential to be higher than it  is today simply because those traders who wanted to sell already sold in panic during the June - July. The ideal picture that I would like to see is a slide with the high volume (low negative MVO) and then strong reversal. Yet, I still consider a possibility that shorter term oversold levels could be ignored and the market can move higher.

I'm sorry, I do not present a chart today. You may check the chart by yourself. As a reference, you may see the 60-day chart setting I use in my last week post and my 1-year chart settings in my DJI post.