Trend shifts to down; sell-off extremes hint at bounce

The trend has shifted down in most markets; both Nasdaq and SPX are closing in on point and figure sell signals following their prices falling below EMA 34. Small Caps have been correcting (and leading the trend change).

Advance-decline ratios have plummeted to the point where, in the past, a short-term low has been made. Reviewing past extremes of the McClellan Oscillator, a 3-4% bounce in equities would not be uncommon. Stocks over their 50-day moving average (especially the Nasdaq) have dropped precipitously and are ready for a bounce. The Put/Call close at 1.21 has signaled short-term bottoms before. While these are elements that can contribute to the trend change to down, they bode watching for signs of short-term extremes as precursors for a bounce (isn't November a typically strong month for stocks)?

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Trend remains up but breaks hint at continued retracement

In reviewing our Market Tour on Stockcharts.com, it has become evident that major indices are testing EMA 34 support (our preferred intermediate-term moving average) and breadth is declining to levels where SPX and Nasdaq retracements have ended. While jittery traders (and investors) take the opportunity to lock in profits, we plan to add to longs following some further shake-out in the equity markets over the very near term.

Caution for Longs

Continued deterioration in market breadth (as emphasized with a downtrend since early Oct in the McClellan Oscillator), widespread signs of divergence, an extremely oversold VIX and weak volume on equity gains have raised our caution level. We will refrain from adding longs, take some profits and set tighter stops.

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Rally continues; volume weak but breadth strong

The rally is broad and a firm uptrend continues. We will continue to add basing positions in strong relative strength stocks.

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Potential trend change in progress

Caution continues to be advised. Stops have been tightened, profits on longs taken, and short hedges established. Market breadth has weakened significantly; transports have led the Dow lower (weakening the Dow Theory buy signal established in July), and initial bear market rally targets have been met.

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Caution at these levels

Setting tighter stops and refraining from adding longs. The rally is in its very late stage. We will hold off hedging with short positions but simply tighten stops. VIX appears to be forming a double bottom; transports are diverging from the Dow's uptrend, and defensives are gaining. While we could see more money enter the market due to seasonal factors, we would rather play it safe.

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Healthy correction so far

Some positive breadth divergences as the major indices correct, coupled with modest volume on the selling, suggest that recent declines are part of a normal corrective pattern and do not comprise a major trend change. Our plan is to identify strong basing stocks with a plan to enter long once the selling finds support.

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