Which Way Will the Market Go?

The recent rally has taken a pause at best, and perhaps the recent rally has run its course. While the market has declined for the past two days, today's decline was much larger than Monday, as the S&P fell by almost 20 points back to 815.6. How can we gauge whether this is the end of a rally or merely a pause in an uptrend?

Technical indicators are helpful for this. The following chart (click to enlarge) is the daily S&P performance over the past six months. There are two conflicting signals in this chart. First, note the performance of the RSI. While the S&P has recently risen sharply, that momentum was not confirmed by the RSI (see the lines in the chart). Recall, this is a bearish divergence. But if we work with moving averages, we get a buy signal. In the chart I have added the 20-day and 50-day moving averages. Notice that in the past few days, the 20-day has crossed above the 50-day moving average. This could potentially be considered a buy signal (recall: this is related to the average-marginal relationship we discussed earlier in the semester).

So, which indicator should we rely on? Since moving averages are lagging indicators and a bearish divergence of the RSI is a leading indicator, I would tend to go with the RSI's "signal." But that is still no guarantee that the rally is over -- it merely indicates a short-term pullback is in store which we are now witnessing.

In a situation such as this, you should look at weekly data for whatever information it contains, since weekly data does not contain as much "noise" as does daily price data. The chart below shows weekly S&P data (click to enlarge). I have added the 13-week moving average since this corresponds to a quarter. Note how well this fits the price data.

The weekly RSI shows very different momentum information than does the daily chart. Note the weekly RSI is far from overbought, and there is no bearish divergence. Actually, the RSI has failed for some time to move beyond 50, which would have indicated movement to more bull-market-type momentum.

In this situation, I recommend that you view an RSI value of 50 as resistance for the S&P's price movement. So, based on the weekly RSI, this rally failed at (RSI) resistance. I would only place bets on upward continuation when (and if) the RSI is able to sustain a break above 50. Were this to happen, daily data would clearly have to show an end to the recent pullback.

Follow Up on GE

A few days ago I wrote a post about a classic bottoming pattern displayed by GE. Now that trading for the week has ended, I want to quickly revisit GE. The chart shows price action for Thursday and Friday (click to enlarge):

Notice that GE outperformed the market on the two bad days that ended the week. Its relative strength (below chart) turned up signifying this fact. Also, while GE is still oversold, it is less oversold than it was on Wednesday. Finally, look at the price bars (I omitted volume to unclutter the chart). There are higher lows, which is good, but we have yet to exceed Wednesday's high.

The fact that GE's price withstood a big down day on Thursday is something to pay attention to. Keep checking to see how this plays out.

I will finish this post with a look at GE from a weekly perspective. How does this week's price action show up? The weekly chart is given below (click to enlarge).

Note that the price bar for this week has a large lower tail, indicating that the potential bottoming we observed with the daily charts is beginning to show up on the weekly level. Weekly volume also shows a surge, consistent with the daily result from Wednesday. Also, the RSI indicates that GE is the most oversold it has been since December (the period of this chart).

As a rule, you should always look at daily and weekly charts before deciding whether to purchase or sell stocks. Daily charts contain a lot of "noise," based on day-to-day fluctuations that might not reflect the overall trend. Weekly charts smooth the daily fluctuations out.

So, the weekly chart has not yet given a buy signal. We require confirmation of the pattern with price next week going above last week's high. How likely is this? I recommend checking the upcoming economic data for next week to see if any potential "land mines" exist. Then, follow the daily and weekly price data in that context.