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MOMENTUM


Momentum Divergence In SPX

10/12/04 03:56:20 PM
by Arthur Hill

The followthrough for the Standard & Poor's 500 is falling short on momentum as a bearish pattern takes shape.

Security:   SPX
Position:   Sell

In Figure 1, the top chart shows the S&P 500 relative to the Nasdaq or the price relative. Note that the S&P 500 outperformed (while the Nasdaq underperformed) during the July-August decline and underperformed (while the Nasdaq outperformed) during the August-October advance. This shows that the S&P 500 does best when the Nasdaq leads or outperforms.

The August trendline break on the price relative coincided with the August reversal. There is now a trendline extending down from the September high and an upside breakout would be considered bearish for the index.

Figure 1: Standard & Poor's 500
Graphic provided by: MetaStock.
Graphic provided by: StockCharts.com.
 
Turning to momentum, we can see that the moving average convergence/divergence (MACD) formed a negative divergence over the last four to five weeks. While the index moved above its September high in October, the indicator failed to exceed its September high. This tells us that upside momentum is not as strong as it was in September.

The MACD moved down to its signal line (the nine-day EMA) over the last three days, and further weakness would confirm the negative divergence for a MACD sell signal.


Indicators and relative strength are important, but the price chart should also be considered. There are a couple of negative developments. First, the S&P 500 failed to move above its June high and formed a lower high (red arrows). Second, the pattern over the last three months looks like a rising wedge. These are typically bearish patterns and a move below the lower trendline would provide the first signal.

The stage is set for a bearish reversal. The MACD needs to move below its signal line, the price relative needs to move above the red trendline, and the index needs to move below the rising wedge trendline. Should all three conditions be met, the initial downside projection would be to the August lows.



Arthur Hill

Arthur Hill is currently editor of TDTrader.com, a website specializing in trading strategies, sector/industry specific breadth stats and overall technical analysis. He passed the Society of Technical Analysts (STA London) diploma exam with distinction is a Certified Financial Technician (CFTe). Prior to TD Trader, he was the Chief Technical Analyst for Stockcharts.com and the main contributor to the ChartSchool.

Title: Editor
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Date: 10/12/04Rank: 4Comment: 
Date: 10/14/04Rank: 3Comment: I have one issue with the Lower High on the index. There was a high in September that was also lower. By using such analysis the September high was bearish. But here we are in October with another high. Higher than the previous, but lower than the June high. Isn t it too presumptuous to assign bearish or bullish labels to this price high? It s natural for this to occur in a longer term bull flag, and who s to say which past high is relavent to this price high, since we haven t established any conspicuous trading at relative price levels to associate these past patterns. Educate me.
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