NASDAQ Rally Is Over

11/03/09 10:21:35 AM

by Alan R. Northam

The NASDAQ has broken down below its upsloping trendline, signaling that the upward rally off the March low has come to an end and a new trend has begun. Is this new rally a trading range, a more shallow upward rally, or a major trend reversal?

Security: !COMP
Position: N/A

In March 2009, the NASDAQ embarked on an eight-month upward rally. In hindsight it is possible to draw a trendline with three touches. It only takes two low points in a rally to define a trendline, the origin of the rally and its first reaction. However, when a market touches that trendline multiple times and then bounces off it, the market gives importance to that trendline. The trendline drawn on the chart in Figure 1 has been touched three times, indicating that this trendline is important to the market.

FIGURE 1: NASDAQ, DAILY. This chart shows a recent price breakdown of the trendline signaling the end of the March upward rally.

Graphic provided by: AmiBroker.com.

Figure 1 also shows that NASDAQ has recently broken down below this important trendline. When a market breaks down below an important trendline, that breakdown is important and should not be overlooked. That breakdown technically ends a trend and the breakdown of the trendline in Figure 1 ends the upward rally in the NASDAQ. However, it does not indicate a trend reversal but a change in trend. This new trend could be in the form of a sideways trading range or the beginning of a more shallow upward rally. A reversal of trend is identified when a market makes a new lower high followed by a lower low, according to the Dow theory. Thus, the NASDAQ has not yet formed a lower high followed by a lower low, indicating that the trend has not yet reversed to the downside.

One way to measure whether price is in a healthy upward rally is to measure the distance between a fast and slow moving average. When price is moving upward at a healthy rate of ascent, the faster moving average will move upward more quickly than the slower moving average and the distance between the two increase. This is what the moving average convergence/divergence (MACD) does; it measures the distance between a 13-day exponential moving average (EMA) and a 34-day EMA. When the MACD indicator is moving upward, it signals that the 13-day EMA is climbing at a faster rate than the 34-day EMA and price is in a healthy uptrend. However, when the MACD line is moving downward, it also indicates that the 13-day EMA is moving closer to the 34-day EMA and the upward rally in price is slowing down. The slowdown of price normally occurs before an important change in trend occurs. Figure 1 shows that from early August the MACD has been moving lower while price continues to move higher. This is an indication that the rate of ascent in price is slowing down, signaling an important change in trend ahead.

The on-balance volume indicator (OBV) is a measure of the accumulative sum total of volume. On days when the market closes above the previous day, that day's volume is added to the previous day's total volume and when the market closes below the previous day's close, that day's volume is subtracted. In this way, a total of overall volume is determined. When the OBV indicator is moving higher, it is an indication that there are more shares of stock being bought than are being sold. When the OBV is moving lower, the opposite is occurring and more shares of stock are being sold than is being bought. In an upward price trend, more shares of stock are purchased and the OBV moves upward to reflect this accumulation of stock, and in a downward price trend, more shares of stock are being sold and the OBV moves downward. As can be seen from Figure 1, the OBV looks to be forming a double-top reversal pattern. A breakdown below the low level of the OBV between the two tops will signal the completion of the double top, indicating that OBV is moving lower, further indicating that price has reversed to the downward direction.

In conclusion, the upward rally from March has now come to an end and a new trend is in its infancy. The MACD has been forewarning traders of this important trend change for several months. More recently, OBV has also been warning of an important change in the trend ahead when TOP 2 failed to make a new higher high. Unfortunately, it is too early to tell if this new trend will be a trading range, a more shallow uptrend, or a major trend reversal to the downside.

Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.