A Stock Market On The Verge Of Collapse

11/30/09 01:04:43 PM

by Alan R. Northam

There are four basic analytical tools an analyst uses to measure the health of an individual stock or the stock market as a whole. One is price patterns, one is momentum, another is volume, and the final one is breadth. By using these four tools we can note whether the stock market is on the verge of collapse.

Security: SPY
Position: N/A

Figure 1 shows that the Standard & Poor's 500 exchange traded fund (ETF) (SPY) has been forming an ascending broadening wedge (ABW) price pattern over the last three months. An ABW price pattern normally develops at the end of a trend and is therefore known as a trend ending pattern. ABW patterns are made up of two upsloping lines close together at the start of the formation and move away from each other as the pattern continues to develop. As long as the daily price bars continue to swing up and down and touch the boundaries, the ABW formation continues to develop. However, when a partial rise occurs -- a move upward that does not touch the upper boundary of the ABW pattern -- a warning is given that the ABW is ending. The ABW is completed once price moves below the lower boundary of the price pattern. Note that the latest upward rally from early November has stalled before touching the upper boundary of the ABW pattern, thus warning of a partial rise and the ending of the rally off the March lows.

FIGURE 1: SPY, DAILY. Here's the ABW price pattern, the MACD a measure of price momentum above the price chart, and OBV, a measure of volume below the price chart.

Graphic provided by: AmiBroker.com.

Figure 1 also shows five short-term rally peaks, two in August, one in September, one in October, and the final one in November, which has not yet been completed. At the peak of each of these five rallies, I have shown the ratio of the number of advancing stocks divided by the number of declining stocks. This ratio is a measure of the market breadth and indicates when there are more stocks moving higher than are moving lower, the market is in an uptrend, and when there are more stocks moving lower than are moving higher, the market is in a downtrend.

Looking at the price peaks in August, note that there were 10.1 and 3.7 times as many stocks advancing as were declining, respectively. This measure of market breadth shows that the stock market was advancing in August as there were 10.1 times as many stocks moving higher than were moving lower in early August and 3.7 times as many stocks moving higher than were moving lower in late August. In September there were 6.2 times as many stocks moving higher than were moving lower.

In October, things started to change. By mid-October there were only 2.1 stocks advancing for each one declining. The stock market was still in an uptrend but the number of advancing stocks compared to those moving lower had started to decrease. In November, things took a turn for the worse, with only 0.7 stocks advancing for each one declining. This ratio indicates that there are now more stocks declining than are advancing, a warning of a major trend change taking place.

Figure 1 also shows the moving average convergence/divergence (MACD) above the price chart. I like to show momentum indicators above the price chart and volume indicators below. The MACD, a momentum indicator, is made up of a 13-day exponential moving average (EMA) and a 34-day EMA. The 12- and 26-day EMAs are the default values, but I prefer the 13- and 34-day EMAs. The 13-day EMA moves up and down along with the closing price at a faster rate than does the 34-day moving average. Therefore, by measuring the difference between these two moving averages, the analyst can determine if these two moving averages are moving closer together (converging) or moving further apart (diverging), hence the name MACD.

When the two moving averages are moving away from each other, the MACD line moves up, indicating that price is in a healthy rally, and when the two moving averages move toward each other, the MACD line moves downward, indicating that the rally is slowing down, and thus the upward and downward movement of the MACD is a measure of price momentum.

Figure 1 shows that from early August, the MACD has been moving lower while price continues to move upward. This shows that over the last four months, the upward rally in price has been slowing down or decelerating. This deceleration of price normally occurs at the end of a trend and is a warning that the market is on the verge of reversing its direction.

Figure 1 also shows the on-balance volume (OBV) indicator below the price chart. The OBV is a measure of the net total volume of the market or stock being analyzed. For example, if today the market moved higher, then its volume is added to the previous total of volume. However, if today the market moved lower, then its volume is subtracted. When the OBV moves upward, it indicates that there is more buying volume than selling volume and buyers are in control of the market. When OBV moves downward, it is just the opposite with more selling volume than buying volume and sellers are in control of the market. From Figure 1, note that OBV has not made a new higher high since mid-September, while price has continues to move higher. This is an indication that the number of shares of stocks is not expanding along with price; a sign of a weakening market.

In this analysis we have looked at price patterns, momentum, volume, and breadth. The ABW price pattern indicates that the upward trend is in its ending stage. Momentum, as measured by the MACD, warns that the upward rally in price is slowing down, a normal occurrence before a price reversal in trend. Volume, as measured by the OBV, indicates a stock market that is weakening due to a lack of expanding number of stock shares being purchased. Breadth also shows that there are now more stocks moving lower in price than are moving higher. These four measures of the stock market all point to a stock market that is on its last leg upward and on the verge of collapse.

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.

	Garland, Tx
Website:	www.tradersclassroom.com
E-mail address:	inquiry@tradersclassroom.com

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Comments

Date:�12/01/09Rank:�5Comment:�

Date:�12/03/09Rank:�5Comment:�Great article. I tend to have a problem with the following part, though (regarding OBV): From Figure 1, note that OBV has not made a new higher high since mid-September, while price has continues to move higher. From looking at this basic chart, it seems that the OBV has made a new high recently. http://screencast.com/t/NThkN2ZmNjUt

Date:�12/05/09Rank:�5Comment:�

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A Stock Market On The Verge Of Collapse

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