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DIVERGENCE INDEX


Can Financials Provide Warning Of A Market Top?

06/16/11 08:07:38 AM
by Matt Blackman

In past market tops, the financial sector has turned down first. It happened in the October 1987 meltdown and again at the 2000 top. So how has the financial sector been doing lately?

Security:   GSPF
Position:   N/A

One financial news analyst commented recently that when financial stocks weaken ahead of the broader market, it usually spells trouble. As we see from Figure 1, financials weakened ahead of the Standard & Poor's 500 at both the 2000 and 2007 market tops (see trendlines in the ellipses), which traders call negative divergence. Although the SPX has rebounded more than 80% since the 2009 bottom, financials have regained just 35% of the territory they lost in 2007 and 2008. And while the S&P 500 rallied strongly from mid-2010, financials have been essentially flat.

Why is financial weakness a bad omen for the overall market? When banks and other lending institutions struggle, it generally indicates a challenging economic environment. But as technical traders, the reason for the rollover is less important than the price action itself.

Are there other signs that the market may be getting ready to change direction?


FIGURE 1: S&P 500, MONTHLY. The S&P 500 versus the financials in blue (GSPF).
Graphic provided by: MetaStock.
 
World record-stock trader Dan Zanger, host of Chartpattern.com and author of high-momentum stock newsletter "The Zanger Report," has commented that his fast-moving market leaders have been looking quite weak of late. He has made millions over the last two decades trading his volatile market leaders, letting his "frisky buddies" tell him which way the market is headed.

After suffering some big down days since May 31, both the Dow Jones Industrial Average (DJIA) and the S&P 500 ended basically flat on Monday, June 13. But a number of Zanger's market leaders lost ground, prompting Zanger to comment in his newsletter that "selling continues en masse even though my short-term trading tool stays at very oversold levels."

Zanger has even been on the hunt for some short trades in stocks such as Chinese Internet companies, Sina.com (SINA) and Baidu.com (BIDU), both well off their April highs. But for the most part, Zanger believes that cash is king right now. And he'll wait for his market leaders to tell him which side of the market to take.

He'll be watching to see what kind of rally the market leaders can mount on any bounces.

"If that fails to happen, it may be about time to put on some shorts," he says, adding, "Isn't summer just around the corner?"



Matt Blackman

Matt Blackman is a full-time technical and financial writer and trader. He produces corporate and financial newsletters, and assists clients in getting published in the mainstream media. He is the host of TradeSystemGuru.com. Matt has earned the Chartered Market Technician (CMT) designation. Find out what stocks and futures Matt is watching on Twitter at www.twitter.com/RatioTrade

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