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DIVERGENCE INDEX


Four Stock Topping Signs

02/04/13 09:02:59 AM
by Matt Blackman

Stocks have registered impressive gains since the beginning of the year, but the rally is showing definite signs of strain.

Security:   DJ-30, DJ-20, EEM, VIX
Position:   N/A

In the first 19 trading days of the year (ended January 30), the Dow Jones Industrial Average (DJIA) registered an impressive gain of 6.1%. And according to two well-known indicators (see my Traders.com Advantage article, "Two Market Forecasting Tools For 2013" http://goo.gl/LRjBb), this performance greatly increases the chances that 2013 will be an up year for stocks. However, after the strong gains enjoyed since mid-December, stocks began showing signs of topping.


Emerging markets flashed the first signs of negative divergence. As we see in Figure 1, the iShares MSCI Emerging Markets Index Exchange Traded Fund (EEM) has been dropping despite the recent strength in one major emerging market index, China's Shanghai Shenzen Composite Index.

FIGURE 1: DJIA VS. DJTA VS. EEM. Hourly chart of the DJIA with the DJTA and the EEM showing the negative divergence of the latter two with the first.
Graphic provided by: TC2000.com.
 
Next, the Dow Jones Transportation Average (DJTA), which began falling January 29 followed by a 91-point (1.54%) drop on January 30 versus a less severe drop of 32 points (0.32%) in the Dow Jones Industrial Average (DJIA), provided the start of another negative divergence. Weakness was further confirmed by the short but steep bearish rising wedge in the DJIA, supported by falling volume over the last four weeks since the formation began (see Figure 2).

FIGURE 2: DJIA, WEEKLY. Weekly chart showing the DJ-30 versus the VIX showing how it rose ahead of each peak in the DJIA over the last two years together with the bearish rising wedge on the Dow.
Graphic provided by: TC2000.com.
 
Another topping sign came from the CBOE Volatility Index (VIX), which hit a 68-month low on January 22 but then rose more than 15% over the next six trading days. The last time investor complacence as measured by the VIX was this low was on June 1, 2007, and we all know what happened not long afterward.

Taken individually, these signs should not be of great concern to traders. But given that these four warnings have occurred together is another matter. It might not be a bad idea for those who have not yet done so, to consider taking some money off the table or at the very least tighten your stops.



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

Company: TradeSystemGuru.com
Address: Box 2589
Garibaldi Highlands, BC Canada
Phone # for sales: 604-898-9069
Fax: 604-898-9069
Website: www.tradesystemguru.com
E-mail address: indextradermb@gmail.com

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