Important Lessons From Market Internals Now and the Prior Two Rallies into Resistance

Sep 16, 2010: 1:44 PM CST

With the market completing an almost exact push up to the S&P 1,130 level, as has been the case two times in the last two months, let’s take a look at the current state of market internal (divergences) and compare those to the prior two times to see if we can get insights into the future move the market is likely to make.

First, let’s see the “Bigger Picture” that the upcoming intraday charts will show us:

All other analysis aside, focus on the highlighted zones, which will be revealed in greater detail in intraday charts.

Reference my former post:  “Third Time’s the Charm?  The S&P 500 Daily Rally Pattern” for more details on the “Rally Pattern.”

The thinking is “It’s happened twice – it will probably happen again,” so let’s take a look at current market internals and compare what’s happening now to what happened internally during the June and July similar rallies.

First, the CURRENT picture of Market Internals:

The internals in all charts – created with TradeStation – show the NYSE Breadth, TICK, and Volume Difference (of Breadth).

Generally, you want to see Internals RISE with price rises as a confirmation, but if internals FALL as price rises into an over-extended position, it is a non-confirmation that suggests a decline – sometimes sharp – is ahead.

That’s what we see right now – price rising, market internals all falling.  Not good for the bulls.

That doesn’t mean that price is required to fall, but that odds – based on historical instances where this pattern formed previously – favor a fall, particularly since the S&P 500 has pushed up into key resistance.

Aggressive traders might start shorting now, placing stops above the breakout resistance of 1,130 (meaning, a push above 1,130 would trigger a “Popped Stops” short-squeeze), while conservative traders might wait until price confirmation (of a down-move) comes via a breakdown of the horizontal support trendline at 1,115 or 1,110.

Let’s now step back in time to see what happened the last two times we’ve had a similar rally into the same 1,130 overhead resistance levels.

Hint:  BOTH times resulted in a pretty sharp decline in the days/weeks ahead.

First, the JUNE Pattern:

We see an almost identical pattern of a market rising but market internals deteriorating.

Unfortunately, buyers gave “one last gasp” before rolling over, resulting in a painful Bull Trap for those who got long on the “Trap” of June 21.  Ouch.

Those CAN happen and it CAN happen again – so that’s why it’s often better to WAIT for a confirmed price signal in terms of an official breakdown of a horizontal trendline, like that at 1,110.

Price then “Collapsed” in a 10-day decline to bottom at 1,010 that kicked off the July rally pattern.

Speaking of the “JULY Rally Pattern,” here is the state of internals in July:

The July rally was certainly the “Rally that Wouldn’t Die!”

When price looked to be topping, buyers rushed back in to support the market, driving it to new highs, as was the case in the July 14th roll-over, then July 27th roll-over.

Even after the price collapse/sell-off of August 6th, buyers gave it one more shot at a final “Last Gasp” rally that resulted in a marginal new high forming just before the “Collapse” that took us back to 1,040.

Again, it was better to wait for the official breakdown, or else risk multiple days of frustration and possible stop-outs if you tried to short ahead of the breakdown.

That leads us to our Lessons portion:

1.  When price has formed lengthy negative momentum divergences, you CANNOT call the exact top.

In fact, in both cases, we had early sell signals that were thwarted with a final “dying gasp” of the bulls before the market rolled over.  It’s possible we’ll see that “dying breath” one more time if indeed we do NOT break above 1,130 soon.

2.  Be on guard for “Last Gasps”

As mentioned above, a “Last Gasp” is a “Bull Trap” that suckers in buyers, thinking the market is breaking out, that then crushes them on a sudden and grossly overdue sell-off.

From the perspective of the Bears/Short-Sellers, this “Last Gasp” likely resulted in stop-losses being triggered JUST ahead of the expected sell-off, leading to immense frustration.

3.  Markets DO eventually roll-over from overextended prices on massive divergences

It’s the way of the world – it happens.  Or at least, it’s what’s “Supposed” to happen.  But that doesn’t mean calling an exact price top is easy.

In these cases, it would have been safer and better to wait for the official price breakdown before going short, and remaining neutral while the upward price trend is … dying.

It’s almost like a cornered dying animal  – yes, it’s dying and its days are numbered, but if you try to mess with it before it ‘dies’, it will lash out and injure you.

Oh – another quick observation – the June rally (which looks most similar to our present rally) ended the day AFTER (Monday) June’s Options Expiration.

Friday gives us September’s Options Expiration.

Watch closely to see if history repeats (leading to a sharp sell-off), or if buyers can break history and break out of 1,130.

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade

6 Comments

6 Responses to “Important Lessons From Market Internals Now and the Prior Two Rallies into Resistance”

  1. Matt Says:

    Looking at the example you gave from June, is it possible that the market gaps slightly above the 1130 resistance and falls apart to create a Bearish Engulfing right at resistance? It just seems like since so many people are watching this level, that it is possible it could be a huge bull trap.

  2. Theyenguy Says:

    Corey, I wrote that Yentervention has restarted the Bear Market; and I suggest a number of short selling opportunities.

    http://theyenguy.wordpress.com/2010/09/16/yentervention-restarts-the-bear-market/

  3. M Logozzo Says:

    Hello Corey,

    Your analysis on $ADD, $TICK and $VOLD is very refreshing. The lessons you point out are very important too. I got up at about 4:00am est to check the pre-market conditions. The S&P500 futures are up 7.5 points. My feeling now is that the market will gap up in the morning. Although I don't think much price deterioration will occur below Thursdays close until options are expired on Monday.

  4. Corey Rosenbloom, CMT Says:

    That's true – it's possible we're setting up another exhaustion gap or bull trap as was the case in the June run-up (they look so similar). Monday's close should give us the official “break or trap” information.

  5. Corey Rosenbloom, CMT Says:

    Exactly!

    Aggressive traders can try for an early but risky positioning while conservative or risk averse traders wait for the official closing signal, probably on Monday or Tuesday.

    You're right – we're all watching this so the resolution – break or fail – could be huge.

  6. Oa Says:

    like your first chart..see that MACD uptrend..is it good??