Rising Prices on Collapsing Internals for SP500 Breakout

May 9, 2013: 3:30 PM CST

I wanted to highlight a curious situation with Market Internals in respect to the recent breakthrough above 1,600 in the SP500 (and 15,000 on the Dow Jones) and note the message from Internals.

While internals are always secondary to price, it’s still important to listen to the message sent by the number of stocks advancing minus those declining (Breadth) with respect to the movement of the equity index itself.

Here’s two perspectives on the “Collapse” in Internals with respect to the surge in equity prices:

The first chart shows us the full April period (to present) with respect to NYSE Breadth ($ADD) and Volume Difference of Breadth ($VOLD).

To recap, a Breadth reading/indication is the difference (subtraction) between advancing issues (those positive on the session) and declining issues (those negative on the session).

The red highlighted periods signify phases of Divergences or Non-Confirmations with respect to price (falling internals with rising prices) while the one green period shows dual positive divergences.

The MAIN LESSON is that price so far has been shaking-off or ignoring the message from internals, meaning the trend dominance overrules the signals from internals.

As the old saying goes, like volume divergences, internal divergences do not matter “until they do” (until price reverses as was the case the last time we saw a price decline from April 11th to the 19th).

A closer perspective drills into SP500-specific internals for a clearer picture:

The 5-min chart above uses only the stocks in the SP500 to calculate the Breadth reading (meaning an indication of 400 signifies that roughly 450 stocks are positive at that moment against 50 which are negative at that moment in the trading day).

The colorful indicator under $ADSPD (SP500 Advance-Decline Difference) is simply a visual representation – a color-coded histogram – of the breadth indicator for clarity.

Numerically speaking, the chart peak of SP500 Breadth occurred straight off the open on May 3rd (the “Jobs Report” breakout day) when the indicator registered a session high of 455.

We can see price creeping its way powerfully higher in pro-trend fashion, yet along the way, internals quietly diverged with the price index.

In fact, with a new all time headline-grabbing index high into 1,635, internals barely managed to poke their head above the zero-line, registering a session high reading of 46.

At the all-time high, 273 SP500 stocks were positive on the session against 227 which were negative at that time.  For the period before and after the intraday high, more SP500 stocks traded negative on the session than were positive (which is logical since the index spent the majority of the session negative).

What’s the bottom line?

Trends can most definitely continue (or extend) beyond what most traders feel like they should, and as such, price is the ultimate arbiter of our decisions, not internals or indicators when messages conflict (this includes other forms of analysis as well).

Nevertheless, we do look “beneath the market” to assess the strength or health of a price swing or trending impulse in motion.  We do this to gather clues with respect to leverage, trade management, and game-planning.

A market moving up with strong volume and internals has greater odds of continuing (reference the big bullish confirmation on May 3) and thus we can trade more aggressively with larger targets and greater confidence during these periods.

A market steadily moving up on declining volume and internals has reduced odds of continuing and thus we need to be more cautious, less aggressive, use tighter stops, and play for smaller targets when compared to the opposite type of bullish confirmation environment (again, reference early May).

It’s easy to get caught up in bullish headlines and sustained trend moves, but for long-term trading success, it’s often better to be more aggressive with our pro-trend trades when a price trend is confirmed by volume and internals, not contradicted by it.

Corey Rosenbloom, CMT
Afraid to Trade.com

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

Corey’s new book The Complete Trading Course (Wiley Finance) is now available

Follow along each evening by joining our membership services for daily or weekly commentary, education, and timely analysis beyond the daily blog commentaries.

4 Comments

4 Responses to “Rising Prices on Collapsing Internals for SP500 Breakout”

  1. brian fortin Says:

    “It’s easy to get caught up in bullish headlines and sustained trend moves, but for long-term trading success, it’s often better to be more aggressive with our pro-trend trades when a price trend is confirmed by volume and internals, not contradicted by it”

    True, it feels better to have lots of technical confirmation on your side, but when it shouldn't continue trending and it ignores all those reasons, it tells a lot about the strength of the “trend” whether natural or manufactured.

    Great post, but your argument assumes that this is a market and not a public policy tool being manipulated by desperate central bankers through their puppets in office. You can't make money trading conspiracy theories, but then again, you also can't ignore $85 billion of pumping a month and a patently manipulated market. So what's a trader to do? View our indicators with suspicion. Over the years, I've come to the conclusion that there's a time to be clever and a time to dummy up and make stupid money with all the other gamblers. This is a textbook example of one of those times.

    When will it end? It happened despite your market internals, so logic tells us market internals won't provide any assistance at all in signaling the end of trend. I am fully behind your statement regarding caution, but trying to out think this stupid market isn't going to work. To me, a simple moving average strategy and active position sizing seems the way to go. That and a whopping dose of ignorance, because when the market is on full retard, it's time to trade like a retard..

  2. Corey Rosenbloom, CMT Says:

    Brian,

    One could make a full blog post from your comment! Thank you for sharing.

    One lesser known axiom is that a market is showing persistent strength (strong supply/demand imbalance or feedback loop) when it continues to overcome evidence to the contrary, especially over-extensions, divergences, all that we're seeing now. This has happened many times and on many timeframes outside of QE/stimulus environments.

    Market internals, like volume, are helpful for short-term traders looking to assess the odds of continuation or reversal of short-term and intraday trends. Sometimes the divergences are good for multi-day moves (April 15) or merely one-day moves (May 1).

    I agree – adjust strategy and position sizing to the environment. With clearly contradictory signals, but you still want to trade the trend, do so on smaller timeframes, perhaps with smaller targets and tighter stops, and consider using a reduced position size.

  3. brian fortin Says:

    I agree completely,

    (Deep sigh) The market has humbled me so many times I find it easy to question everything, the fundamentals, history, even the existence of a market, and especially myself.

    On balance, this has made me a better trader. It has forced me to abandon fundamental analysis but also be more suspicious of technical conclusions. Never the measurements of technical analysis, just my conclusions which were always more dangerous when I clouded my mind with “facts” about the economy or the markets.

    Your response regarding looking at the market on different time frames couldn't be more spot-on, if we are willing to move to a different time frame, we couldn't care less if the trend is “valid” or the result of some type of price manipulation. The last five years has been an eye opener for a lot of us.

    Long time fan of the web site. Thanks Corey

  4. Barron Maestro Says:

    See an overlay of this year's market versus 1987, where similar overconfidence in equities led to a single day collapse of 23%:

    http://stockmarketadvantage.co