Indicators Show Market at a Near-Term Decision Point

Last week, the bellwether SP 500 continued its rebound from a successful test of underlying support at 1,730 at the beginning of the month. The U.S. broad market index finished Friday's session at 1,839, 2.3% higher for the week and just off the all-time high at 1,851.

Year to date, however, the SP 500, along with the blue-chip Dow 30 and small-cap Russell 2000, are in negative territory. The tech-laden Nasdaq is the only major U.S. index in positive territory in 2014, up 1.6%, and it must continue to lead on the upside for the broad market advance to continue.

U.S. Stocks at a Minor Decision Point

One quick look at a daily bar chart reveals that, despite a new all-time high being set on Jan. 15 at 1,851, the SP 500 has essentially been drifting sideways since the beginning of the year. Moreover, the longer this sideways trade persists, the more it will look like the distribution phase that follows a sustained price advance and precedes a correction, as price momentum starts to wane and investors start booking near-term profits.

One way to measure price momentum is via the Moving Average Convergence/Divergence (MACD) indicator, which plots the difference between a 12-day and a 26-day exponential moving average. The MACD indicator appears in the lower panel of the chart below, along with its dashed "trigger line," which is a 9-day exponential moving average of the solid MACD line.

The zero line of the MACD represents a balance point for the SP 500, which is plotted along with its 200-day moving average (major trend proxy) in the upper panel. Heading into this week, the MACD was testing its zero line from below. This represents a near-term decision point from which the decline that started on Jan. 27 (the day the MACD fell below the zero line) should resume if still intact.

The red vertical highlights show that sustained declines by the MACD below the zero line in June-July and August-September coincided with declines in the SP 500. The green vertical highlight shows that a successful test of the zero line from above on Oct. 9 coincided with an important near-term bottom in the SP 500.

The MACD's current test of the zero line from below sets up another such inflection point, from which the index's decline from the Jan. 15 high should resume if still intact. Put another way, a sustained rise back above the zero line by the MACD would be necessary to indicate that the SP 500's major uptrend, as defined by the 200-day moving average, is resuming.

Volatility Also Suggests a Near-Term Decision Point for Stocks

The CBOE Volatility Index (VIX) also suggests that the broader market is at a near-term inflection point. The VIX, sometimes referred to as the fear gauge, measures the market's expectation of 30-day volatility and is derived from the implied volatilities of a wide range of SP 500 index options.

The next chart plots the VIX daily since September 2013 in the lower panel, along with its 50-day moving average (MA), with a corresponding chart of the SP 500 plotted in the upper panel.

The red vertical highlights show that periods when the VIX rose above its 50-day moving average, indicating increasing fear of a market decline, coincided with declines in the SP 500.

The green circle at the lower right edge of the chart shows that the VIX has edged back below its 50-day MA, which was situated at 14.66 at the end of last week. This indicates that investors have become complacent enough for a new leg higher to emerge within the SP 500's larger 2013 advance. However, another spike back above 14.66 by the VIX would indicate that another wave of fear has hit the marketplace, one that is likely to put more near-term downside pressure on stocks.

This article originally appeared on Market Outlook: Indicators Show Market at a Near-Term Decision Point

One thought on “Indicators Show Market at a Near-Term Decision Point

  1. Apart from this study, all sharp and major falls were taken place just without providing any prior alerts, so even now too, we must concentrate and become conscious as well cautious about on overall economic conditions, rather then pure dependency on technical picture.

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