Rhythmic market suggests caution on new buys «

    Rhythmic market suggests caution on new buys

    Elephants are credited with having exceptional memories, but so do the markets. Although traders would in many cases do better to forget mistakes or successes of the past and just respond to what they see, the fact of the matter is that we just seem to be wired in such a way as to recognize duplications in the price action.

    It’s this very notion that lends credibility to technical analysis, as oftentimes patterns tend to repeat themselves, and markets (whether indexes, individual equities, futures or any other instrument) frequently exhibit a rhythm to the way they move. The past doesn’t guarantee anything in the future, but if traders are involved, it’s a sure bet that the past will be considered in buy and sell decisions of the future.

    Right now, there are some undeniable similarities to previous price action, and it may prove wise to take those similarities into consideration. My intent is never to predict the next move because I don’t need to in order to trade well. Proper management of positions is ultimately what makes me profitable. Rather, it is my intent to share some of my thought process in hopes of illuminating the landscape more fully so that better decisions can be made.

    Let’s examine three major market indexes for this discussion: the Nasdaq Composite Index /quotes/zigman/12633936/realtime COMP -0.50% , Standard & Poor’s 500 Index /quotes/zigman/3870025/realtime SPX -0.39% and the small-cap Russell 2000 Index /quotes/zigman/2759624/realtime RUT -0.40% . These are not only widely followed, but they encompass a variety of stocks, sectors and market capitalizations.

    The similarities I really want to examine exist between the current rally from the June low and the spring rally from the April low to the May high. The charts, as always, serve as my guide. Today, they’re the centerpiece of the discussion, not just for the visuals they provide but the statistics they deliver as well.

    The Nasdaq Composite Index painted an intermediate-term low on the daily chart on April 18 at 3154.96. It then rallied for 5 weeks into the May 22 high of 3532.04 for a gain from low to high of 377.08 points. Then it pulled back quietly for roughly five weeks to the tune of 237.09 points, or 6.7%. Once that dip was complete, the index rallied 4 weeks into last week’s high of 3624.54, or 329.59 points off the low.

    We saw a small dip on Friday, but we don’t yet have technical evidence to declare that the rally is finished. What we do have is an extended index which just moved a similar amount and for a similar length of time to the previous rally, giving grounds for some short-term caution on the buy side. Here’s a chart for a better look.

    The S&P 500 offers a couple of examples today for us to look at. The first is more recent and is similar to the Nasdaq example we just saw.

    This index saw a five-week lift from the April low of 1536.03 to the May high of 1687.18. That represented a rally of 151.15 points before a five-week pullback to the June low kicked in that erased 126.85 points (7.5%) off the highs.

    From the June low of 1560.33, the S&P rallied 132.79 points into last week’s high, a lift which took four weeks. This index has not rallied quite as much or as long as the prior move, but it is approaching the size and duration of the prior move, and traders will take notice of this. Here’s a chart highlighting these moves.

    The S&P monthly chart also reveals a much longer-term look at this index and its propensity to move in rhythmic fashion.

    Eyeballing the price action below shows similar declines from 2000-2002 and 2007-2009, as well as similar advances from 2002-2007 and 2009-2013.

    Finally, let’s look at the Russell 2000 . This small-cap index is exhibiting some eerie similarities between the current rally and the previous advance which simply should not be ignored. This is the index which has outpaced the others with ease since the November low was made last year, making it the leader of this discussion.

    From the April low of 898.40 to the May high of 1008.23, the Russell rallied 109.83 points, taking five weeks to do so. The lift off the June pullback low of 942.79 to last week’s high of 1052.46 represented a 109.67 point advance over the course of four weeks. So, the current advance has matched the prior advance but just took a little less time.

    Also note on the chart below that the rest phase following the March high lasted seven weeks, and the rest which followed the May high lasted six-and-a-half weeks. This index truly has been moving with a memory. Here’s the chart.

    Whether you’re a bull or a bear, it’s difficult to ignore the tendency of the market to move in a rhythmic manner. If anything, after the tremendous rally from the June low, the indexes are looking a bit extended here.

    That doesn’t mean we roll right over and enter a correction phase, but if we’re closer to the end of the current run than the beginning, it certainly warrants selectivity with new buys. A rest phase might be just around the corner, but that could be a good thing because previous pauses have proven to be good buying opportunities.