Above The 40 – The S&P 500 Slips, Not Falls, Off The Edge

AT40 = 58.7% of stocks are trading above their respective 40-day moving averages (DMAs)
AT200 = 59.4% of stocks are trading above their respective 200DMAs
VIX = 10.3 (volatility index)
Short-term Trading Call: cautiously bullish

When AT40 (T2108), the percentage of stocks trading above their respective 40-day moving averages (DMAs), fades from overbought status, I take note. A fade from overbought means that buyers are not strong enough or sufficient enough to keep lifting all boats in the rising tide of the stock market. If the S&P 500 (SPY) continues to rise while AT40 declines, I flag a bearish divergence that is supposed to bode poorly for the sustainability of future gains for the general stock market.

In January and February of this year, AT40 faded multiple times from overbought status and eventually went into a definitive bearish divergence with the S&P 500. However, when the declining AT40 finally weighed down the major indices on March 2nd and more dramatically on March 21st, the indices sold off from levels much higher than the January and February trading levels. The selling was also collectively mild and 50DMA support held on both the S&P 500 and the Nasdaq.

A more distinctive fade from overbought status came on April 26th. This time, the S&P 500 went nowhere until, all of the sudden on May 17th, the sellers took over all the trading action. The sellers were able to gap the market down the next day, but the indices rocketed higher from there and never looked back.

The latest fade from overbought levels happened from July 20th to the 26th. So of course I think that the sudden swoon on July 27th was related to buyers running out of steam as suggested by AT40’s fade. Yet, there is a tension here. If this pullback is like all the others for 2017, then it will be short-lived; in the rearview mirror, the selling will look like yet one more speedbump to higher prices. On the other side, seasonality and the extended amount of time that AT40 has spent below overbought status suggest that the S&P 500 should at least flatten out for the next few months if not sell-off altogether. Since sellers have consistently failed to follow-through in this market, I am keeping my short-term trading call at cautiously bullish under these conditions. This is why when the swoon descended upon the market, I was quickly covering shorts, locking in profits on put options, and looking for fresh buys.

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Disclosure: long AAPL call option, long SVXY call option, short BBY, long CMG call options, long DPZ call option

*Charting notes: FreeStockCharts.com uses midnight U.S. Eastern time as the close ...

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