The Week Ahead: Double Top Or Not?

Last week, stocks were pushed sharply lower on Monday due to an escalation in the US-China trade war. But the postponement of auto tariffs on Wednesday rescued the market from continuing decline. This set the stage for a nice rebound on Thursday, but then the sellers again took over on Friday. Overall, the major averages closed the week lower.

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TomAspray- ViperReport.com

Last week, the small cap Russell 2000 was hit the hardest, down 2.37%. The Nasdaq 100 and the Dow Jones Transportation Index were down just over 1%, while the losses in the S&P 500 and Dow Jones Industrials were smaller. Only the Dow Jones Utilities bucked the trend by closing up 1.64%.

Along with the numerous articles encouraging traders and investors to sell stocks in May, there have also been several that have warned that the stock market was forming a double top.

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TomAspray- ViperReport.com

Looking at a daily chart of the S&P 500, one can see the reasons that some fear the formation of a double top. However, there are also reasons to be skeptical of the alarm over a double top. First, it should be noted that in a double top, the second high is usually lower. This is not the case here, as the September 21st 2018 high in the S&P 500 at 2940.91 was exceeded by the May 1st high of 2954.13.

Secondly, a double top requires a substantial second drop to confirm. I last wrote about double tops and bottoms in 2012, with my Forbes.com article “Using Options to Trade Double Tops”. In that article, I pointed out that to confirm a double top, the market needed to drop below the intervening low. For the S&P 500, this would mean a decline below the December 26th 2018 low of 2346. That's a decline of almost 18% from last Friday’s close. Clearly, it's too early to be declaring a double top, on that evidence.

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TomAspray- ViperReport.com

When looking for major chart formations, I find the monthly time series to be the most useful. Those who diagnose the current situation as a double top sometimes use momentum indicators, like the relative strength index (RSI), to support their conclusion. On the bottom of the above chart, I have included the 14-period RSI for comparison. The RSI did peak in January 2018, and has since formed lower highs (line b). This negative divergence does suggest a loss of upside momentum.

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