Trend Insights From The Monthly Charts

Two traders confer seconds after the closing bell on February 1, 2019 (Photo credit should read JOHANNES EISELE/AFP/Getty Images)GETTY

The 7.9% gain in for the S&P 500 in January snagged the headlines last week, especially after the 10.2% decline in December. It was the best January since 1987 when the S&P 500 was up 13.2%. After the strong January in 1987, the S&P was higher for six of the next seven months, peaking in August 1987.

However, the monthly, weekly, and daily advance/decline lines formed bearish or negative divergences at the highs in August 1987. These divergences were warning signs of the October 1987 plunge. That's why I use divergence analysis as a tool to predict trend changes. Divergence analysis is an important tool in technical analysis that can identify when an indicator, like the advance/decline line, is acting stronger or weaker than prices.

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The above 1986-87 chart of the NYSE Composite includes the NYSE Cumulative Advance/Decline Line, which broke through resistance (line a) in the first week of January 1987. The A/D line made its high on March 20 (point 1) before an eight-week correction that dropped the A/D line below its Weighted Moving Average (WMA).

By June, the A/D line was back above its WMA, as the NYSE Composite rallied to a new high the week of August 14. That week, the A/D line made a lower high (point 2). This bearish or negative divergence was a sign that fewer stocks were moving the market higher in August than were in March, and so higher price action lacked crucial support in the broader market.

By the first week of September, the A/D line had dropped below its WMA, and then on October 9, the A/D line dropped below support (line b).  This was further confirmation of the divergence, and the NYSE Composite dropped 30% over the next two weeks.

So, what are the A/D lines saying now? The advance/decline numbers on the rally from the December low have been very strong, as the market was deeply oversold just before Christmas. At the time, I pointed out the S&P 500 A/D line had reached good support from early 2018 (see chart).

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