Stock markets ready for a reason to correct soon: Turning Points update by Andre Gratian

The stock market already looked weak today, and some of that negative divergence showing up recently has something to do with it. But it needs to confirm a top formation first. Let's take a look at Andre Gratian's technical analysis update of the stock markets. He typically reviews the S&P 500 index, but this time he gives an interesting analysis of the ever-popular Nasdaq 100 tracking ETF (QQQQ) - and you'll see why we always keep his Market Turning Points site in the list at the right side of the page. His subscribers received this report over the weekend, and also receive his several intraday updates via email each trading day. This time he's not only addressed the stock market with technical indicators and the VIX as a sentiment gauge; he's also updated his review of gold and its ETF, GLD:
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October 31, 2010

Week-end Report
Turning Points
By Andre Gratian

As I mentioned Friday, there are several events due next week which are likely to have an impact on the market. They are: the election, the Fed Report on Wednesday, and the jobs report on Friday. Of these, the second one will probably influence the indices the most. On Wednesday, the Fed is supposed to clarify its intentions about QE2 (quantitative easing, round two).

This will most directly affect the $ which will, in turn, affect the indices. So, should we wait until Wednesday to see if the market goes up or down? Or do we already have a pretty good idea just by looking at the charts?

There is a saying that “when the market is ready, the reason appears”. And, technically, the indices are ready to correct. Therefore, the odds favor a sell-off after the Fed’s announcement on Wednesday.

While both indices that I follow closely show signs of being ready to reverse, the QQQQ is easier to analyze than the S&P 500 (SPX), and I can obtain a more accurate count from the re-accumulation pattern that it formed between the right shoulder and the head of the (bullish reverse) head-and-shoulders (H&S) pattern shown on the chart. When it broke out of its H&S bottom, the index formed an Andrews pitchfork channel pattern. Prices have reached the top of that channel, and are overbought. This is reflected in the second oscillator which has remained at the top of its range for several weeks without an adequate correction. Incidentally, note that the QQQQ has gone beyond its April high, while the SPX still has not. Not only that, but the QQQQ is only a couple of points away from its October 2007 high.

This relative strength will have to give way to relative weakness before we come to the end of this bull market. Therefore, the anticipated correction should only be one of short-term duration.

Since I called your attention to the middle oscillator, let’s examine all of them. The first thing that stands out is that they are all showing some negative divergence, and the worst divergence is exhibited by the breadth indicator, at the bottom. That normally indicates that a reversal is not far away. In this case, it will come when the advance/decline indicator (A/D) closes the trading day with a number negative enough to send the oscillator below its trend line which extends back to May. Minus 1500 or more would probably do the trick.

Of even greater value to confirm that the index is at a high point and ready to reverse is the fact that the price projection obtained from the Point & Figure (P&F) chart has been reached … well, almost! The minimum P&F count is $52.50 and, on Friday, the QQQQ traded at $52.49 before pulling back into the close.

Besides the Fed report probably being the trigger, the timing should also be helped by increased selling pressure brought about by the two short-term cycles that are due to bottom at the end of next week.

The report is still two and a half days away. Does that mean that we go sideways for another two days, or will something else trigger the reversal before then? There is some ambiguity about what the next couple of days will produce. On Friday, the dollar ($USD) closed on the low of the day and, right after the close, it was hit with some selling.

Unless this trend changes over the week-end, if the dollar opens weak, the tendency will be for the equity markets to open strong. If this happens and the SPX pushes beyond 1190, it will invalidate the potential H&S top formation which was developing in that index. Somehow, I am sure that the market will know exactly what to do, and instead of asking questions that are unanswerable, let’s just wait and see what happens over the next three trading days. Because 3 days can be a long time on the hourly chart, I don’t think that it would serve us to analyze it further, as the present patterns and their significance will be completely altered by Wednesday.

Gold

My revised count for gold via its ETF, GLD, called for a projection to $134 with a possible extension to $139. A correction did occur after it reached $134. Since then, GLD has formed a small consolidation base at $130 and, if the dollar does move a little lower in the next couple of days, it would be an incentive for gold to move up.


The consolidation that gGLD has undergone has created a small base which has a potential count to $135. If GLD does move up to $135, it will most likely be as part of a larger top building process rather than a resumption of the uptrend. When that process is complete, we should have an appreciation for the level to which gold/GLD should correct on its next pull-back.

Sentiment

The volatility index (VIX) not only moves inversely to equity indices, but when it trades at the low of its range, it signals that a reversal in the market is near. On its Daily Chart (below), we can see that the VIX has recently reached a level which is normally associated with a pull-back in the SPX. It has also started an uptrend which was signaled by a bullish crossover of its indicators. If this uptrend continues, the SPX will start moving in the opposite direction.


I have created a Point & Figure chart of the VIX but will need to work with it for a while to see if the counts are as reliable as they are for the SPX and QQQQ.

Andre

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The above comments about the financial markets are based purely on what I consider to be sound technical analysis principles. They represent my own opinion and are not meant to be construed as trading or investment advice, but are offered as an analytical point of view which might be of interest to those who follow stock market cycles and technical analysis.