Deep Thoughts
By Jim Raker
www.smartdaytrader.com
April 29, 2004

The stock market has been under pressure for most of 2004. In spite of a push to nominal new recovery highs early in the year, the cumulative breadth of the market has been weak and falling. At SmartDayTrader it is our contention that breadth is the engine which runs price. If more stocks are advancing that is a healthy sign, while a lack of broad market participation is suspect.

Remember this information is only of value if you are trading stock indices or stock index futures. Breadth can be analyzed a variety of ways, but the basic components that we are interested in are the NYSE advancing issues and the NYSE declining issues. On Thursday, April 29th, 2004 there were only 847 issues up and 2410 issues down. We keep a running tally of the net issues up and down, similar to the summation index and utilize a 20 day moving average filter of this sum. The first chart shows the picture for the past 12 months.

You can see that cumulative NYSE breadth turned down in mid to late January and has been negative and falling ever since. You can also see that the trend line drawn on the S&P 500 index from this breadth data is currently projecting 1050 in that index.

(SPX with NYSE Cumulative Breadth Indicator)

Another way to examine breadth is using our short, intermediate and long-term breadth calculator. In a generally bullish environment as we saw over the past year, this index will run between plus and minus 1200 for short-term breadth. In that environment, one can profit by going short at plus 1200 and going long at minus 1200.

However, there has been a subtle shift to a more defensive, if not bearish, tone in the markets. Note how our short term indicator recently fell to nearly minus 1500. This is a rare occurrence and suggests much stronger "unloading" of stock.

The rally back from that deep level was tepid and we are once again seeing a decline in prices. As of Thursday night's close, the short term indicator was at minus 1213. If the stock market is unable to rally off this level, that would be strong evidence of an injured market environment.

Note that the long-term component is at plus 100. In March of 2003 this turned positive for the first time in several years and was the basis of the strong markets we saw over the past 12 months. If this drops back below 100, the bulls are in deep trouble.

(Short, Intermediate and Long Term Breadth Indicator).

One excellent measure of a market's health is the relative strength indicator. In a bull market environment this index will move between 40 and 80. Reactions back to the 40 level will often represent buying opportunities.

Note the reactions in August, October and November of 2003. But now look at the "shift" that has taken place since the start of 2004. Rallies have stalled at much lower levels and declines have pushed down to much lower levels. This pattern is typical of a bear market environment. In other words, the market is not "relatively strong" but "relatively weak".

(OEX with 14-day Relative Strength Index).

There are several ways that traders will try to determine if we are in a bull or bear market environment. The "classic" measure is the 200 day simple moving average and in spite of it being well known, it is still helpful. Simple but elegant: bullish above and bearish below. But there are variations on this theme which can also be useful.

At SmartDayTrader we track the weekly SMA 21 along with its companion 5-week rate of change indicator which we call the "R5W". Here you can see why we are concerned about the current market. Note what happened to the stock market each of the last four times the OEX dipped below the weekly SMA 21 and the R5W dropped below 100. Not a pretty picture. As of Thursday's close the OEX has been below the SMA 21 for 2 days while the R5W is sitting right on 100.

(Weekly chart of the OEX with SMA 21 and ROC 5).

Having determined that the stock market may be at risk for further decline, we try to see if there are any clues as to where support may lie. At SmartDayTrader we break the market down into its trading quadrants. From this we overlay the Fibonacci Fan lines from the all time highs to the bear market lows. This gives us the following support areas.

First, there is often "knee jerk" support and resistance around "whole" numbers, so there may be a bit of a tug of war at the 1100 level. From there, there is a broad area of support at the 1050 to 1070 level. Next quad support brings us back to 960-970, while Fib support comes in below that around 920 to 940. Far fetched? Not really. It all depends on breadth.

If these upper levels give way and cumulative breadth is unable to begin to turn around, I would strongly suggest that you increase your defensive posture if you are bullish.

(Weekly Quadrant Chart of the S&P 500 with Fibonacci Fan Lines).

At SmartDayTrader, we will on occasion take an intermediate position in the QQQ. Note the recent "failed" double top off the March lows, when the SMA 200 was briefly violated. Note also that as of Thursday's close the upper down sloping channel line was holding.

A definitive break of this support level will set the stage for a decline back to the lower end of the trading channel, just above 32.00 and falling. Note how close the SMA 200 is again. A second test that holds would be significant, as would a failure. Even if you don't trade the QQQ I would keep a close eye on this as it "led" the market higher over the past 12 months. Weakness here could spill over into the other major averages.

(QQQ Index within its trading channels).

We also track and trade the 30-year Treasury bond futures. Bonds have been hammered lately following a classic "head and shoulders" formation which set up during most of March. This was accompanied by absurdly high RSI readings and the results have been just as "classic".

For the past 2 weeks we've been stuck in a sideways rectangular consolidation pattern which broke to the downside on Thursday. This implies a 2 point decline from here and we would be looking to cover shorts any where between next low and low pivot (shown).

Finally, I want to leave you with one of our SmartDayTrader "pearls". Those of you familiar with SmartDayTrader know that we provide daily pivot calculations in addition to detailed market analysis and a trade plan. One of our favorite trades is the "pass through the pivot" trade. Using the pivots, we teach our subscribers how to take the pulse of the market every 15 minutes. That way they are able to make trading decisions intra day which will allow them to determine if a particular pivot is going to act as support or resistance or whether it will be the anchor point for initiating or ending a trade.

The next chart: June SPM: 15 minute chart with PIVOT POINTS for Thursday April 29th 2004 - Chart Powered By Futuresource), shows a 15 minute bar chart of the June SPM for yesterday, Thursday June 29th, 2004. I've drawn in mid, next low and low pivots.

In our Nightly Report, we advised our subscribers that mid-pivot would act as a major "fulcrum" and further suggested going short there if the TICK was between plus 800 and plus 1000. Note that during the first hour of trade the market popped into this zone on PLUS 900 tick. We went short "back through" 1125.90 and took our profits at Next Low pivot at 1117.50. The market then made a noble, but feeble, rally attempt, so we went short "back through" 1117.50 and rode this down to Low pivot at 1111.70. The market tried to stabilize at that level, too, but could not, so we went short "back through" low pivot and were able to exit on minus 1400 TICK 5 points lower.

(June SPM: 15 minute chart with PIVOT POINTS for Thursday April 29th 2004)

If you would like to learn how we take the market's pulse and are able to make these intra day decisions, drop by www.smartdaytrader.com. I'd be more than happy to discuss how I can help you with your trading. We provide a detailed Nightly Report for our subscribers. In addition we offer intensive web-based on-line trading seminars.

Information can be found on our web site or by writing me at jim@smartdaytrader.com. Please sign up on line for our free Weekend Report. Until next time, please be careful in this market environment. Trade Smart and have a great weekend!