MONTHLY MARKET TREND IS STILL UP, BUT JUST BARELY -- WEEKLY MACD LINES TURN NEGATIVE
MONTHLY AND WEEKLY SIGNALS ARE MORE IMPORTANT THAN DAILIES... I've been emphasizing daily (and hourly) charts recently to study the January downturn. While daily charts show the short-term trend, weekly and monthly charts are the ones that determine the major trend of a market. To study that longer-term trend, I'm using the Wilshire 5000 Composite Index. It's large size makes it one of the best (if not the best) overall measure of the entire stock market. I'm going to employ only two indicators -- MACD lines and Bollinger Bands. I like the MACD lines because they combine the trend-following qualities of moving average signals; and they offer some qualities of oscillators. And their longer-term signals are pretty reliable. Bollinger Bands provide an excellent guide to potential support and resistance levels. Chart 1 shows monthly bars for the Wilshire 5000 for the last seven years. The two solid lines surrounding the price action are Bollinger Bands. The middle (dashed) line is a 20-month moving average. The middle line determines the direction of the market. A drop below the 20-day line is bearish; a move above it is bullish (see circles). In an uptrend, prices should trend between the 20-month average and the upper band. The uptrend continues as long as the middle line isn't broken. Prices are meeting resistance at the upper band (see blue arrow). That sets up a possible retest of the 20-month average line and the entire uptrend. Now let's study the MACD lines.
Chart 1
MONTHLY MACD READINGS ARE WEAKENING... The two lines along the bottom of the monthly bars are MACD lines. They are a combination of exponentially smoothed moving averages. A major sell is given when the solid line crosses under the slower line as happened in the middle of 2000 (see red arrow). A major buy is given when the solid line crosses back over the slower line as happened in the spring of 2003 (see green arrow). Those are the only two signals that have been given in the last four and half years. The lines are still positive. But they're converging. We can tell that by studying the green histogram bars. The histogram plots the difference between the two MACD lines. You can see that peaks and troughs in the histogram take place much sooner than the actual buy and sell signals. The histogram peaked at the start of 2004 and is still narrowing. That means that the uptrend has lost upside momentum. If the histogram falls below zero (which would coincide with a downside MACD line crossing), a major sell signal would occur. It hasn't done that yet, but it's getting dangerously close to doing so. Another way to tell if the long-term trend is weakening is to study the weekly chart.
WEEKLY MACD LINES GIVE SELL SIGNAL ... The weekly MACD lines show that four signals have been given in the last two years. Buy signals were given in October 2002 and October 2004 (see green arrows). A sell signal was given in February of 2004 (first red arrow). And another one has been given this week (second red arrow) as the solid MACD line has crossed below the slower line. Notice also that the late 2004 peak in the MACD lines fell short of the early 2004 peak. That's called a "negative divergence" and warned that the last price move to a new high was on dangerous ground and probably marked the end of the two-year advance. Taking a look at the Bollinger Bands, notice how well the middle (20-week) line has provided support during uplegs. It's now being tested (see blue arrow). I'll show you how to transfer that support line to your daily bars.
Chart 2
COMBINING BOLLINGER BANDS ... The next chart shows daily bars for the Wilshire 5000. It also shows how to combine short and long term Bollinger Bands to measure different trends. The blue solid lines are the daily Bollinger bands using the standard 20 days. Right now, prices are trading beneath the blue (dashed) line which is the 20-day average. There's short-term support at the lower band. But the price has to close back over the 20-day line to turn the short-term trend higher. The red (dashed) line is a 100-day moving average. To get that I simply plotted a 100-day version of the Bollinger Bands. I did that to make it coincide with the 20-week bands on the weekly chart. By switching 20 weeks to 100 days, you can transfer the weekly bands onto a daily chart. The red dashed line shows where major support is located at the 100-day (or 20-week) average. Prices have to stay over that line if the current uptrend is to be maintained. A decisive close under the 100-day average would be a major bear signal. Chart 3 also shows that the daily MACD lines are negative. That leaves only the monthly chart still in an MACD uptrend. Chart 4 shows what 100-day Bollinger Bands look like by themselves. They do a good job of defining the tops and bottoms of major trading cycles (see circles). During an uptrend, the 100-day line helps define major uptrend support. I recently wrote that I rely mainly on the 20-, 50-, and 200-day moving averages. I also keep an eye on the 100-day. Now you know why.
Chart 3
Chart 4
