RELATIVE STRENGTH IN LARGE CAPS -- S&P 500 EQUAL WEIGHT ETF LAGGING -- S&P 100 ETF STALLS AT RESISTANCE -- RSP HITS KEY RETRACEMENT -- IDENTIFYING CORRECTIONS -- USING OSCILLATORS FOR OVERSOLD BOUNCES -- FINDING MORE SIGNALS
LARGE CAPS CONTINUE TO LEAD... Today's Market Message was written by Arthur Hill. John Murphy will be back tomorrow. - Editor
Bigger is better when it comes to relative strength in the current market environment. John Murphy has been talking about leadership in large technology stocks and the Nasdaq 100. In addition, the S&P 100 ETF (OEF) is outperforming the S&P 500 Equal Weight ETF (RSP). The S&P 100 represents the largest companies in the S&P 500. These include stalwarts like Exxon Mobile (XOM), General Electric (GE), AT&T (T), Microsoft (MSFT) and Citigroup (C). GE and T broke above their July highs this month while XOM is challenging its summer high. These are the leaders and this is where the big money is flowing.
Chart 1
Chart 2
Chart 3
OEF VERSUS RSP... The S&P 500 Equal Weight ETF (RSP) represents the "other" 400 stocks by ignoring market capitalization and treating everyone equal. This means the smallest stocks in the S&P 500 count just as much as the biggest stocks. Brunswick (BC), with a market capitalization of $2 billion, carries as much weight at Exxon Mobile, which has a market cap of $512 billion. Chart 4 compares the performance of the S&P 100 ETF (OEF) with the S&P 500 Equal Weight ETF (RSP). The price relative goes from the lower left hand corner of the chart to the upper right hand corner. In other words, it is a clear uptrend with large-caps leading the way higher.
Chart 4
OEF FORMS FLAG AT RESISTANCE... The S&P 100 ETF (OEF) met resistance near its July highs and stalled the last six days (Chart 5). The ETF bottomed in mid August and surged to resistance over the last six weeks with an 8.3% move. The double Fed cut prompted last week's big move and these gains are holding as OEF consolidates near resistance. The mid August trendline and last week's low hold the key to this uptrend and the bulls are clearly in charge as long as both hold. Chart 6 focuses on the current consolidation with the 60-minute chart and the pattern looks like a falling flag. The ETF surged to 72 and then corrected with a falling consolidation the last six days. Flags are said to fly at half-mast and a breakout would target a move to the mid 70s.
Chart 5
Chart 6
CATCHING A RIDE ON THE TREND... The Nasdaq 100 ETF (QQQQ) is in a clear uptrend with the recent break above the July high (Chart 7). RSI is close to 70 and on the verge of becoming overbought. While RSI could certainly remain at or near overbought levels as QQQQ continues higher, traders may also consider using indicators to identify tradable pullbacks. I find the Relative Strength Index (RSI), Stochastic Oscillator and Commodity Channel Index (CCI) quite good for this purpose. These indicators oscillate above and below a centerline with clear overbought and oversold levels. The Relative Strength Index (RSI) has a centerline at 50 and is considered overbought above 70 and oversold below 30. The Stochastic Oscillator has a centerline at 50 and is considered overbought above 80 and oversold below 20. The Commodity Channel Index (CCI) has a centerline at 0 and is considered overbought above 100 and oversold below --100. In place of the default settings, I adjusted the Relative Strength Index to make it more sensitive (fewer days) and the Stochastic Oscillator to make it less sensitive (more days). See chart 9 for differences. I would suggest playing with various settings to find those that fit your trading style and timeframe.
Chart 7
Chart 8
THE END OF THE CORRECTION... There are three steps to identifying corrections in an uptrend. First, we must establish that there is an uptrend. This can be with moving averages, trendlines or a visual confirmation of higher highs and higher lows. In this example, I am using the 200-day moving average and the long-term trend for QQQQ is up as long as the 200-day holds. Second, we must wait for the indicators to become oversold. The number of oversold readings will differ because some indicators are more sensitive than others. In the last 12 months, RSI became oversold twice, CCI became oversold four times and the Stochastic Oscillator became oversold three times. RSI is the least sensitive of the three. Third, we must look for evidence that the correction has ended. This is where the centerline comes into play. An oversold reading followed by a move above the centerline can be used to confirm the end of the correction. The trend bias changes from bullish to bearish with moves above or below the centerline. The yellow boxes on the chart 9 capture oversold readings followed by centerline crossovers.
RSI produced two bullish signals while CCI and the Stochastic Oscillator produced three bullish signals. The January signals in CCI and the Stochastic Oscillator would have resulted in a whipsaw because QQQQ broke to new lows in March. The March signaled turned out pretty good and traders were able to catch the April to June advance. The last signals occurred in August when all three became oversold and then moved above their centerlines.
Chart 9
USING 60-MINUTE CHARTS ... More active traders looking for more signals can turn to the 60-minute charts. The system above only generated three signals in the last 12 months. With the 60-minute charts it is possible to identify shorter corrections and generate more signals. Of course, more signals means more trading and more trading means more risk. Chart 10 shows the advance from mid August with the same indicators applied to the 60-minute chart. RSI became oversold twice and generated two bullish signals. CCI and the Stochastic Oscillator became oversold three times and generated three bullish signals. As with all bullish signals, these work well in uptrends and lousy in downtrends. For example, trading bullish signals on the 60-minute charts from mid July to mid August would have produced a series of losses. This is a difficult game and experience is the best teacher.
Chart 10
