BROAD DECLINE ROCKS WALL STREET - SPY TESTS 50-DAY - SMALL-CAPS LEAD LOWER - RUSSELL 2000 ETF FORMS DOUBLE TOP - XLB, XLI AND IYT ALSO FORM DOUBLE TOPS - EURO AND STOCKS FALL TOGETHER - DOLLAR ETF SURGES

STOCKS DECLINE ON INCREASED VOLUME... Video Link (click here) Selling pressure picked up significantly on Wednesday. All of the major indices were down over 1% with the Russell 2000 leading the way lower (-3.51%). All sectors were lower with energy, finance and materials down over 3%. Declining stocks outnumbered advancing stocks 8.6 to 1 on the NYSE and 5.6 to 1 on the Nasdaq. Down volume outpaced up volume 9.4 to 1 on the NYSE and 11.7 to 1 on the Nasdaq. It was a rout. Chart 1 shows the NY Composite slicing through its 50-day moving average with above average volume. Despite this moving average break, the index is nearing support from the early October low. Chart 2 shows the Nasdaq doing the same. Keep in mind that both indices forged higher highs in October and have yet to forge lower lows. This means the medium-term uptrend has yet to be reversed. Also note that the major indices are getting short-term oversold and ripe for a bounce or consolidation.

Chart 1

Chart 2

SPY TESTS 50-DAY MOVING AVERAGE... With a decline over the last eight days, the S&P 500 ETF (SPY) is testing its 50-day moving average for the second time this month. Chart 2 shows SPY holding the 50-day in early October and moving above its September high in mid October. This higher high affirms the medium-term uptrend. Technically, it would take a close below the early October low (~102) to forge a lower low and call for a trend reversal. Even though the medium-term uptrend remains in place, bearish signs are starting to appear. First, notice that On Balance Volume (OBV) formed a lower high in October. With a higher high in SPY, this means OBV forged a bearish divergence. A similar bearish divergence occurred in May-June and SPY corrected in June-July. Incidentally, OBV for IWM and DIA also formed a bearish divergence. OBV for QQQQ did not.

Chart 3

For the second sign of weakness, -DI is edging above +DI as the uptrend in SPY weakens. The indicator window shows ADX (black) with +DI (green) and -DI (red). After peaking in the upper thirties in August, ADX moved lower over the last two months. Currently in the low 20s and falling, ADX signals that the uptrend is not strong. Notice how ADX rose as the uptrend gained strength in July. +DI moved above -DI in mid July and held above for most of the last three months. There was a brief cross in early October. With a downturn in +DI and an upturn in -DI this week, a bearish cross is in the works. The combination of a bearish cross, weakening trend and bearish divergence in OBV points to a correction ahead for SPY.

Education Note: On Balance Volume (OBV) is a cumulative measure that adds volume on up days and subtracts volume on down days. J. Welles Wilder developed the Average Directional Index (ADX). In general, above 20 and rising signals a strengthening trend and below 35 and falling ADX signals a weakening trend. ADX does not provide directional clues, but we can use crosses of the Positive Directional Indicator (+DI) and Negative Directional Indicator (-DI) for directional clues.

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SMALL-CAPS LEADING THE WAY LOWER... Relative weakness in small-caps is negative for the market overall. Perfchart 6 shows performance for the Major US Markets for October. After rising the first two weeks, the Russell 2000 performance was the first to peak on October 14th (dotted line). Performance for the other major indices peaked a few days later. Since peaking, the decline in the Russell 2000 has also been more drastic. As of the October 28 close, the other major indices are still up 1/2-2% for the month, but the Russell 2000 is already down over 2%. The Russell 2000 represents small-caps, which are more sensitive to broad market trends. In other words, small-caps tend to rise and fall faster than the S&P 500 and Dow Industrials. Small-caps also tend to lead the broader, suggesting that weakness could spread into the broader market.

Chart 6

IWM BREAKS OCTOBER LOW... Of the major index ETFs, the Russell 2000 ETF (IWM) is the first to break below its early October low. Chart 7 shows IWM with a double top forming over the last two months. These bearish reversal patterns are confirmed with a break below the intermittent low. Based on traditional technical analysis, the downside projection is based on the height of the pattern, which is around 5 points. With the support break around 57.4, the downside target is 52.4. Keep in mind that the other major indices have yet to break their October lows for confirmation.

Chart 7

The bottom indicator window shows RSI with its second bearish divergence in three months. RSI also moved below its August lows and broke the 40-50 support zone. This shows the most downside momentum seen since mid July. I consider this RSI break below 40 as bearish for momentum. It would take a move back above 60 to call for a reassessment.

OTHER DOUBLE TOPS IN PLAY... John Murphy pointed out the possible double top in the Materials SPDR (XLB) on Monday. Chart 8 shows XLB declining sharply over the last four days with high volume the last three. Selling pressure is increasing significantly. XLB is nearing double top support around 29. Even though a support break would be medium-term bearish, keep in mind that the ETF is short-term oversold and ripe for a bounce.

Chart 8

Chart 9 shows the Industrials SPDR (XLI) with a double top working. Support resides around 25.2. Notice that OBV formed a large bearish divergence over the last two months.

Chart 9

Chart 10 shows a double top for the Transport ETF (IYT). The ETF broke below its October low today. IYT is down five days straight with above average volume four of the last six days. While the Dow Diamonds moved above its September high, the Transport ETF failed to confirm with a higher high. This amounts to a Dow Theory non-confirmation.

Chart 10

DOLLAR RISES AS EURO FALLS... Chart 11 shows the Euro ETF (FXE) with the S&P 500 ETF (SPY) over the last four weeks. It is hard to tell which one is leading and which one is following. Even so, there is clearly a positive correlation as both rise and fall together. FXE and SPY rose from early October until the third week of October. Both fell over the last 1-2 weeks. I did notice that SPY peaked before FXE and started down a few days ahead of FXE. Also notice that the price relative (SPY:FXE) peaked on October 19th. Stocks were outperforming the Euro until October 19th. Stocks are now underperforming the Euro as the price relative declines.

Chart 11

Chart 12 shows the DB Dollar Bullish ETF (UUP) surging above short-term resistance with a sharp advance the last four days. Broken support around 23 turns into the next resistance level to watch. A break above 23 would be most impressive for the greenback. In the indicator window, RSI formed a bullish divergence and moved above 50 this week. In fact, RSI broke above its summer highs. This advance shows the most upside momentum since March.

Chart 12