CONSUMER DISCRETIONARY SPDR CHALLENGES RESISTANCE - A BEAR TRAP OR OVERSOLD BOUNCE? - WATCHING THE VOLATILITY INDICES - ACCUMULATION DISTRIBUTION LINE VERSUS ON BALANCE VOLUME

CONSUMER DISCRETIONARY SPDR CHALLENGES RESISTANCE... Link for todays video. While the S&P 500 and the Dow remain well below their January highs, the Consumer Discretionary SPDR (XLY) is challenging its January highs after a sharp advance the last few weeks. Chart 1 shows XLY within a rising price channel that extends back to August. In fact, there are many ETFs with rising price channels extending back to this period. XLY held channel support with a bounce in early February. While the uptrend remains in place, the ETF is trading at potential resistance from the December-January highs. It is positive to see the consumer discretionary sector showing relative strength - as long as it holds.

Chart 1

The indicator window shows MACD(5,35,5). I shortened the short moving average and lengthened the long moving average to make the oscillator more sensitive. Increased sensitivity provides quicker signals, but also a higher chance of whipsaw. That is the trade-off. The first thing you might notice is the extended negative divergence. XLY has been moving higher since August, but MACD(5,35,5) formed a series of lower highs. The same is true for default MACD(12,26,9). Let this be a lesson. Negative divergences, and positive divergences for that matter, dont always work. There are, however, other signs of weakening momentum that warrant attention. MACD dipped into negative territory in early November and again in late January. The January-February dip was deeper than the November dip. Momentum aint what it used to be. MACD is still trading in positive territory and above its signal line. A move below the signal line would be the first sign of weakness.

A BEAR TRAP OR OVERSOLD BOUNCE?... Chart 2 shows the Dow Diamonds (DIA) breaking a channel trendline in January and exceeding support in February. The support break did not last long as DIA surged back above the green support line five days later. Did this support break mark a trend change or was it a bear trap? A bear trap occurs with a failed support break. Instead of continuing lower, a security recovers to leave the bears trapped with losses. While this could certainly qualify as a bear trap, it should be noted that DIA was already oversold below 100 and ripe for a bounce. Moreover, this bounce is nearing its make-or-break point. John Murphy and I have been pointing out reason for resistance over the last several days. If this is just an oversold bounce, then I would expect a continuation of the January-February decline sooner rather than later. The downside target would be the 38-50% retracement zone around 93-96. This area coincides with the October-November lows. RSI is also at its make-or-break. Notice how the 40-50 zone acted as support during the August-January advance. If the January-February decline started a downtrend, then the 50-60 zone should act as resistance.

Chart 2

WATCHING THE VOLATILITY INDICES... The volatility indices are still in downtrends overall, but higher lows may be forming. Chart 3 shows the S&P 500 Volatility Index ($VIX) hitting resistance near the March trendline and 200-day moving average in January-February. Despite the sharpest surge in over a year, the index ultimately failed to take out the 200-day moving average. The direction of the VIX is important to watch. From March to January, notice how the S&P 500 moved higher as the VIX moved lower. It appears that stocks favor falling volatility, which equates to lower risk. At some point, volatility will reach low enough levels that reflect complacency among the bulls, but determining that level is tricky. Alternatively, we can watch the VIX for signs of a trend change that could affect stocks. The VIX pulled back in February, but remains above its January low. Support around 20 extends back to the October-November lows and a bounce off this level would forge a higher low. Follow through with a break above the January-February highs would call for a new uptrend in volatility. It hasnt happened yet, but it is definitely something to watch in the coming weeks. Chart 4 shows the Nasdaq 100 Volatility Index ($VXN) with similar characteristics.

Chart 3

Chart 4

ACCUMULATION DISTRIBUTION LINE VERSUS OBV... The Accumulation Distribution Line and On Balance Volume (OBV) are two popular volume based indicators. Joe Granville created OBV and Marc Chaikin developed the Accumulation Distribution Line. OBV is a straight forward cumulative indicator. Volume is added on up days and subtracted on down days. The Accumulation Distribution Line is also a cumulative indicator, but it uses a divisor to value volume. This divisor is positive when the close is above the mid point of the high-low range and negative when below the mid point. The divisor ranges from -1 to +1. Zero indicates a close in the exact middle of the high-low range. +1 indicates a close on the exact high and -1 indicates a close on the exact low. This divisor is then multiplied by volume to form each periods affect on the cumulative line. Because these indicators are calculated differently, we can use them to confirm or refute each other.

Volume based indicators are based on the theory that volume leads price. Higher highs in these volume indicators are considered bullish. Non-confirmations flash warning signs. Lower lows are considered bearish. I am showing the next two charts more for educational purposes. Volume is important, but price action is foremost.

Chart 5 shows the Nasdaq with the Accumulation Distribution Line (green) and On Balance Volume (red). Both indicators hit new reaction highs and remain in uptrends overall. According to the theories, this is bullish action for these volume-based indicators. It is certainly impressive that these indicators moved above their January highs this month. Also notice that the indicators have been moving in lock-step with the Nasdaq since early July.

Chart 5

Chart 6 shows the NY Composite with the Accumulation Distribution Line edging to a new high this month. On Balance Volume (OBV), however, fell well short of its prior high and failed to confirm. The downtrend in OBV shows underlying weakness in volume on the updays (or strength in volume on the down days). There was good volume when the market advanced in early January, but volume increased during the subsequent decline and failed to rise as the market rebounded in February.

Chart 6