A POSSIBLE BROADENING FORMATION FOR THE NY COMPOSITE -- NASDAQ HOLDS ABOVE FEBRUARY LOWS WITH VOLATILE RANGE -- NY COMPOSITE UNDERPERFORMS NASDAQ -- NYSE AD VOLUME LINE IS WEAKER THAN THE AD LINE -- VIX AND VXN REACH MEDIUM-TERM EXTREMES

A POSSIBLE BROADENING FORMATION FOR THE NY COMPOSITE... Link for todays video. With a big bounce on Thursday, the market is making another concerted effort at holding the February lows. Chart 1 shows the NY Composite ($NYA) piercing its February lows, but moving back above by the end of the week. Even though the NY Composite bore the brunt of selling pressure in May, the index is attempting to firm near in the 50-62% retracement zone. The Fibonacci Retracements Tool is based on the advance from the July low to the April high. A normal correction would retrace 50-62% of the prior advance. Anything more would be considered abnormal.

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Chart 1

2010 has been a rather volatile year with a higher high in April and now a lower low in late May. Connecting the highs and lows this year reveals a potential broadening formation. The swing within this potential broadening formation remains down and a break above resistance at 6900 is needed to reverse the seven week downtrend. The indicator window shows RSI also at its moment-of-truth. This momentum indicator dipped below 40 at the end of May, but rebounded back in the zone this month. A break below the May low in RSI would be bearish. Chart 2 shows the daily candlesticks for reference.

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Chart 2

NASDAQ HOLDS ABOVE FEBRUARY LOWS WITH VOLATILE RANGE... In contrast to the NY Composite, Chart 2 shows the Nasdaq holding above its February lows with a volatile trading range the last three weeks. The last three weekly candlesticks show the Nasdaq dipping below 2150, surging above 2300, dipping back below 2150 this week and currently around 2233. It is a real tug-o-war between the bulls and the bears in this support zone. Sharp one-two day declines are met with sharp rebounds, but sharp rebounds are followed by steep declines. A break from this three week range will provide the first clue on the ultimate winner. A move above the June high would be bullish and keep the long-term uptrend alive. A move below the June lows would likely lead to a bigger support break below the February lows. 14-week RSI for the Nasdaq held above 40 in May and is currently in the 40-50 support zone. This is an important test for Nasdaq momentum. Chart 4 shows daily candlesticks for reference.

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Chart 3

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Chart 4

NY COMPOSITE UNDERPERFORMS NASDAQ... Relative weakness in the NYSE can be attributed to some large-caps that are not to be found in the Nasdaq. Like many indices, the NY Composite is weighted according to market-capitalization. According to the NYSE website, top sectors include finance (22.16%), Oil & Gas (14.21%), Industrials (11.58%), Consumer Goods (11.47%) and Healthcare (10.37%). The top 10 stocks account for around 13% of the index. The top ten include Exxon Mobil, Procter & Gamble, GE, IBM, Johnson & Johnson, HSBC Holdings, Bank of America, AT&T, JPMorgan Chase and Chevron. With concentrations in energy (XOM, CVX) and Finance (BAC, HBC, JPM), its easy to see why the NY Composite fell sharply over the last seven weeks. Of note, BP slipped from the number 4 spot to the number 22 spot over the last few months, perhaps even weeks. Chart 5 shows the price relative comparing the NY Composite with the Nasdaq. This ratio broke down at the end of 2009 and steadily declined in 2010. The decline accelerated from early April until the end of May.

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Chart 5

LARGE CAPS AND MOST ACTIVE DOMINATE AD VOLUME LINE... While the AD Line is holding up quite well over the last seven weeks, the NYSE AD Volume Line was pummeled with a break below the February low. This discrepancy reflects relative weakness in large-caps and volume leaders. It also shows relative strength in small-caps and the average stock. The AD Volume Line is dominated by the volume leaders, which also tend to be larger stocks. Here is the 25-day average volume for some key NYSE components: Citigroup (920 million), Bank of America (206 million), GE (96 million), ExxonMobil (38 million), BP (60 million). All are down sharply the last seven weeks and all have relatively high volume. Chart 6 shows Citigroup with volume and On Balance Volume (OBV). OBV can be used to measure the net affect for volume. Volume is added on up days and subtracted on down days. OBV for Citigroup peaked the second week of April and declined until the third week of May. Chart 7 shows BP being decimated with high volume for seven weeks.

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Chart 6

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Chart 7

AD VOLUME LINE BREAKS FEBRUARY LOW... Chart 8 shows the NYSE AD Volume Line free falling in May and breaking its February low. This indicator is a cumulative measure of Net Advancing Volume (volume of advancing stocks less volume of declining stocks). Weakness in the volume leaders during May pushed this indicator sharply lower. There is possible support from the November low, but a move above the late May high is needed to reverse the downtrend in the AD Volume Line.

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Chart 8

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Chart 9

Chart 9 shows the NYSE AD Line holding well above its February high. This indicator is a cumulative measure of Net Advances (advancing stocks less declining stocks). All stocks are treated equal, regardless of price or market cap. An advance counts as +1 and a decline counts as -1. This levels the playing field between large-caps and small-caps. With many more small-caps than large-caps, the AD Line reflects the performance of the average stock. Although deeper than the January-February decline, the May decline in the AD Line looks like a normal correction. Also notice that the AD Line found support on May 20th and has been trading flat the last 3-4 weeks. This means the AD Line is showing some relative strength, especially compared to the AD Volume Line. Relative strength is one thing. Absolute strength is another. A break above the late May and early June highs is needed to reverse the seven week downtrend. A breakout in the AD Line would be bullish for the market overall.

VIX AND VXN REACH MEDIUM-TERM EXTREMES... Yesterday I showed how the volatility indices can be used as coincident indicators with long-term trend analysis. The volatility indices can also be used as contrarian indicators over a shorter timeframe. Relatively high volatility or surges can be viewed as excessively bearish. This suggests too much fear in the market that could lead to a rally. Relatively low volatility or plunges can be viewed as excessively bullish. This suggests too much complacency that could lead to a decline. Chart 9 shows the S&P 500 Volatility Index as the Percentage Price Oscillator (PPO). This indicator is the percentage difference between the 10-day EMA and 50-day EMA. Applying the PPO normalizes the volatility indices and removes much of the trend, which makes it easier to identify extremes. From this chart, surges above +5% show excessive bearishness and plunges below -10% show excessive bullishness.

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Chart 10

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Chart 11

In contrarian thought, excessive bearishness is bullish and excessive bullishness is bearish. Once the PPO of the VIX reaches an extreme (above +5% or below -10%), it is important to wait for a reversal and moving average cross before considering a reversal. Volatility can reach extremes and continue as it did in May. The thin blue line is the 10-day EMA of the PPO. Currently, the PPO of the VIX reached a bearish extreme with the surge above 45%. The PPO turned down the last few days and broke its 10-day EMA, but it remains well above +5%. Two things are possible here. First, a move below +5% would complete the current bullish signal. Second, the bigger trend reversal in the VIX could mean new extremes will be established. In other words, there are bull market extremes and bear market extremes. Bull market extremes applied from April 2009 until April 2010. Should the market enter a bear phase, it is possible that -5% will be deemed excessively bullish now and +10% will deemed excessively bearish. Chart 10 shows the PPO of the Nasdaq 100 Volatility Index for reference.