SMALL AND MID-CAPS LEAD STOCKS LOWER -- OIL ETF PLUNGES AS BASE METALS ETF HITS NEW LOW -- USING HEIKIN-ASHI CANDLESTICKS TO REDUCE VOLATILITY -- SPY FORMS TRIANGLE ON WEEKLY HEIKIN-ASHI CHART -- WHEN DOES A RISING FLAG BECOME SOMETHING MORE

SMALL AND MID-CAPS LEAD STOCKS LOWER... Link for todays video. Stocks moved lower on Wednesday with small-caps leading the way. Before looking at the charts, just a note on the current Euro-Greek hysteria. It all boils down to the economy. If the US economy were strong and growing, the European issues would be put on the back burner and stocks would be rising. However, it appears that the US economy is not strong and perhaps not growing. An outright recession is unlikely as long as jobless claims do not jump. Evidence that weakness in US stocks is more a US problem than a Euro-Greek problem can be see with the performance of small and mid-cap stocks. These companies are the most sensitive to the domestic economy. They are the canaries in the coal mine. Chart 1 shows the Russell 2000 ETF (IWM) breaking triangle support with a sharp decline last week. Even though the ETF surged back above 68 early this week, I would chalk this up to volatility because the surge did not hold more than a day. The ETF is trading back below the triangle break. The indicator window shows the Price Relative (IWM:SPY ratio) moving to a new low this month. Small-caps are showing relative weakness and this is bearish overall. Chart 2 shows the S&P MidCap 400 SPDR (MDY) with a similar pattern and its Price Relative hitting a new 52-week low.

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Chart 1

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Chart 2

OIL ETF PLUNGES AS BASE METALS ETF HITS NEW LOW... Commodities are also sensitive to the economy, and the Dollar. The combination of a bouncing Dollar and falling stock market weighed on industrial metals, oil and gold. Chart 3 shows the US Dollar Fund (UUP) holding its Double Bottom breakout and moving higher on Wednesday. Chart 4 shows the US Oil Fund (USO) dropping over 3%. The ETF remains in a clear downtrend with a test of the August-September lows at hand. Perhaps most telling of all, chart 5 shows the Base Metals ETF (DBB) hitting a new 52-week low today. Led by a falling in copper, DBB is down over 25% in the last two months. This is not a vote of confidence in the global economy.

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Chart 3

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Chart 4

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Chart 5

USING HEIKIN-ASHI CANDLESTICKS TO REDUCE VOLATILITY... Stockcharts.com recently added a new type of candlestick, Heikin-Ashi Candlesticks. These candlesticks use data from the current period and the prior period. In this regard, the candlesticks incorporate two days of price action instead of one. This produces a more trend-focused candlestick that is not subject to one day movement. Normal candlestick patterns are not applicable to these candlesticks, but you can use spinning tops and doji to indentify periods of indecision. Chart 6 shows the S&P 500 ETF (SPY) with Heikin-Ashi Candlesticks in the main window and regular candlesticks in the indicator window for comparison. Notice that 13 black Heikin-Ashi Candlesticks formed from late July to early August when the ETF broke a major support level. After bottoming in early August, SPY zigzagged higher to form a rising flag. The ETF broke flag support with a sharp decline last week. Even though SPY moved back above the flag break, it remains well below resistance in the 122-123 area. Moreover, the bigger trend is considered down and this favors a bearish resolution to the rising flag.

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Chart 6

SPY FORMS TRIANGLE ON WEEKLY HEIKIN-ASHI CHART... Chart 7 shows weekly Heikin-Ashi Candlesticks for SPY. The pattern on this chart looks more like a triangle after a support break. Triangles represent indecision or a consolidation. After a support break and sharp decline, the pattern carries a bearish bias. In other words, a continuation of the downtrend is expected. A break below the lower trendline would signal the start of this continuation and target a move to the next support zone in the 100-102.5 area. Notice how the last three Heikin-Ashi Candlesticks are spinning tops. These also denote indecision. A break above triangle resistance would show some bullish resilience and call for a reassessment of the early August support break. You can read more about Heikin-Ashi Candlesticks in our ChartSchool Article.

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Chart 7

WHEN DOES A RISING FLAG BECOME SOMETHING MORE... A reader asks how one can distinguish between a rising flag and the start of an uptrend. After all, a rising flag forms with at least one higher high (peak) and one higher low (trough). To recap: rising flags are bearish continuation patterns that formed after a sharp decline. They represent a zigzag higher that retraces a portion of the prior decline. The trick is to determine if the rising advance looks corrective or impulsive. A corrective advance is against the bigger downtrend. An impulsive advance is part of the bigger uptrend. Corrective advances usually occur with lighter volume. Rising flags form with peaks that reverse just after exceeding the prior peak. A move that exceeds the prior peak and continues with good volume indicates that the rising flag is in fact a new impulse move.

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Chart 8

Chart 8 shows the Consumer Discretionary SPDR (XLY) with weekly candlesticks over the last two years. After a sharp decline and support break in early August, a rising flag took shape over the last eight weeks. Even with the long white candlestick three weeks ago, prices remained within the rising flag. In other words, prices did not exceed the upper trendline and break the flag formation. Moreover, prices reversed soon after exceeding the prior high to keep the flag formation intact. At this point, I think a surge and weekly close above 39 would negate the rising flag. A decline and weekly close below 35 would confirm the pattern and argue for a continuation lower. Next support resides in the 28-29 area. Also watch the TRIX for a move below its signal line to confirm.