OBV HITS NEW HIGH FOR SPY AND QQQ -- SEMIS AND RETAILERS LEAD PULLBACK -- HOME CONSTRUCTION ISHARES TESTS NECKLINE -- THE HEAD-AND-SHOULDERS PATTERN THAT WASN'T -- BRIC SPDR MAINTAINS POSITIVE CORRELATION WITH THE CRB INDEX

OBV HITS NEW HIGH FOR SPY AND QQQ... Link for today's video. The S&P 500 ETF (SPY) broke above its May highs in July and these highs are turning into the first support zone. Chart 1 shows this support zone in the 167.5 area. Since first crossing above 167.5 in mid July, SPY has experienced some mild selling pressure on various days. The red bars mark down days. This selling pressure, however, is interspersed with up days that mark buying pressure. Should SPY break support at 167.50, I would then expect a deeper pullback that could extend to the 162.5 area. Support here stems from broken resistance in early July.

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Chart 1

A look at the volume bars shows higher volume on the down days from February to June. This may seem a bit strange because SPY moved higher during this time frame. One would not expect much headway with downside volume outpacing upside volume. Volume bars, however, do not always tell the entire story. The indicator window shows On Balance Volume, which adds volume on up days and subtracts volume on down days. It is a simple indicator that measures accumulation and distribution. Despite several high volume distribution days(selling days), OBV marched higher along with SPY. In fact, OBV hit a new high in early August and remains above first support (the late July low). Even though volume on down day seemed strong, there were more up days and this pushed OBV higher. If you are using volume in your analysis, use a volume indicator to further quantify buying and selling pressure. Chart 2 shows the Nasdaq 100 ETF (QQQ) with broken resistance turning support in the 74-75 area.

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Chart 2

SEMIS AND RETAILERS LEAD PULLBACK... The consumer discretionary and technology sectors are two of the most important sectors in the stock market. The consumer discretionary sector is the most economically sensitive sector and has the highest correlation to the S&P 500. The technology sector has many high growth stocks and represents the appetite for risk. Within these two sectors, the retail group is vital to the consumer discretionary sector and the semiconductor group is important to technology. Therefore, I watch the Retail SPDR (XRT) and the Semiconductor SPDR (XSD) rather closely for clues on their respective sectors, and, by extension, the stock market. XRT consists of over 90 retail stocks, while XSD has over 50 semiconductor stocks.

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Chart 3

I am concerned because the Retail SPDR (XRT) and Semiconductor SPDR (XSD) fell rather sharply the last two days. Chart 3 shows XSD falling over 1% and nearing broken resistance in the 54-55 area. The overall trend is still up, and broken resistance marks the first support test. The indicator window shows the price relative edging below the late July low and the May trend line. XSD is starting to underperform and this is a short-term concern. Chart 4 shows XRT failing to hold the flag breakout and falling over 2% the last two days. Even though the late July low marks support at 80, I am going to watch support from broken resistance in the 78-79 area.

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Chart 4

HOME CONSTRUCTION ISHARES TESTS NECKLINE SUPPORT... Chart 5 shows the head-and-shoulders pattern continuing to evolve on the Home Construction iShares (ITB). In fact, it is now about as picture-perfect as anyone could want. The right shoulder is a little smaller than the left shoulder, but the pattern is clear with neckline support in the 21.2-21.5 area. A break below support would confirm the pattern and target further weakness towards the 16-17 area. The height of the pattern is subtracted from the support break for a target.

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Chart 5

Volume is an important part of the head-and-shoulders pattern. In particular, chartists should see evidence of increased selling pressure when the right half of the pattern takes shape. The indicator window shows On Balance Volume (OBV) peaking along with ITB in mid May and breaking support in late June. Notice that OBV broke support ahead of ITB. Also note that OBV moved to a new low in late July. Joe Granville, creator of OBV, theorized that volume leads prices. According to Granville, this new low in OBV suggests that ITB will indeed break support and move lower. Chart 6 shows the Homebuilders SPDR (XHB) holding up better than ITB, but still underperforming SPY.

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Chart 6

THE HEAD-AND-SHOULDERS PATTERN THAT WASN'T... Before buying into this head-and-shoulders pattern, note two items. First, the bigger trend is up and ITB is entitled to a correction. Chart 7 shows that this head-and-shoulders could evolve into a falling wedge that corrects back to the 19-20 area.

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Chart 7

Second, I have seen picture-perfect head-and-shoulders patterns evolve into falling wedges that marked a mere correction. Chart 8 shows the S&P 500 from August 2009 to December 2010. A pretty nice head-and-shoulders pattern formed from November to June, and several chartists were pointing it out (yours truly included). The S&P 500 did indeed break support at 1040 to confirm, but this support break did not last long as the index surged right back above 1100. After another support test at 1040, the index formed a higher low and surged the rest of the year. Two items stand out. First, the support break did not last long. Second, a falling wedge evolved and the index quickly broke wedge resistance. The moral of the story: be prepared for the unexpected.

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Chart 8

BRIC SPDR MAINTAINS POSITIVE CORRELATION WITH THE CRB INDEX ... The BRIC SPDR (BIK) represents equities in Brazil, Russia, India and China, four premier growth markets. The CRB Index, of course, represents a basket of commodities, which includes oil, unleaded gas, corn, soybeans, gold, copper, silver and more. Chart 9 shows the BRIC SPDR and the CRB Index moving in lockstep over the last three years. The indicator window confirms this with the Correlation Coefficient ($CRB,BIK). Notice how this indicator has been largely positive the last three years. Emerging markets and commodities are positively correlated because these emerging markets are driving demand for said commodities.

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Chart 9

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Chart 10

Well, it looks like growth rates are slowing in the BRIC countries and demand for commodities is also slowing. Chart 10 shows BIK forming a massive triangle from late 2011 to early 2013. With a sharp decline this year, the ETF broke triangle support to signal a continuation of the 2011 decline. BIK bounce in July, but turned back near the triangle support break. This looks like an oversold bounce. With this week's downturn, chartists can mark resistance in the 22-22.5 area and expect a continuation lower as long as resistance holds.