USING RSI(5) TO PLAY THE PULLBACKS -- QQQ HITS FIRST SUPPORT ZONE -- TRADING THE THROWBACK AFTER THE BREAK OUT IN ITB -- A CLASSIC CORRECTIVE PATTERN FOR THE EURO -- THE DOLLAR COULD BE SETTING UP FOR A BIG MOVE
USING RSI(5) TO PLAY THE PULLBACKS... Link for today's video. It looks like stocks are having a New Year's Eve hangover with weakness over the last three days. I would not consider this an omen for the rest of the year just yet though. A few days of weakness, even at the beginning of the year, can be expected after the big advance from December 16th to December 31st. Some profit taking at this stage is perfectly normal. More importantly, keep in mind that the major index ETFs hit new highs at the end of December and the long-term trends are clearly up. At this stage, traders should be looking for some sort of playable pullback. However, we don't know if this will be a short pullback that last a few days or a longer pullback that last two to three weeks. Regardless, chartists can use a combination of indicators and chart analysis to identify a pullback and a subsequent breakout. Chart 1 shows the S&P 500 SPDR (SPY) with 5-day RSI in the indicator window. The default setting for RSI is 14, but I decreased the look-back period to increase sensitivity and the number of overbought/oversold readings. With the bigger trend up, I am not concerned with overbought readings, which occur more frequently than oversold readings during uptrends. Instead, I am interested in oversold readings to identify small pullbacks or consolidations within the uptrend.
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Chart 1
No two pullbacks are the same, but we can identify at least three signals on this chart and learn for future reference. First, notice how RSI(5) dipped to the 30 area twice in August and then broke a clear resistance level just above 50. Second, the indicator dipped to the 30 area three times in late September and early October, and then broke a clear resistance level just above 50. These two signals were pretty straightforward because the dips to 30 established short-term oversold conditions and the intermittent highs established a clear resistance level to base a breakout. The third signal was not so straightforward because RSI dipped below 30 twice and surged to 70 in between these two dips. Alas, not all signals are perfect. Chartists using this system would now be waiting for the dip to 30 and establishment of resistance. On the price chart, broken resistance in the 180-181 area turns first support and chartists should watch this area on a throwback, which is explained in section covering ITB.
QQQ HITS FIRST SUPPORT ZONE... It often makes sense to combine indicator analysis with price chart analysis. For example, chartists can use 5-period RSI to identify short-term oversold conditions and then turn to the price chart for bullish signals. Chart 2 shows the Nasdaq 100 ETF (QQQ) with three oversold readings and three bullish signals. First, RSI became short-term oversold in mid October and then formed a small bullish divergence. QQQ broke out the second week of September for confirmation. Second, RSI became oversold on October 8th. QQQ then hit support from broken resistance on the 9th and gapped up on the 10th for a short-term bullish signal. Third, RSI became oversold on November 7th. QQQ then formed a harami the next day and broke flag resistance a few days later. Fast forward to early January and RSI is nearing 30 for another oversold heads up. QQQ is at its first support zone from broken resistance in the 86 area, but has yet to firm. The second support zone is set in the 84-84.50 area.
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Chart 2
TRADING THE THROWBACK AFTER THE BREAK OUT IN ITB... The Home Construction iShares (ITB) finished the year strong with a breakout in the second half of December and a seven month high. The breakout is clearly bullish and chart 3 shows the broken resistance zone turning into the first support zone to watch. Chartists should watch this zone because a "throwback" could provide another opportunity to partake in the uptrend. A sharp advance and breakout often creates a short-term overbought condition. Prices can work off overbought conditions with a consolidation or a correction (pullback). The throwback is a pullback that returns to broken resistance. The broken resistance zone for ITB is around 23.5 and this is the area to watch should a throwback occur. Also note that this area marks a 50-62% retracement of the December surge. Chart 4 shows DR Horton (DHI) with throwback support marked in the 20-20.2 area. Chart 5 shows Toll Brothers (TOL) with throwback support marked in the 35 area.
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Chart 3
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Chart 4
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Chart 5
A CLASSIC CORRECTIVE PATTERN FOR THE EURO... The Euro Index ($XEU) backed off resistance with a sharp decline last week and a significant top could be in the making. Chart 6 shows the index hitting resistance in the 138.50 area for the second time in three months. Resistance here stems from the October high and the 62% retracement. Also notice that the index traced out a large rising wedge the last eighteen months and remains well below its 2011 peak (lower high?). Both the pattern and the retracement are typical for counter trend rallies, which suggests that the long-term trend is down. A break below the October low and wedge trend line would reverse this counter-trend advance and signal a continuation of the prior decline (148 - 122 = 26). Using the measured move methodology, the downside target would be around 112 (138 - 26 = 112). Fundamentally, such a big move is entirely possible if European economy stumbles and the Fed continues its taper.
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Chart 6
The indicator window shows the MACD Histogram moving into negative territory as momentum deteriorates. A negative histogram means MACD has moved below its signal line, which is the 9-period EMA of MACD. The histogram is basically an indicator of an indicator, which means it measures the momentum of momentum and is extra sensitive. This does not necessarily make it better, but it does make it more prone to whipsaws.
Chart 7 shows the Euro ETF (FXE) breaking below the 50-day moving average on the daily chart. Long-term support is marked in the 132 area with the early November low and 200-day moving average.
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Chart 7
THE DOLLAR COULD BE SETTING UP FOR A BIG MOVE... It was a rough summer-autumn for the US Dollar ETF (UUP), but the ETF managed to hold above its October low and surge above first resistance. Chart 8 shows UUP breaking the July trend line with the early November surge. After a decline back to 21.50, the ETF firmed in December and broke above the mid December high with a strong two day surge to start the year. Even though UUP fell back on Monday, the higher low and last week's surge have yet to be negated. Chartists can consider this breakout bullish and mark key support at 21.40.
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Chart 8
CHINESE STOCKS START THE NEW YEAR ON SOUR NOTE... Chinese stocks moved sharply lower on Monday after China's Purchasing Managers Index (PMI) dipped to 50.9 in December. This is down from 52.5 in November and on the verge of breaking below 50, which is a key level for this report. Anything above 50 favors economic expansion, while anything below 50 suggests economic contraction. Even though the December reading was above 50, a 50.9 reading is hardly inspiring for an economy that is supposed to be growing more than 5% per annum. Chart 9 shows the index forming a lower high in early December and then breaking the June trend line with a sharp decline. After stalling for two weeks, the index broke flag support with today's decline. This break down signals a continuation of the December decline and targets a move to the low 1900s.
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Chart 9
Chart 10 shows the index in a long-term downtrend with lower lows and lower highs. The index attempted a flag/trendline breakout in November, but this breakout failed after a few weeks. With today's move to 2045, the index is trading at a four month low and chartists can mark long-term resistance at 2300. The bears rule China as long as this resistance level holds. The indicator window shows the Shanghai Composite relative to the S&P 500 using the price relative ($SSEC:$SPX ratio). Chinese stocks continue to underperform as this indicator hit another new low to start the year.
