Bearish Two Bar Reversal Says Further Probing of Recent Lows Is Likely

• Intermediate rally/consolidation for US equities still on the menu
• Test of the lows is likely first
• Emerging markets continue to look vulnerable
• Gold showing strong technical signs

The Intermediate Rally/trading range

The intermediate rally possibilities, which I have been discussing for several weeks, is still a probability. That’s because a number of indicators remain in a very subdued and therefore potentially bullish position. Chart 1, for instance, shows my Global Diffusion indicator. This one measures the number of positive trends within a basket of individual country ETF’s. The arrows show that reversals from a low level have typically been followed by a rally of some kind. Currently, it’s at a very constructive reading and has only just started to turn.

Chart 1

Chart 2 features another breadth indicator, the DJ Sector Percent Buy Index. As you can see this series diverged positively with the S&P between last August and this February. The solid arrows show that reversals from a low level in a bull market are typically followed by strong moves. The dashed arrows tell us that we should not expect to see such good results when a reversal takes place in a bear market as is currently the case. In effect, the divergence and the recent upside reversal from a low level tell us that conditions are still ripe for an advance.

Chart 2

Test of the lows is likely

Having said that, Tuesday’s action for some market averages represented a two-bar (day) reversal. Bearish two-bar formations follow a rally and consist of the first day opening close to its low and closing near its high and the second day to open near the previous close and close near the previous session’s open. Thus, anyone who has bought during that two day period is coming home with a loss (i.e. future selling pressure.) These patterns usually have an effect for between 5-10 sessions, so it’s not exactly the kiss of death. However, it does suggest that a test of the lows is probably in order.

Finally, if the two-bar formation works, and there are few grounds for suspecting otherwise, that will mean that the PPO, calculated from the very sensitive 6/12 parameters will turn down. You can see in Chart 3. Except for last October’s sell signal, flagged by the dashed arrow, all previous downside reversals ended in tears.

Note also that during the formation of this two-bar pattern, the NASDAQ broke above the green down trendline but by Tuesday’s close was unable to hold above it. That’s likely a false breakout and false breakouts are usually followed by above average price moves. Note also that the price was unable to cross above its (blue) 50-day MA. The small blue arrows show that this benchmark has represented a formidable resistance for many of this bear market’s rallies.

Chart 3

Chart 4 shows that the NASDAQ McClellan Volume Oscillator has reached an overbought zone. The solid red arrows indicate that about half the time the indicator reaches this line this was immediately followed by a halting or reversing of the advance. On the other hand, the dashed arrows show a more consistent downside sensitivity. The difference between the two classes of arrows is, of course, is that the solid ones developed under a bull market scenario and the dashed ones a bear trend. Now, in the interest of being objective, we do have to note that the indicator is still rising. However, if our two-bar reversal does “work” this will mean lower prices and a declining volume oscillator.

Chart 4

Emerging markets experience false upside breakout

The MSCI Emerging Market ETF, the EEM, completed a head and shoulders consolidation pattern earlier in the year. Since then it has been experiencing a retracement rally, which appears to have peaked on Monday. Note how the price was able to move above the extended neckline on Monday. However, Tuesday’s action was disappointing because the breakout was unable to hold.  The same can be said for the move above the (blue) 50-day MA. Normally I like to see some confirmation of false breakouts, such as a drop below the small red up trendline at about $29.5. However, in this case, we see the rally being associated with a declining trend in the PVO. Rallies accompanied by trends in shrinking volume are a typical bear market experience. The only time declining volume on a rally makes sense is following a selling climax, when by definition an advance should be associated with declining activity. An example of a selling climax came last August when the right shoulder and head were forming.

Chart 5

Gold and gold shares –overstretched but probably in a primary bull market

Chart 6 shows that in the last couple of weeks the gold price has succeeded in rallying above its bear market trendline and its 12-moth MA. Since the long-term KST is also moving higher this sets the scene for a bull market.

Chart 6

On a short-term basis, things are pretty overstretched, so some form of corrective activity would not be surprising. However, it is also apparent that the price could be forming a pennant. These patterns typically develop as consolidation formations in the middle of a move. Normally volume shrinks as it is being formed, subsequently expanding on the upside breakout. We will have to see how this one turns out.

Chart 7

Price action from the miners shares appears to be supporting the metal. For example, Chart 8 tells us that the upside-downside volume line has confirmed the price by breaking above a major down trendline. The GDX itself is also well above its 200-day MA.

Chart 8

More good news for the gold shares comes from Chart 9, which tells us that the 20-day MA of net new gold share highs has crossed above the green trendline for the first time in well over a year. The cumulative line is right at its 50-day MA and seems likely to surpass it. Finally please note a great example of a failed head and shoulder pattern, that was followed by an above average price move.

Chart 9

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.