Using The Special K To Identify Major Trend Reversals

Using The Special K To Identify Major Trend Reversals:

• What’s the Special K saying for US equities?
• Important parts of Asia are looking sick
• Gold and the dollar two diverging trends

At my bi-weekly Tuesday Market Roundup Webinar 2015-05-10 last week, I had a few words to say about the Special K, an indicator I created years ago. I think it will help us identify whether the post-February rally is real in a primary trend sense. Alternatively, it could be the final hurrah before the current correction leads us to new, bear market territory. Before we get to that, let’s take a step backwards to review what the Special K (SPK) is designed to do, as well as expounding a little on its limitations.

Chart 1 shows the three KSTs for short, intermediate and long-term primary  trends. The vertical lines flag the primary trend highs and lows, and the small arrows point to lags for long-term KST turning points. The small arrows pointing towards these vertical lines show that in many instances the short-term KST turns ahead of these long-term turning points. The thought occurred to me that developing an indicator that literally summed up the calculation in these KSTs would return a series that more closely peaked and troughed with the actual turning points. Ergo the Special K in Chart 2.

Chart 1

It’s a much more jagged indicator that the long-term KST, but in the case of the CRB Composite ($CRB), and for most of the time with most price series, the SPK turns simultaneously with the price. Naturally this is no holy grail, which means that there are exceptions. These develop during linear up or down trends, which causes the SPK to peak and trough ahead of the cyclic turning point. Indeed, no indicator designed to monitor trends evolving over a 9-month to 2-year span will ever be able to maintain its integrity under such conditions.

It’s possible, of course, to identify the final turning points for the SPK with the benefit of hindsight. However, but in the real world they don’t ring a bell for those things. That means we must try to identify a trend reversal in this momentum series as soon as possible. The most useful are price pattern completions, trendline violations, a default moving average crossover and a reversal in peak/trough progression. The “default” in this case is a 100-day Simple Moving Average (SMA) smoothed with a 100-day SMA. Of these techniques the trendline violation is the most useful. Sometimes it’s not possible to construct a meaningful trendline, but in most instances it is. Nevertheless, such penetrations should always be confirmed by some kind of trend reversal in the price. Several examples of price pattern completions and trendline violations are shown in Chart 2. Note that we have just witnessed two trendline violations, which suggests that commodity prices have bottomed for a while. What the SPK does not tell us is the magnitude and duration of the current rally. Note also that in about half the instances of SPK trendline violations a moving average crossover is not far behind. All of which brings us to the current market picture.

Chart 2

What’s the Special K saying for US equities?

Chart 3 shows the same price/SPK action for the NYSE Composite ($NYA). The premature SPK peak in 1998 reflects the difficulties of calling a primary bear market during a secular or very long-term bull market. Apart from that, the SPK peaked more or less simultaneously with the price the rest of the time. A joint sell signal was given in late 2014 and early 2015 and both series have experienced negative zig zag trends ever since. Right now the SPK is a tad under its MA and the 2014-16 down trendline, which means that a worthwhile rally would trigger a bull signal, which would also reverse the series of declining SPK peaks and troughs.

Chart 3

This is all shown in greater detail in Chart 4, where I have drawn the price trendline slightly differently. Obviously, the level to beat is the green resistance trendline at 10,600 since a bettering of that level would complete a reverse head and shoulder pattern. In the meantime, I think the weight of the evidence continues to move narrowly in favor of the bear, especially over the short-term.

Chart 4

Chart 5 shows that the ratio between stocks and bonds ($NYA:TLT) and the Dow Jones Transports ($TRAN) have both broken back below their respective head and shoulder necklines, which is not a healthy sign. The stock/bond ratio also experienced a false upside break above its green down trendline, which in itself suggests a sharp drop is in the wind. Such a drop would only suggest that bonds will outperform stocks, but usually, that means that stocks themselves will head south.

Chart 5

Important parts of Asia are looking sick

Charts 6 and 7 feature the Nikkei ($NIKK) and the Shanghai Index ($SSEC), together with their respective SPK’s. The Special K for the Nikkei has already completed a top, but has not yet been confirmed by the price. That would require a decisive daily close under the 15,000 area. Note that the SPK is showing no signs of a reversal and is very close to its bear market low.

Chart 6

Chart 7 shows that the SPK for the Shanghai Composite ($SSEC) has already registered a new bear market low. The rule is “where the SPK goes the price usually follows”.

Chart 7

Chart 8 overlays the S&P 500 ($SPX) over the Shanghai Composite ($SSEC). They have not always moved in tandem, but since last August they certainly have. The two arrows show that the S&P 500 peaked ahead last October and bottomed first in February. However, it was Shanghai that completed a head and shoulders top last week and the S&P which followed this week. The Chinese Index has just about reached its downside objective, but twice the objective would call for a drop to the February low of 2650. That objective for the S&P is for a move just below 2000 (see the scale on the left).

Chart 8

Gold and the dollar - two diverging trends

Finally, Charts 9 and 10 show that the SPK has peaked for the Dollar Index ($USD) and completed a base for the Gold tracking ETF (GLD). This is certainly consistent with the theory that gold and the dollar usually move inversely.

Chart 9

Chart 10

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.