Key Index Experiences a Bearish Outside Day: Could There Be More Downside to Come?

One piece of Monday's market action that really stood out to me was a bearish outside day in the NASDAQ, as shown in Chart 1. A classic outside day develops after a persistent short-term rally and signals a short-term reversal in sentiment. The outside part refers to the fact that its price range exceeds that of its predecessor. From an analytical point of view, the wider the bar, the better, since a wide bar reflects a bigger battle between buyers and sellers than a narrow one. Also, it's important to have the closing price develop near the low of the day. Remember, during the period preceding the bar, buyers were in control. If the price can close near the low, it is a signal that sellers now have the upper hand.

With these yardsticks, Monday's NASDAQ action represents a very powerful signal since it reflects buyer exhaustion. This negative action was augmented by the fact that the RSI experienced a failure swing and violated the up trendline.

It's important to stress that these one-day formations are only expected to have a short-term effect, say for 5-10 sessions. Moreover, no long-term indicators, such as the 200-day MA, have come anywhere close to triggering a bear signal. That said, a deeper dive into some of the NASDAQ breadth indicators leaves a lot to be desired, which could mean that the outside bar represents an opening salvo.

NASDAQ Breadth Indicators

Chart 2, for instance, features the NASDAQ Bullish Percentage Index. It peaked back in February and has been working its way progressively lower, as the NASDAQ itself has been steadily rising. That kind of discrepancy developed on a smaller scale in the summer and fall of 2020, but was resolved in a positive way. It's possible that the current one will experience a similar outcome. For that, we will have to wait for an upward penetration of that March/November down trendline. On the other hand, a break below the red support trendline at 45% would suggest a negative outcome.

Breadth can also be measured by monitoring the number of issues reaching net new highs over a 52-week lookback period. Chart 3 indicates three instances of a small negative divergence where the Index registered a new high but the number of individual issues touching net new highs did not. A fourth such divergence appears to have formed in the last week, as the mid-November all-time high was barely accompanied by any of its components; the indicator could barely make it above zero. Equally as important, this week the net number of new lows fell to its lowest level since last March.

Between March 2020 and February of this year, the percentage of NASDAQ stocks trading above their 200-day MA's moved more or less in gear with the Index itself. Since then, that number has been steadily declining in the face of an even stronger Index. At the recent high, barely 35% of NYSE issues were above that key average. The technical position of this indicator could change, given a break above the green 2021 down trendline. Such action would be very positive, since it would indicate a rising trend of stocks trading above their 200-day MA. However, the indicator, which does not reflect weak Tuesday action, is right at  the August/November support trendline and its KST has just gone negative. Based on current action, I therefore interpret this relationship as bearish. Please remember, this chart can be updated simply by clicking on it.

The NASDAQ Composite Has a Relative Problem

Chart 5 shows that, like the indicator in Chart 4, relative action was moving in gear with the Index until February of this year. The first set of dashed red arrows demonstrates that, at the marginal new high in April, the RS line was well off its February peak. It even broke down from a head-and-shoulders top. However, that break has so far turned out to be false. The second set of arrows shows that the price/relative strength divergence continued to extend.

Chart 6 holds out the possibility that the RS line is in the process of tracing out an inverse head-and-shoulders pattern. Completion would require a decisive break that can hold above the green resistance trendline. Such action, should it take place, would merely indicate the likelihood of the NASDAQ outperforming the S&P. Most of the time, though, it is true to say that a rising RS line does reflect improving confidence and tends to lift all boats.

That said, a more likely outcome is that the RS line, having falsely broken above the green trendline and its 200-day MA, is now testing support in the form of the 2021 red dashed up trendline. If such a break develops, we would expect to see the RS line move significantly lower, as that would confirm the late November upside break as being truly false. Whipsaw moves are often followed by above-average moves in the opposite direction to the whipsaw.

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 Groupof Walnut Creek or its affiliates.