Trend Check with Tushar Chande

Back to Basics: Why do RSI divergences occur?

I have an original, autographed copy of "New Concepts in Technical Trading System" by J. Welles Wilder, Jr.  The original signature is dated July 8, 1985, and made out to Stanley Kroll, who in turn gifted me his copy. I quite enjoy looking through the path-breaking book, as untold thousands have used the RSI and its other indicators over time. The original hand-written spreadsheets are just priceless.  Today I will try to explore why divergences occur between the RSI and underlying prices.

 

Chart 1: A pair of true originals, J Welles Wilder, Jr and commodities trader Stanley Kroll were good friends.  Stanley gave me his copy of the book, and I love this connection to one of the most popular set of technical indicators on the planet.

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Can't Keep a Good Market Down

The rapid rebound from the sell-off last week was impressive.  On the other hand, utilities made new highs and high-yield bonds resumed their rally.  The internals of the Russell 1000 index are pointing to weakness, even as trend-following models remain mostly bullish.  I look at some of the mixed signals from this sideways market.

Chart 1: The breakout in utilities has pushed XLU to the top of the trend strength rankings.

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SPX Breaks Cup-With-Handle Formation

The bull entered the china shop yesterday.   The momentum divergence I have worried about for the past week resolved to the down side, breaking the cup-with-handle formation on the hourly chart.  As a result, the short-term trends have turned flat on the trend check carpet, though longer periods remain unaffected, as they should.  I have also pointed to the broader market being weaker than the indexes.  The overall path of least resistance from the Russell 1000 universe remains lower in the 25-to-50 day interval, as it has for the past several days. The big picture shows a double-top and a sideways move, with support from 2320-2280.  Lastly, Berkshire Hathaway, my proxy for the broad market and the financial sector, broke key support, pointing to more weakness ahead.

 

Chart 1:  The sharp sell-off in the market broke the short-term cup-with-handle formation leading into the recent highs.

 

 

Chart 2: The momentum divergence I commented on last weekend was resolved to the down-side, pushing the market into a broad trading range.

 

Chart 3: The trend check carpet shows that the trends have turned flat on the short-term, but remain unaffected on longer time periods, as they should.  A one-day sell-off typically will not budge the longer-term trend-following models due to greater smoothing.  Here time periods range from 25-200 days, doubling at each step from to bottom. The market breadth increases from left to right, from 30 to over 2000 stocks.  (See model details here.)

 

I use trend-following models to check the percentage of the Russell 1000 universe above the upper bands for each time step.  I then show the plots as the path of least resistance to get a sense for how the trends are distributed below the surface of the index.  I have noted that the path of least resistance is lower in my recent posts, and that trend continues as you can see below.

Chart 4: The roll-up of the Russell 1000 universe shows the path of least resistance for the broad market is down in the 25-50 day range, flat in the 100-day range, and up in the 200-day area.

 

The Bigger Picture

The broader market, and now the SPX are essentially moving sideways.  This means there can be large one-day moves in either direction without moving the market out of its trading range.

 

Chart 5: The blue box shows the SPX is now in a broad consolidation.  The Aroon indicator in the lower panel still shows an up-trend since it is only a few days since the most recent 20-day high.

 

Chart 6: The SPX weekly chart shows the market moving sideways away from the upper boundary of a rough up-trending channel since the 2016 February lows.  The market seems to have made a small double top. Initial support starts at the March lows, extending down to the top of the December/January consolidation, say at 2300(+/- 20).

 

Financials Falter


Berkshire Hathaway is another stock telling the story of the weakness in Financials.  Yesterday it broke important support, and will remain in a down trend until it can decisively break the dashed down-trend line.  The next support is down near 157 area.

Chart 7:  Berkshire broke key support, and must now test the next support at 157.5 and overcome the down-trend line before the correction can end.

 

Summary

The fear factor from the selling will take some time to dissipate.  The vulnerability to head-line risk I had worried about for the past few posts arrived with a bang, and will remain with us for the immediate future.  The market seems to have retreated into its consolidation region.  The trend-following models have turned flat in the short-term, but the longer term models remain unaffected, as they should. The more sensitive path of least resistance calculations have been on track, pointing to short-to-medium weakness before the latest breakdown.  Bonds and gold have rallied in a risk-off mode, and also enter a seasonally friendly period. We just have to be patient as the market comes to grip with the daily drip of the leak-of-the-day.

Thank you for your time, and please subscribe below for automatic reminders of future posts.

Enjoy!

Tushar

 

 

 

 

 

High Yield Corporate Bonds Greenlight Breakout

High-yield corporate bonds are pointing to higher equity prices.  The iShares IBOXX High Yield Corporate Bond ETF (HYG) formed a nice cup-with-handle formation, broke out above the prior high, came back to re-test the breakout point, and then rallied to new highs.  This is a very powerful chart pattern, and is indicating a risk-off market environment (see Chart 1).  The VanEck Vectors International High Yield Bond ETF (IHY) paints a similar picture (see Chart2), as it responds to the strong up-moves in European equity markets.  IHY shows a high correlation to the S&P 500 index, which implies that rising equity prices have pushed these funds higher.  Thus, high yield bonds ETFs are strongly implying a risk-on market environment.  We search for the strongest industry groups responding to the high yield bond signal.

 

Chart 1: HYG, the iShares iBoxx High Yield Corporate Bond ETF is suggesting a risk-on environment with this powerful chart.  We see a clear cup-with-handle before the breakout, followed by a re-test of the breakout level.  Multiple new highs soon followed with good momentum, pushing the CTM above 95.

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Detour Ahead for the SPX? (Or, Is it 2015 All Over Again?)

The S&P 500 chart this year is starting to resemble the market's evolution in 2015. Then, as now, the market had lost all its up-side momentum, and it was listlessly moving sideways into the summer.  Then, in 2015, we had a mini-crash in response to a currency move in China, and it led eventually to the lows in January, 2016.  We look at the similarities in the market’s price action in 2014-15 and 2016-17 for clues to what might happen next.

Chart 1: Is there a detour ahead for the market? Perhaps there are clues to be found in 2015.

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Divergence in SPX, But No Pick-up in Selling Pressure

A glaring divergence is developing on the S&P 500 chart as it makes new highs, but with a lower 14-day RSI.   Such a divergence implies a loss of up-side momentum. However, there is no discernible pick-up in selling pressure, even after the turbulence from Washington.  I converted RSI values from 7-70 days into the corresponding buy/sell pressure.  I show that buying pressure exceeds selling pressure, and buying pressure is relatively constant versus selling pressure as we extend the look back period.  So, the market is happy staying up here for now.

 

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Weekly Trend Check May 05 -- Trend-following Models All Green

My trend-following models trend check carpet is a lovely color of green across all time frames and market breadth, but event risk rises this weekend with round two of the French elections due Sunday.

Chart 1: Trend-following models are all green, pointing to higher prices.  The degree of smoothing increases from to top to bottom, and market breadth increases from left to right, from 3o to over 2000 stocks.

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Sunscreen for your Portfolio: What to do if you can't sell in May and go away?

As summer vacations breach the horizon, and beaches beckon, equity traders leave market worries behind, and equity prices have their summer fade.  But, what to do if you cannot sell in May and go away?  I found some stocks and sectors that gain from summer fun.  Naturally, momentum trumps seasonality, and well, this year is different, so a bit of caution/ sunscreen is always desirable.

 

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Insights from Vanguard ETFs on Style and Cap Weight Performance -- The Magic Behind Vanguard MGK ETF

Vanguard ETFs provide interesting insights into recent performance of funds by style (growth vs. value) and market capitalization (large vs. small).  Even a casual glance at industry net assets will show you that most of the US assets are in large or mid cap stocks.  Hence, whether you are an individual trying to gain an edge, or a portfolio manager trying to stand out, understanding their recent performance is well worth your while.

 

Chart 1: The Vanguard Mega Cap Growth ETF (MGK) is trending strongly.  It has leaped to the top of our CTM rankings of Vanguard ETFs dedicated to cap weighted investing.

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April Trend Check -- Sector Vectors -- Trend-Weighted Sector Portfolio -- SPX Cup Needs Handle

Trend Checking The Market


The major indexes all rallied sharply towards month end, and with that our trend-check carpet has turned  positive over the short term.  The short-term trend check carpet tells us that the broad market is now trending higher on the short term, in sync with the long-term, which increase the odds that the rally can continue.

Chart 1: All of the major indexes are now trending higher over the short-term.  Market breadth increases from left to right, from 30 to over 2000 stocks.

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