Trend Check with Tushar Chande

Risk of Reversal Rises with Parabolic Move

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The powerful January rally has turned "parabolic" across all key indexes, increasing the risk of a market reversal.  The sheer flow of investment dollars into stocks has driven the acceleration in prices, but this flow is also nearing an extreme (see BAML), increasing the risk of a reversal.  Eventually this rocket will run out of fuel and the so-called parabolic rise will lead to a correction.

 

Chart 1: The strong move in January has the look of an accelerating parabolic advance.  Note how the stochRSI in the lower panel has not dropped below 0.20 since early September.


 

Parabolic Moves In All Major Indexes

The key indexes have had parabolic moves that have accelerated this month, as the four panel composite below shows clearly via the 2-hour charts (see Chart 2).

 

Chart 2: This four panel composite of the 2 hour charts of the major indexes shows the parabolic nature of the moves.  The Dow 30 Industrials is in the upper left, the NY Stock index composite is on the upper right, the Nasdaq Composite is in the lower left and the S&P 500 index is in the lower right.  The moves in the market have accelerated in January.

 

Parabolic Patterns Are Powerful, and Hard to Break

Parabolic moves can accelerate for a while, but can breakdown dramatically, as Carl Swenlin has discussed in the Bitcoin context.  The breakdown out of parabolic moves usually requires an external event to trigger a reversal (combined with price exhaustion - see BAML reference above), so the pattern is hard to break.  So headline risk plays a role in motivating a reversal or drift out of the rising price pattern.  Chart 3 shows the Fibonacci retracement levels, and implies a drop to 2600 is not impossible.

 

Chart 3: An external event is usually the trigger for a reversal in strong moves, so it is difficult to pin down the start of the breakdown.  However, one can use Fibonacci retracements to guess potential pullback levels. A move to the 2675-2600 area is is certainly possible with intermediate halts at say 2800 and 2750.

 

Looking Ahead

The rally has been impressive and broad as I have touched upon over the past few posts.  The market internals are strong, as we should expect from such a sustained rally.  The flow of assets into stocks has been the fuel, and once that slows a bit, any external event could trip this market out of its meteoric rise.  In the mean time, En Garde!

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Tushar Chande
About the author: , PhD, MBA, is the inventor behind an impressive collection of technical indicators, including the Aroon and Stochastic RSI. He has written several books, holds both a PhD in Engineering and an MBA in Finance, and has over two decades of experience trading the financial markets. Follow Tushar in this blog as he highlights his new "Trend Meter" indicator and shares his analysis of current market conditions. Learn More
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