A lesson on momentum and reversal pivots

Chris Schumacher ...

The right side of the head-and-shoulders pattern is still forming on the daily chart. This typically leads to a coil within a base so that when support fails, it fails hard. This is what I was hoping to avoid in the first quarter. There have been enough entry points available to bulls who wanted to go long from 1635 and 1650 that I was hoping the bulls could create momentum at highs rather than from lows. When momentum comes from lows, it exhausts itself just to get back to resistance.

When indicators are mixed ...

Helene Meisler

I can't recall the last time the indicators were so mixed.

The 30-day moving average of the advance/decline line has been overbought since the beginning of the year, keeping a lid on any rally. Meanwhile, the oscillator has moved back and forth between overbought and oversold, giving us rallies and declines that last no more than a few days at most.

This has translated into a McClellan summation index that has gone nowhere as well. I can't recall another time when it would take a net differential of less than 1,000 issues on the A/D line to move the indicator from down to up or vice versa. It seems that each time it gets in gear going one way, it immediately snaps back to the other. And then when it feels like it's back in gear that way, it changes again.

Usually this indicator gets to the point where it requires a big net differential to move it, but that's presently not the case. Several up days in a row would turn it upward whereas several down days would turn it lower. Yet we can't seem to get several days of anything in a row!

Then there are the new highs and new lows. The raw data, as I mentioned here Thursday, aren't very good. They are telling us how narrow each rally is getting. Yet the 10-day moving average of the net differential of highs and lows is currently trending upward. Typically the market moves in the direction of the 10-day moving average. I suppose we might call this an up week, but there hasn't been the vigor we've come to expect.

Then there's sentiment. The Investors Intelligence readings clearly show too many bears and too few bulls. That would have us believe we are close to a low in the market.

The 10-day moving average of the put/call ratio shows something different. It's currently heading back toward the bottom of the page. Typically moves from the bottom of the page are associated with market highs, not lows!

But it's the volume that is the real conundrum. The 30-day moving average of upside volume as a percentage of total volume has dipped below 50%. Normally a reading in the low to mid-40s would be associated with a low in the market. So it's drifting toward a low in the market, not a high.

All the data leads me to think that a decline here would lead to a good rally, not a massive bear market.

Let's say the put/call ratio is correct and we aren't quite done rallying. So we rally a few more days. But being so low already, the put/call ratio is telling us this rally would be short-lived. That's also what the new highs are telling us, and the overbought oscillator and the 30-day moving average of the A/D line, which isn't yet oversold.

But if the Investors Intelligence readings are correct, then a decline after that rally would only lead to more bearishness, not more bullishness. And more bearishness is bullish.

Then let's go back to the volume chart. It's telling us that if we do end up getting a whack in early March, we can very well get that indicator down to the bullish zone quickly.

So what we really need to get a trend to trade is a short-term rally that lasts into next week, followed by a solid whack to the downside. This would set us up for a springtime rally that could last more than two or three days.

The problem with well known technical patterns

Rev Shark ...

A lot of folks have been pointing at developing head-and-shoulders top patterns in a number of indices as a reason to be worried. I certainly can see what they are talking about, as can just about anyone else who looks at the chart.

However, it is my experience that it is a pattern that seldom works. I would guess that the head-and-shoulders pattern is probably the most well known of all technical patterns, which is why it doesn't tend to work that well.

When everyone sees and expects the same things, they act in anticipation. The sellers who are worried about a head-and-shoulders top do their selling before it is fully formed, which tends to undercut its development.

We see the same problem with breakouts at times as well. When they are well anticipated, they are often sold and fail. Technical patterns can't be considered in a vacuum. You also have to think about the emotions that surround them. When anticipation that a particular pattern may play out is running very hard, the chances of a quick failure are also high.