Watch for Signs of Trouble

01/03/2011 10:05 am EST

Focus: STOCKS

Thomas Aspray

, Professional Trader & Analyst

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Chart Analysis: Stocks continued to edge higher in light year-end trading, though the S&P 500 has not yet been able to surpass the resistance at 1262-1263. A convincing close above this level could signal a rally to the next Fibonacci price projection targets in the 1285 area. The first good support level is at 1230, which corresponds to the early-November highs. You should remember that once a level of strong resistance is surpassed, it then becomes a good level of support. There is further chart support at 1200 to 1184. Studying the NYSE Advance/Decline (A/D) line, a cumulative total of the number of advancing stocks minus the number of declining stocks, is one of my favorite ways to assess the stock market’s intermediate-term trend. The A/D line continues to make new highs with the market averages, indicating that the intermediate-term trend is still positive. The A/D line also has good support at the November highs and also at its rising weighted moving average (WMA).

What It Means: For a healthy stock market, it is important that the NYSE A/D line makes new highs with the major averages. In April 2010, the new highs in the key averages like the NYSE Composite and S&P 500 were confirmed by new highs in the NYSE A/D line. This provided strong evidence that the market’s trend was still positive even though stocks declined last summer. A break of the uptrend in the NYSE A/D line over the next few weeks will signal that a correction is underway, but would not change the positive intermediate-term trend.

How to Profit: The first sign of trouble, or indication that a stock market correction is starting, would be if the number of declining stocks is four to five times greater than the number of advancing stocks an hour or so before the market’s close. These negative readings would be difficult to reverse before the close and would increase the odds of a 2%-5% market correction. This would be reason enough to raise stops or briefly reduce one’s equity exposure.

Tom Aspray, professional trader and analyst, serves as senior editor for MoneyShow.com. The views expressed here are his own.

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