3 Signs of a Rally Failure

05/21/2014 10:30 am EST

Focus: ETFs

Thomas Aspray

, Professional Trader & Analyst

Heading into the official start of the often-lackluster summer season, the markets are wilting in the heat, so MoneyShow's Tom Aspray takes to the charts to see if a summer rally is in the cards.

By the time Philadelphia Fed president Charles Plosser commented that the Fed might "begin raising interest rates sooner rather than later," the stock market internals were already negative. This made the market more vulnerable and the stock index futures dropped six points in 15 minutes.

All of the major averages closed the day lower, led on the downside again by the small-cap Russell 2000, which closed down 1.48%. This was in contrast to the 0.65% decline in the S&P 500 and the 0.42% drop in the Nasdaq 100. Only the Dow Utilities managed to close with a minor gain. All the averages closed above the day's lows.

This close was what I was concerned about in Friday's short-term market outlook when I said "This favors a further rebound early this week but it will need to be watched closely." The futures are higher in early trading but it will be the close today that is more important. Traders are waiting for the release of the FOMC minutes this afternoon.

In today's column, I would like to take a look at the major average-tracking ETFs to demonstrate why Tuesday's action had two of the three key signs of a failing rally.

Click to Enlarge

Chart Analysis: The daily chart of the NYSE Composite (NYA) shows that last Thursday's low at 10,518 was tested Tuesday.

  • The close was just above the monthly pivot at 10,522 with more important support now at 10,422, which was the April 28 low.
  • A close below this level will make the drop to the quarterly pivot at 10,270 more likely.
  • This is 2.6% below Tuesday's close with major support still in the 9900-10,000 area, which includes the quarterly projected pivot support.
  • The NYSE Advance/Decline is now testing its WMA with next support at last Thursday's low.
  • The A/D line has longer-term support at the March-April lows, line b.
  • The McClellan oscillator shows a pattern consistent with a failing rally.
  • It had a low last Thursday of -104 and then rebounded to -8 on Monday.
  • After failing to move above the zero line, it has dropped to -144, which is just above the April low of -149.
  • The pattern of lower highs, line c, does increase the odds of a break to the downside, which will increase the odds of a further decline.
  • To stabilize, the NYSE Composite needs to close back above 10,605.

The Spyder Trust (SPY) had a low of $187.04 but closed at $187.55. It now needs a close above $188.90 (see arrow) to improve the technical outlook.

  • A failing rally will generally last just two days as noted by the highlighted bars from April.
  • The inability of the market to close higher for three consecutive days is the second sign that a rally has failed.
  • The third sign of a failing rally is that you need to see a close below a prior swing low.
  • For the SPY, a close below the May 7 low of 186.01 would be negative.
  • That will increase the odds of a drop to the minor 38.2% Fibonacci support at $183.75 if not the quarterly pivot support at $182.99.
  • The April 11 low in the SPY was $181.31.
  • I have included the NYSE Arms Index on this chart as it is one of the few positive signs as it closed at 2.04 on Tuesday, which is an oversold reading.
  • At prior short-term lows in March and April, it had highs of 2.48 and 2.37 respectively.
  • The daily OBV did confirm the recent highs but has now dropped below its WMA.

NEXT PAGE: 2 More Drooping ETFs


Click to Enlarge

The PowerShares QQQ Trust (QQQ) held above its 20-day EMA on Tuesday but still needs a close above $88.61 to reassert the uptrend.

  • The negative chart interpretation is that the QQQ is forming a bear flag formation, lines a and b.
  • There is next support at $86.58, which was last week's low with more important at $85.53, which is the month's low.
  • A daily close below this level would complete the flag formation with initial targets at the April low of $83.28.
  • The quarterly projected pivot support is at $83.53 with the 127.2% downside target from the flag formation at $81.77.
  • The daily OBV is still below the downtrend, line c, from the February highs.
  • The OBV is testing its WMA with important support now at line d.
  • The weekly OBV has just rallied back to its flat WMA so an AOT sell signal could occur with a lower weekly close.

The iShares Russell 2000 Index (IWM) closed lower on heavy volume, Tuesday, as it just tested the declining 20-day EMA at $110.97 on Monday.

  • The support at last week's low of $107.44 has not been violated with the monthly projected pivot support at $103.22.
  • The early April rally (point 1) failed after two days as the next day IWM closed below the prior low, point 2.
  • The rally from the mid-April lows lasted five days as the quarterly pivot at $114.53 was tested.
  • The rally that began on Friday, May 9, ended on Monday (point 3) as IWM closed lower on Tuesday and soon broke to new lows.
  • The monthly pivot at $113.04 was tested on this rally.
  • The OBV just moved above its WMA on last week's rally but sill showed a pattern of lower highs, line e.
  • The OBV is now very close to breaking below the year's lows at line f.

What It Means: The positive factors for the market as it heads into the long holiday weekend are the oversold reading from the Arms Index and sentiment. One TV commentator wondered whether the US had already started a new recession, and it is difficult now to find a bullish trader. Some are even looking for a 25% decline, which would be the first time this has happened without a bearish divergence in the NYSE A/D line.

This is similar to what happened in May of 2012 as the Dow Industrials peaked on May 1 and then made its low on June 4. The technical studies indicated the market had bottomed out just two days later.

This behavior, in my opinion, is more consistent with a continuation pattern that will eventually be resolved to the upside. The market may have to go lower first, and if the Spyder Trust (SPY) closes below $186.01, it could lose another 1.5-3%. This would be the final sign that the rally had failed. This would make the market even more oversold and should be enough to raise the bearish sentiment to levels associated with market bottoms.

How to Profit: No new recommendation.

Portfolio Update: Should be 50% long PowerShares QQQ Trust (QQQ) at $86.88 or better as the second level at $84.72 was just missed. Use a stop now at $86.47.

Should be 100% long the Spyder Trust (SPY) at $185.02. Use a stop at $185.83.

  By clicking submit, you agree to our privacy policy & terms of service.

Related Articles on ETFs

Keyword Image
ETFs & the COT
03/19/2019 9:19 am EST

The moves forecasted by the COT signals make them very adaptable to commodity based ETFs, writes And...