Stocks Are at a Critical Juncture

11/17/2009 12:01 am EST

Focus: STRATEGIES

Thomas Aspray

, Professional Trader & Analyst

As I have been discussing for the past two weeks, my analysis of the advance/decline and high/low data for both the NYSE and NASDAQ has been showing some deterioration. Since my daily chart section has limited room for explanation, I wanted to discuss in more detail the potential implications of this internal deterioration. The key thing to remember is that a divergence in the market internals, either bullish or bearish, needs a significant change in momentum to generate a buy or sell signal. The formation of the divergences should be viewed as warning that the current trend is weakening, making a change in market direction more likely. I should also point out since these divergences formed over just the past month, they are likely warning of a correction within the intermediate-term uptrend.

The current analysis suggests that this week’s trading could determine whether we are going to see another move to new market highs and a test of the S&P 500’s major 50% retracement resistance at 1120, or the deepest correction since June.

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I have found the NYSE A/D line to be one of the most reliable indicators for determining the market’s internal strength or weakness, and therefore, its direction. At the March lows, the A/D line was acting stronger than prices, and it surpassed first key resistance on March 17, starting a pattern of higher highs and higher lows. The chart above (updated through November 13) shows that the A/D line and prices both made convincing new highs in October before declining to retest the previous lows and the A/D line began acting weaker than prices. This, I believe, was significant. The new recent closing highs for the S&P 500 at 1098.51 were not confirmed by the A/D line. A close above these highs, and particularly above 1100, should signal an upside breakout and possibly a rally to the 1120-35 area. Conversely, decidedly negative A/D ratios early in the week could cause the A/D line to drop below the previous lows and violate its three-month uptrend. This should signal a stronger correction. The NASDAQ A/D line is acting even weaker, as you can see in this recent chart.

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As I noted in October, the number of NYSE stocks making new highs was 433, well above the September reading of 340, therefore confirming the price action. However, on the recent rally, the peak in the number of new highs has been 213, well below the October level. This is another indication that the rally in the stock market is not as strong as it was in October.

It should be pointed out that these divergences, or those seen in some of the momentum indicators, are consistent with an intermediate top, but are more likely warning of a correction within the intermediate-term uptrend. Be sure to watch the A/D ratios early in the week, and for a continuation of this discussion, sign up to receive our next Trading Lessons e-letter, which will be released this Thursday, November 19.

By Tom Aspray, video content editor, MoneyShow.com

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