My Secret Tool for Spotting S&P Reversals

07/19/2010 10:54 am EST

Focus: STRATEGIES

Corey Rosenbloom

Founder and President, Afraid to Trade

I’ve been pointing out recently that just prior to major market downturns, we have seen either a breakout in the TLT (20+ year bond fund) or a strengthening in the fund while the SPY held up, just before a sharp fall.

This is the third such instance in the last few months, the others being:

  1. TLT broke and gapped sharply higher on Tuesday, May 4, just two days prior to the “flash crash”
  2. TLT broke out again from key resistance during the June 22 market turn

And now, let’s look at the current pre-crash signal that TLT gave us in the last couple of days:


Click to Enlarge

Look closely to see that the TLT ETF bottomed on June 13 when SPY hit the key $110 level. Nothing unusual about that.

What was unusual was that TLT began to move clearly higher on July 14 while the SPY stagnated at the highs, forming a double-top pattern on massive negative market internal divergences, as I highlighted in the Nasdaq at the time.

We now see the expected sharp downside resolution the divergences forecast.
But we also got a warning from TLT as well.  So, on July 14, the SPY was flat while TLT rose sharply higher.

The big clue came last Thursday when TLT broke sharply higher as the SPY turned lower (expected) but rallied on BP and GS news into the close… yet TLT held its gains.

Thus, the SPY and TLT being up after a TLT breakout was another big caution signal of a potential market reversal.

And on Friday we saw a big market reversal.

We can never know exactly when the market will reverse, but we can look “under the hood” at situations that have been known to form prior to reversals, such as massive market internal divergences and breakouts in TLT or IEF (7-10 year note ETF).

As a reference, here is the current chart of the TLT that showed a bounce higher off support as the stock market came into daily resistance:


Click to Enlarge

Though IEF actually bounced right off the rising 20-day EMA, TLT dipped one day under the $99 level, but came back very sharply as seen above on Wednesday, Thursday, and Friday.

Pullbacks to support in the bond ETFs, or breakouts (such as that which occurred at the start of May and end of June) are often key signals that the stock market is likely to turn lower—or at least that’s been the recent development lately.

Either way, it pays to watch TLT, IEF, and other important bond funds (and bond prices themselves) in conjunction with market internal divergences and daily structure (overhead resistance, trend, etc.) to anticipate potential stock market turns more accurately.

By Corey Rosenbloom, trader and blogger at AfraidToTrade.com

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