Some Signals Flash Green

02/28/2008 12:00 am EST

Focus: MARKETS

Lawrence McMillan

Founder and President, McMillan Analysis Corporation

Larry McMillan, editor of the Option Strategist, spots some rare technical indicators that offer hope to investors—at least for now.

The chart of the Standard & Poor’s 500 Index ($SPX) is one of the most negative indicators. Twice it has tried to poke above its declining 20-day moving average. The first attempt came at the beginning of February and failed, leaving resistance at 1390-1400.

[Recently], $SPX once again rallied off a good support area (1315-1325) and closed above its 20-day moving average. However, that moving average is still declining and is thus still bearish. So, except for the fact that $SPX showed good support at 1315-1325, there isn’t much positive about its chart. Looking at the $SPX chart, one could make a case for a trading range between roughly 1320 and 1400. A breakout in either direction would be a significant development.

Market breadth has been a surprisingly good indicator in the last couple of months, but it hasn’t issued a new signal recently. Volatility indices ($VIX and $VXO) can be considered bullish. $VIX was moving bearishly higher when the broad market was testing the $SPX 1320 support level, but once that test was successfully passed, $VIX has dropped below 26, confirming a short-term bullish trend.

In summary, the indicators are mixed, but are generally leaning more to the bullish side than the bearish. Hence we expect to see the top of the $SPX range (1390-1400) challenged before the bottom is.

One [indicator]—breadth oscillator divergence—has just given a buy signal (it only gives buy signals). Buy signals from this indicator are rare, occurring only once every two years or so. The last one was a buy signal in August 2006, preceding the slow, steady 180-point climb by $SPX into February of 2007. However, since the sample is small, we don’t know if it is extremely reliable.

The indicator relies on the relationship between our two breadth oscillators—the NYSE-based and the “stocks only.” The NYSE has a relatively large number of issues that are not stocks—most of these are interest-rate related. Meanwhile, the “stocks only” breadth figure–as its name implies–contains only stocks. Hence, it is a purer measure of true advancing and declining issues.

We noticed that if the “stocks only” oscillator plummets to levels at least 300 “points” less than the NYSE-based oscillator, a potential buy signal sets up. This has just recently occurred. On January 4th, the “stocks only” oscillator stood 302 points lower than the NYSE-based one. The nadir [came] on January 15th, when they were 380 points apart. The oscillator differential stayed large until February 11th, when it finally narrowed to 156. 

So, not only did the differential widen, but it stayed wide for quite a long time—25 trading days. This is potentially a bullish, intermediate-term signal. The market has already moved sharply higher since the signal was initiated. This setup is rare, in that it has only occurred ten times since 1998 (not including the current occurrence).

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