Major Trend Goes Bearish

05/24/2010 12:00 pm EST

Focus: MARKETS

Lawrence McMillan

Founder and President, McMillan Analysis Corporation

Lawrence McMillan, editor of the Option Strategist, says the big sell-off a couple of weeks ago triggered sell signals from some indicators he watches closely.

When [the Standard and Poor’s 500 index] broke down below the 1180 level last week, it changed the technical picture from bullish/neutral to bearish.

There have been several oversold, bullish signals springing up since then, but the most important indicator—price—is in a bearish trend. Thus, that dominates our outlook. After breaking support at 1180, the S&P 500 plunged rapidly (and somewhat artificially) to the 1065 level.

As is often the case in a bearish market phase, the S&P 500 declined well below its 20-day moving average, creating a massive oversold condition. Those conditions propelled the market back towards that breakdown level and the now-declining 20-day moving average.

The S&P 500 failed at the 1170-1175 zone, and now has fallen back. (It closed Friday above 1087—Editor.) Thus, the resistance area extends from about 1170 to 1185, and the S&P would have to close above that level to reverse itself out of the bearish chart pattern that exists.

The equity-only put-call ratios remain solidly on Sell signals. These were the first indicators to turn bearish, a few weeks ago (which is somewhat unusual, because they are 21-day moving averages).

In contrast, however, there is another put-call ratio—the total ratio (of all stock and index options)—that occasionally gives important signals. When the total ratio is above 1.00 for the day, it is a short-term Buy signal.

On each of the last three trading days of [the week the market took its big fall], the total ratio was above 1.00, and that marked a severe oversold Buy signal. Finally, the weighted [Nasdaq 100] ratio [has been] getting oversold.

Breadth was very negative during the decline. Breadth swings have been volatile, as well, as there was a difference of at least 2,000 issues between advances and declines ten times between April 27th and May 12th.

The frequency of “90% days” has exploded as well, with three down days and two up days. The breadth oscillators declined to very oversold levels, and issued Buy signals [last] week, which are still in effect.

Volatility indices spiked upward during the sharp market decline, rising above 40—which was quite extreme for what is, to date, only a modest percentage correction in the S&P 500. They reversed back down [the following week], forming a spike peak Buy signal. VIX futures have supported the bullish case, to a certain extent, for over a year now.

In summary, the signals are mixed. Equity-only put/call ratios, the trend of VIX, and the S&P 500 chart are bearish. Positive signs include the spike peak in VIX, the breadth oscillator buy signals, and the total put-call ratio.

When signals are mixed, we defer to the price chart of the S&P 500, and that is now in a down trend as long as the S&P 500 remains below resistance (1170-1180) and below its 20-day moving average (1185).

Subscribe to the Option Strategist here…

Related Articles on MARKETS