Big and sudden declines create short-term oversold conditions ripe for a short bounce, but they also distort chart patterns with their volatility. These outsized moves make chart analysis difficult and the volatility increases risk overall. Note that these moves occurred on a pseudo holiday and could be over-reactions. This week’s price action will be more telling. Gaps and big declines are also problematic for traders using closing prices for their entry and exit signals. In other words, traders that make their decisions after the close and do not watch intraday price action. See the analysis of DBE at the end for some stop-loss considerations.
SPY Plunges, but Still No Setup
The S&P 500 SPDR (SPY) fell 2.2% on Black Friday, but is not yet oversold by my definition and I do not see a short-term bullish setup yet. This is important information for most equity-related ETFs because they are highly correlated to the S&P 500. Most will pullback when SPY pulls back and advance when SPY moves higher.
Oversold conditions and bullish setups depend on your timeframe. Mean-reversion traders looking for 1-2 day pops would consider SPY oversold after Friday’s sharp decline and look to play the bounce. I am a swing trader who looks for pullbacks within the bigger uptrend using daily charts. In general, I am looking for a two to eight week pullback that creates short-term oversold conditions and generates a tradable pattern.
The chart below shows SPY and four indicators to identify short-term overbought and oversold conditions. These indicators cover 14 to 50 days, which fits my pullback timeframe. Indicators covering 100 or more days fit into my trend timeframe.
–The Momentum Composite is considered oversold when at -3 or lower.
–SPX percent of stocks above 20-day SMA is considered oversold when below 20%.
–SPX four week High-Low Percent is considered oversold when below -40%. Percentage of 4-wk Highs less percentage of 4-wk Lows.
–SPX percent of stocks above 50-day SMA is considered oversold when below 30%.
–SPX thirteen week High-Low Percent is considered oversold when below -20%. Percentage of 13-wk Highs less percentage of 13-wk Lows.
Four of these five indicators were oversold in mid September (yellow shading) and three of the five were oversold again in late September. Oversold conditions serve as an alert to watch price closely for a bullish setup or catalyst. As we saw in September, there was a double oversold dip as prices bounced back above the 50-day SMA and dipped again into late September. It was not until late September that the falling wedge formed.
The Momentum Composite aggregates signals in five momentum indicators. RSI(10) is oversold below 30 and overbought above 70. 20-day StochClose is oversold below 5 and overbought above 95. CCI Close (20) is oversold below -200 and overbought above +200. %B (20,2) is oversold below 0 and overbought above 1. Normalized ROC (10) is oversold below -3 and overbought above +3. Normalized ROC is the 10-day absolute price change divided by ATR(10). -3 means three of the five indicators are oversold and +3 means three of the five are overbought.
The Momentum Composite and StochClose are part of the TIP Indicator Edge Plugin for StockCharts ACP. Click here for more details.
Note that I published a SPY update on Saturday showing potential support in the 450-455 area. This was based on a 38-50 percent retracement of the October-November advance, broken resistance and the rising 50-day SMA. While these kinds of target zones seem logical, pullbacks do not always follow the idealized scenario. We are, after all, dealing with the market and anything is possible.
What do we know? Or at least “think” we know. First, we are in a bull market (per the Market Regime). Second, we are in the midst of a pullback after Friday’s gap down and sharp decline. Third, pullbacks present opportunities when the bigger trend is up and the market regime is bullish. We do not know how long a pullback will last, what trajectory it will take and how far it will extend. We can make educated guesses, but nobody really knows.
The next chart focuses on price bars and Advance-Decline Percent. The Black Friday decline was excessive and occurred on a pseudo holiday. It was probably an over-reaction, but it does show a certain level of nervousness in the market. Note that S&P 500 AD Percent hit -87%, which means more than 90% of S&P 500 stocks fell on Friday (yellow shading). That is some serious downside participation that needs to be countered. Advance-Decline Percent dipped below -80% twice in September and the decline ended with a surge above 80% on October 14th (and a wedge breakout). At this stage, I am in the pullback monitoring phase where I am simply watching this pullback closely and waiting for a setup to materialize. I do not see one on the chart so will have to exercise some patience.
Market Regime Notes
The Composite Breadth Model (CBM) remains bullish and has been bullish since May 2020 (see Market Regime page for charts covering the CBM, yield spreads and Fed balance sheet).
There was a bullish breadth pop with the SPY breakout on October 14th and a bullish Zweig Breadth Thrust on October 25th.
SPY moved into pullback mode with a gap down, sharp decline and a plunge below -80% in Advance-Decline Percent.
Investment grade and junk grade corporate bond spreads widened a bit in November, but remain at low levels overall (since July).
The Fed balance sheet expanded by $7 billion and hit another new high last week.
TLT Surges within Bullish Consolidation
The 20+ Yr Treasury Bond ETF (TLT) surged on Black Friday as money moved into safe-haven bonds. Overall, TLT has been stuck in a trading range since mid July and gone nowhere. As noted in mid November, rising inflationary pressures are bearish for bonds. This is supposedly bad news, but TLT held above its March-May lows in October and is not breaking down. It is possible that a triangle is forming the last two months and a breakout at 152 would be bullish. Such a move could be negative for risk assets, such as stocks.
Gold Fails to Hold Breakout
The Gold SPDR (GLD) broke out of a triangle in early November and then fell back into the triangle with a sharp decline below 170. The GLD chart is even more chaotic than the TLT chart when it comes to trends and analysis. GLD has been stuck in a range since March and is currently just below the mid point of this range. There is potential support in the 165-167 area, but the ETF is not yet oversold and I do not see a short-term setup.
UUP Surges above Channel Line
The Dollar Bullish ETF (UUP) extended on its wedge breakout and surged above 26 last week. This big move also pushed the ETF above the upper line of the rising channel. The Dollar is in a strong uptrend, but quite extended after this big advance. There is no setup right now.
DB Energy ETF Fails to Hold Wedge Breakout
The DB Energy ETF (DBE) was setting up bullish with a small falling wedge and oversold condition on November 19th. A StochRSI pop followed on Tuesday, November 23rd and there was even a break above the wedge line. This bullish setup and signal were turned on their head with a gap down and 9.6% decline on Black Friday. The wedge breakout clearly failed, but close-only traders (such as myself) would be seeing this failure after the close. As far as stops are concerned, I place stops just below the low of the failure bar to insure that this is not an over-reaction. A move below the low of the bar would show renewed selling this week and trigger the stop. Note that a limit order can be used. Another exit strategy would be to exit on the first oversold bounce and step aside until volatility subsides. Oil futures are trading (5%) higher this morning.