Invesco QQQ Trust Series 1 (QQQ)

[frenchee]

Support Breaks As the Market Falls

FOR WEEKS, GETTING TECHNICAL has been chronicling the market's slow deterioration.

We've been watching as volume (enthusiasm) faded, momentum disappeared, market leadership evaporated and trends rolled over.

This week, the bears got yet another piece of the technical puzzle to fall their way as giant wedge formations in the Standard & Poor's 500 and the large-cap-biased Wilshire 5000 have made tentative breakdowns (see Chart 1).

CHART 1



Wedges are normally bearish patterns where the market makes higher highs and higher lows, but the lows are rising a lot faster than the highs. In other words, each successive rally attempt gets smaller as bulls take profits sooner because of waning conviction and the bears jump into short positions sooner because of increasing conviction. We also can see confirmation of this shift in psychology as momentum indicators set lower peaks at each new price high.

That's the recipe for a market reversal, and all that is needed is for the wedge's lower border to break to the down side. On an intraweek basis, that break has occurred in the big stocks. It is not a conclusive "head for the hills" sell signal on its own just yet, but when combined with all the other technical evidence that has been piling up since July, it begs for investor attention.

What makes this more intriguing and more dangerous is that investors are shrugging off the daily breakdowns in sector after sector. There are many indicators in the chart watcher's bag of tricks that bear this out, but two in particular now stand out to this analyst.

The first is the often misconstrued Chicago Board Options Exchange volatility index (VIX) in its various flavors (see Chart 2). This index, dubbed the "fear index" for its propensity to spike when investors are panicking, has risen significantly in percentage terms since the current stock market swoon began October 3, but in the big picture it's still in a declining trend.

CHART 2



The VIX is very good at spotting major market bottoms when it spikes to extreme high levels. But it isn't quite as good at spotting tops when it's low. "How low is low?" is often unanswerable, so the real signal comes when this index is low but rising. In other words, when the trend in the indicator turns around and fear starts to creep into the market, watch out.

So far, the VIX hasn't broken its declining trend. Certainly, there are other more sophisticated methods to measure a topping market based on the VIX, such as breakouts from trading bands or moving-average crossovers. But if simpler is better, then the naked eye can do the job. Right now, the trend remains down.

That would be more of a bullish argument, however, if all of this weren't happening while prices are falling and sectors are actually breaking down. Witness the new 52-week low in the banking sector (see Getting Technical, "Bank Stocks Are Mired in Quicksand," October 3) and the devastation this week in the semiconductors (see Getting Technical, "Chipping Away at Chip Stocks," October 10). The market is very fragile now, yet investors have taken very little heed of the warning, as reflected in the VIX's modest rise in absolute terms.

Another indicator that shows business as usual for investors is the Arms Index, a.k.a the Trin (see Chart 3). Again, it is more useful in finding bottoms than tops, but nonetheless you can glean plenty of information from a simple moving average of its closing values.

CHART 3



The Arms index measures how much volume is going to stocks that are rising each day vs. how much is going to stocks that are falling. If the bulls are in charge, then the Arms reading will be below one.

If the bears are more aggressive on any given day, then the reading will be above one. When the reading spikes above two, we know that selling pressures were intense.

Many analysts look at a ten-day moving average of the index to smooth out the pattern and expand the analysis to more than just the events of a single day.

If the index stays high for a number of days, the moving average will also move higher, and when it spikes to an extreme, we can presume that the selling was so intense it was washed out of the market. That sets up a bottom.

Today's ten-day average shows only a minimal rise, and like the VIX, the trend in the average itself is still declining. So, no fear and presumably no hedging of long positions.

If and when the breakdowns in the remaining major stock market indexes occur, the rush for the exits could trample investors. Nobody seems to be preparing for the possibility that a major decline is coming -- there's no wall of worry -- and that is also bearish.

It may cost a little to protect a portfolio by diversifying into gold, money market funds and protective put options. But if the market does fall, then a little insurance will go a long way. Call it the price of sleeping at night.