My analysis last week showed that the market was in the process of topping out. Nonetheless, Friday's broad market decline didn't mean that the market had finally topped out. Let’s get technical and see how far along we are in this process.
This is the NASDAQ Composite intraday 10-minute chart that covers the past 8 trading days - 5/24 through 6/3/2005. Let's walk through the action of these 8 sessions first.
This Fibonacci Arc was constructed by drawing a Trendline (red diagonal line) connecting the highest and the lowest price points (small black circles) on this chart. The lowest point (2,041.95) occurred on 5/25 and the highest point (2,097.80) on 6/2/2005. The percentages on the left are the Fibonacci Retracement. A 50% retracement from the high of 2,097.80 is at approx. 2,070 (see aqua color horizontal line).
On 5/26, after a gap-up advance, NASDAQ hit the 2070 overhead resistance, which happened to be the first outer layer (blue circle) of the Fibonacci Arc. In an uptrend, these outer layers serve as critical resistances. And, on this day, NASDAQ got stopped cold right outside of the Arc.
On 5/27, it finally broke through both the 50% retracement and the first layer of the Arc. However, it then bumped into the second layer resistance (blue circle), which coincidentally was at the 61.80% Fibonacci Retracement. This resistance turned out to be a tough one to crack. As a result, NASDAQ dropped below both the Trendline and the 50% retracement level on the first trading day after the long Memorial Day weekend.
Except for June 1, the subsequent market action pretty much took place below the Trendline. NASDAQ did manage to cross above the Trendline on 6/1, but it fell right back below the Trendline at closing. Moving below the Fibonacci Arc Trendline seemed to indicate the weakening of the current trend.
On Friday, June 3, it took just one day to undo all the effort that the market took 4-5 days to put together. Now, on the decline, the inner layers of the Arc become the supports. On this day, it set right above that 2070 level, which happened to be the critical 50% Fibonacci Retracement. This 2070 is now as tough a support as it was a resistance just three trading days ago. In addition, we must keep in mind this is only the first line of defense. There are two more layers of defense approximately at Fibonacci Retracement of 38.2% and 23.6%.
The market didn't fall apart on Friday by any measure. It actually sit quite comfortably 2 layers above the breakdown. Let's seek further confirmation.
This is the chart that I posted on my Trade Journal on Wednesday. As you may see that the bottoming of the NASDAQ option Volatility Index (VXN) usually indicates that the top is near. Let's check out the updated chart.
Just when I thought VXN volatility couldn't' go any lower, this updated chart below shows that it did drop lower - see red arrow. The Aroon UP (green line) had actually formed another lower high to make it 4 in a row. Aroon UP eventually would have to move up, and that's when VXN would also begin to rise. Meanwhile, Aroon DOWN (red) just broke below the previous lows for the first time since May 11 - see red horizontal line. When Aroon DOWN crosses below 70, that's when the downward momentum picks up. By the way, Aroon is a great direction indicator. Aroon means "Dawn's Early Light" in Sanskrit.
This updated chart shows us that it's getting another step closer to the top, but it's not there yet. It refused to go down without a fight. And it may take a little more time than we thought.
Next, let's check the Fed's money stock supply. In my previous analysis I pointed out the inverse correlation between the market and the M2 minus M1. For new visitors, backing out M1 leaves M2 with just the savings accounts, time deposits of under $100,000, and balances in retail money market mutual funds.
M2-exM1 is currently on a downtrend. This means that money's going back into the equity market again. The only concern is that the Fed's money stock report has almost 2-week lag time. But, going by the latest data available to us (for the week ended 5/23/2005), the market didn't seem ready to go down just yet.
Looking at how Friday's decline was stopped right at that inner layer of the Fibonacci Arc and the 50% Fibonacci Retracement, I would not be surprised to see the market rally back up early next week. It takes time for the topping process to complete. I wouldn't go too overboard shorting the market, yet.
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