Index topping formation resolved, down volume expands

Speaking of windmills, there was the market itself. Ninth largest point drop in a single session last Thursday with the Dow 30 down 512.76 points, or 4.31% (1987 was the largest percentage decline at -22.61% and -508 points in the Dow). Big increase in downside volume to confirm the downward break from Head and Shoulders Top formations. Price weakness in all of the major indexes below 200-Day moving Averages. New Short-term lows in our Most Actives Advance/Decline Line (MAAD) and the Call/Put $Value Flow Line (CPFL). Dow Theory Sell confirmation via the Dow 30 and 20. Downside break by Cumulative Volume in the S&P 500 Cash Index and the S&P 500 Emini futures contract below long-term uptrends stretching back to March 2009. And another nail in the bull market coffin with a break by Emini CV below the March 2009 plot lows.

But there are still bulls out there, bless their hearts. And, admittedly, the long-term trend does remain positive, albeit substantially frayed. In fact, all of the major indexes stalled out on the downside in early session weakness Friday after slightly penetrating defined Monthly Price Channels (only the Dow 30 fell short by a bit) to suggest that in the face of deeply "Oversold" short-term conditions, some bargain-hunting and/or short-covering could develop in the sessions just ahead. In fact, we suggested that possibility after Thursday’s losses via our brief comments Friday morning when the market stabilized and improved somewhat relative to the day’s lows over the remainder of the session. Index prices are also in the vicinity of long-term support coincident with the April 2010 price highs where S&P Cumulative Volume made a plot high that was never exceeded by subsequent CV action.

S & P 500 Emini Futures contract with Cumulative Volume

But it’s not the short-term term trend that is now the issue. Nor the Intermediate. It’s the Major Cycle that is under a very big spotlight. Huge. Is the 14.7% loss in the S&P since its May 2 high (1370.58) through last Friday’s intraday low (1168.09) the extent of the decline? Or not? Maybe and maybe. The bigger answer to that question will be the extent of the rebound relative to the Neckline of the H&S Top (near 1260--S&P) that was fractured last week. When it develops, such a return move would be classic and so would an ensuing failure. What we want to know is how volume performs on an upmove from here. Best guess? It fails miserably and, as prices turn lower once again, CV makes new lows before prices. That action would imply more distribution by the Smart Money crowd as reflected in MAAD and then a move to new lows by the indexes. As a return action rally inevitably unfolds, there is also the perennial truth that we are approaching that time of the year which has been coincident with some special market moments – 1929, 1987, 2007.

Note:Stop levels, a function of the extant trend, are based on the trailing moving average price channels for the Highs or the Lows of an index. Whether or not a specific index is suggesting a "Buy" or Sell" is determined by whether or not index prices are above or below the current channel Stop levels. Stop levels should only be used as an entry or exit guide and in conjunction with other market entry and exit strategies.

So, after a history-making week, we suspect that the Long-term Bull that began in the spring of 2009 will make its last stand not far from current levels. Even if it turns out that weakness will prove to be merely a lull in a longer-term "Up," it’s likely that recent damage will not be corrected any time soon. It’s also possible that the Major Cycle would have to "reset" with long-term Oscillators moving back to Neutral or Oversold from currently "Overbought" conditions. But such unfolding usually takes months, not a matter of weeks. If we are wrong with that prognosis, nothing but new index price highs would be required with coincident indicator confirmation.

McCurtain Most Actives Advance/Decline Line (MAAD)

New lows in both Daily and Weekly MAAD statistics were made last week coincident with significant market losses. Both series moved to their lowest levels since last August and early September. Weakness in MAAD simply underscores the apparent and ongoing lack of confidence in this market as exhibited by the so-called Smart Money crowd which has been exiting equities on a net basis since mid-February.

While we expect the major indexes to stage some kind of price rebound on the Minor Cycle from "Oversold" conditions relatively soon, we also suspect that MAAD will remain "skeptical" of such upside movement. If a return action rally fails near resistance at recently broken Head and Shoulders Necklines (1250-1260 S&P 500), and we suspect it will, more price weakness would probably propel MAAD to new lows. A resumption of market weakness would then set up the indicator for a decisive fracture of the long-term uptrend that stretches back to March 2009, which would not be a good omen for longer-term market prospects.

Click charts to enlarge

McCurtain Call/Put Dollar Value Flow Line (CPFL)

Net options selling last week caused CPFL to move to new short-term lows while also forcing the indicator on both the Daily and Weekly cycles back to and slightly below defined Major Cycle uptrends stretching back to March 2009. As with our other indicators, this sentiment measurement continues to suggest that all is not well with the market internals.

There is one bright spot, however, which CPFL could be revealing. If it turns out that recent market weakness proves to be nothing but a correction in an ongoing bull trend, albeit a severe one, the fact that CPFL has not shown significant deterioration since last February when it peaked could be an indication that while options players have been net negative for nearly six months, they have done so within the context of a bull trend. To resolve that issue, however, we would need to see CPFL rally to new highs on index strength.

Click charts to enlarge

Conclusion

Last week’s selling in the stock market substantially weakened the 2 ½-year-old bull market begun in March 2009. The bullish camp is not yet down and out, but their uptrend is into its 15th round with two knockdowns, one pending with a referee count of 8 out of ten. Clearly, the bulls have a big point to prove.

Nonetheless, "It ain’t over ‘til it’s over" even though index prices temporarily found some stability near the bottom edge of Monthly Price Channels (1191.37—S&P) near our downside Major Cycle "failsafe" levels. That action occurred with developing Short-term trend "Oversold" conditions in both Momentum and our proprietary Trading Oscillators.

And while we could see some rebounding in the sessions just ahead, we would be surprised to see such action evolve into anything more than just a reflex weak volume bounce spurred by short-covering. There is also the chance more selling stimulated by negative news events could develop within the context of still negative trends. Such action would be consistent with our view that news only has an effect on trends already under way. In other words, we do not believe that any "positive" news would reverse currently negative trends.

MAAD data for past 30 Weeks* CPFL data for past 30 Weeks

*Note: All data is for calendar week ending on Friday even though ending date may be a holiday.
Unchanged issues in MAAD calculations are not counted.

MAAD data for past 30 days**　　　　 　CPFL data for past 30 Days

**Note: Unchanged issues are not counted.

Robert McCurtain is a technical analyst, market timer and private investor based in New York City. He is a member of the Market Technicians Association and can be reached at traderbob@nyc.rr.com. If you would like to read more about how the CPFL is constructed, read a Futures article on the concept. This will take you to the MAAD article.