Divergences Raise Yellow Flag for Traders

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Stocks rose Wednesday, breaking a three-day losing streak despite a lower opening. The recovery came after a Wall Street Journal article indicated that China may replace the governor of the People’s Bank of China with a more dovish officer.

After the initial weakness, stocks charged ahead, led by mid and small caps. The health care sector led throughout the day, gaining 1.7%. Biotech stocks did well with the iShares Nasdaq Biotechnology (IBB) rising 2.8% to a new high.

The Nasdaq jumped 1% even though its most influential component, Apple (AAPL), fell 0.9%.

New homes jumped 18% in August from July in their best month since May 2008. Economists had only expected 3.4%.

At Wednesday’s close, the Dow Jones Industrial Average gained 154 points at 17,210, the S&P 500 rose 16 points to 1,998, the Nasdaq jumped 46 points to 4,555, and the Russell 2000 was up 10 points at 1,128.

The NYSE had total volume of 3.4 billion shares, and the Nasdaq crossed 1.8 billion shares. On the Big Board, advancers outpaced decliners by 1.5-to-1, and on the Nasdaq, advancers were ahead by 2-to-1.

SPX Chart
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Chart Key

We’ve talked about the small cap’s failure to keep pace with the big caps, which technicians call a “divergence” in that broad market advances normally “float all boats.” But there are other divergences occurring on the S&P 500 that were pointed out by Andrew Adams of Raymond James in his “Morning Tack.”

Note the failure of the Relative Strength Index (RSI) and MACD to make new highs last week when the S&P 500 rose to a new closing high at 2,011.36. At this point, the divergences may be minor, but as he said, they raise the yellow flag.

But I would note again that price trumps everything, and this may be just an anomaly. Of greater significance is the 50-day moving average, now at 1,977 (Wednesday’s low was 1,979).

Russell 2000 Chart
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This 5-minute chart of the Russell 2000 shows the action since Monday. Wednesday opened weak, falling to 1,116.13, but then rallied for the remainder of the day. There is clear resistance at 1,131. For traders only, this is a useful point to take profits if you are long, or go long if that line is broken on high volume.

Conclusion

The number of divergences is concerning. Rather than attempt to outguess the market, it is best for most investors to stand aside until the broad market moves in one direction or the other.

The long-term trend is not in doubt. It is strongly up; however, we have not had a significant correction (10%-plus) this year, and that is unusual. Perhaps the warning divergences will dissipate and all will turn bullish, but until the indices turn up and confirm the highs of last week, investors should be cautious when adding new positions.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.


Article printed from InvestorPlace Media, https://investorplace.com/2014/09/divergences-raise-yellow-flag-traders/.

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