Pay Attention, Market Throwing Down the ‘Hammer’

by Serge Berger | November 21, 2012 2:36 am

Serge Berger is the head trader and investment strategist for The Steady Trader[1]. Sign up for his free weekly newsletter here[2].

On Friday, the S&P 500’s chart displayed a hammer candlestick. This bullish reversal pattern occurs after a sell-off when a significant rally brings prices back up creating a long lower wick. Then, renewed buying sentiment acts as support and pushes prices back to the upper range to close near the opening price, creating a short body. This pattern signifies weakening bearish sentiment.

Monday followed with a 2% rally on the S&P 500, which was a difficult performance to follow on Tuesday, but stocks held up well ahead of what is sure to be a slow day on Wednesday ahead of the Thanksgiving holiday.

Friday’s intraday upside turnaround coupled with Monday’s massive rally was enough to put a solid bottom, or at least a reference point, in place for stocks. On the S&P 500, that reference point is 1,345, which also happens to be the 61.8% Fibonacci retracement of the entire June-to- September rally. 

The hammer candlestick from Friday, coupled with Monday’s follow-through buying, all converging at a level where the McClellan Oscillator was heavily oversold, is an occurrence traders should take notice of.

SPX Chart
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The sharp reversal left its mark on stock and index charts in the U.S. and European markets. The Dow Jones Transportation Average, for example, found support at its June lows and also left a powerful hammer candle on its daily chart.

DJT Chart
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From a sector perspective, things look promising, as well. The October to early November correction in stocks was led in part by defensive sectors, which is another way of saying that cyclical sectors outperformed on the way down. In true risk aversion mode the opposite would have happened, and the fact that cyclical sectors outperformed during the correction is a sign of underlying strength in the broader market. 

The chart below shows utilities and consumer staples underperforming the more cyclical industrial sector, as well as the S&P 500 itself.

Cyclicals vs Non-Cyclicals Chart
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From here, I would expect the cyclical sectors, technology being one of them, to start outperforming the S&P 500 in the coming weeks. 

The next chart shows the ratio of the Technology Select Sector SPDR (NYSE:XLK[3]), which is at the bottom, to the SPDR S&P 500 (NYSE:SPY[4]). As technology has underperformed the broader market in the September-to-October period, this ratio has declined. Should technology become a relative outperformer again, then this ratio should increase, giving me further confidence in a more sustainable market rise into the first quarter of 2013.

XLK vs SPY Chart
Click to Enlarge

Lastly and maybe most importantly, the U.S. Dollar Index has developed a topping pattern right at its 50% retracement of the July-to-September sell-off, and not coincidentally right as stocks started to rally on Friday.

Dollar Index Chart
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Given the above points, I remain positive on stocks into year-end and possibly into the first quarter of 2013.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here[5].

For a list of this week’s economic reports due out, click here[6].

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