Starting last year, many technicians on our podcast turned bearish and believed we had likely seen a major peak in the stock market. Why? What were they looking at that told them the trend for stocks had changed? Here are three charts or indicators that many technicians follow, which predicted the current market downturn (note: all charts below were created using Stockcharts.com).
NYSE Advance-Decline Line (AD Line)
Brief description: “The Advance-Decline Line (AD Line) is a breadth indicator based on Net Advances, which is the number of advancing stocks less the number of declining stocks. Net Advances is positive when advances exceed declines and negative when declines exceed advances… Bullish or bearish divergences in the AD Line signal a change in participation that could foreshadow a reversal.” (Source)
Since stocks tend to trend over long time periods up or down in bull or bear markets, the addition of a moving average is often used to detect major trend changes. In the chart above, I’ve added a 52-week moving average to show that the AD Line turned bullish (moved above the 52-week moving average) in April of 2009 – one month after stocks made their final bottom – and then proceeded to stay above for the remainder of the bull market until finally breaking below in August of last year. To many technicians, this is a major red flag that the longer term trend for stocks has either changed or is susceptible to further declines.
NYSE New Highs-New Lows
Similar to the NYSE AD Line, the NYSE New Highs-New Lows Index measures market breadth. As Investopedia notes, “Traders will specifically look at the number of companies that have created a 52-week high relative to the number that created a 52-week low because this data can provide longer term information about whether the bullish or bearish trend will continue.”
The New Highs-New Lows Index confirmed the bullish trend in the stock market starting in 2009 and definitively broke below in September of last year as new lows began to significantly outpace new highs.
Moving Average Convergence/Divergence Oscillator
The third and final indicator, which I began presenting with others in February 2015 as part of an ongoing series, Signs to Watch for a Major Peak in Stocks and Impending Bear Market, is called the moving average convergence/divergence oscillator (or MACD). The MACD is considered “special” because of its unique ability to combine both trend and momentum into one indicator.
As noted in prior articles, it is often used by technical analysts for buy and sell signals when a slower and faster moving average cross, referred to as a MACD crossover. A MACD sell signal occurred at both prior market tops in May of 2000 and December of 2007 and, again, more recently, in June of 2015.
Summary
Whether we look at the advance-decline line, new highs-new lows, or the combined momentum and trend of the market using the MACD, it is clear why many well respected and widely followed technicians on our show began to turn long-term bearish on the stock market last year. As of January 21st, all three measures are still in a strong downtrend and have yet to show signs of a recovery.
Though the market is clearly oversold on a short-term basis and may stage a rally in the coming weeks or months, as ECU Group's Chief Technical Strategist Robin Griffiths told Financial Sense Newshour listeners last week, “I would resist being brave at the moment… If you try and catch a falling knife, you might cut your hand. It’s better to let it stick into the floor first, and then pick it up.” Seeing a turnaround in the charts above will be a good sign we've found the floor.
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