Published May 25, 2018
Technical analysis is the examination of supply and demand for stocks, usually expressed in chart form. The charts can help us see at what price buyers step in to support a stock – e.g. at what price the market shows overwhelming interest in buying; at what price sellers overwhelm buyers and drive the stock back down. When a stock price leaps to a new high only to be met with an onslaught of selling, that tells us the market overall is not ready for that leap in price. This occurred not long ago in our focus Nasdaq 100 (QQQ) index. As shown in the circle below, the price spiked above 170 to a new high only to be met with heavy selling. That selling accelerated into a three-week downtrend as the purple arrow denotes. That selling left the breakout above $170 as a failure – a price point where sellers overwhelmed buyers.
The leap in price occurred on a powerhouse employment report that provided evidence of strong economic growth. The Nasdaq 100 (QQQ) broke out to new highs, rising above the 170 price level after two prior failed attempts to find fresh buyers at that level. A breakout means buyers are enthusiastic enough to pay more for a stock (or the market overall). Investors were willing to pay MORE than $170 for shares of the QQQ on March 9th. That encouraged further buying the following day on March 10th. The market then abruptly shifted gears. Buyers were nowhere to be found and sellers descended to drive stocks down for 5 consecutive days and lower for 8 of the next 9 trading sessions. What caused the abrupt change in tone? On March 12th, President Trump called into question a major semiconductor deal. That threw a bucket of cold water on one of the market’s leading sectors, injecting uncertainty where there had been none before. Then, a few days later, another market leader, Facebook, was embroiled in the data security scandal with Cambridge Analytica. Stocks had lost their momentum.
Stocks regained their footing after a couple of months of chopping around. A few days ago, the Nasdaq 100 (QQQ) found its way back to the $170 price level that had been the scene of the failed breakout two months before.
The expectation would be that sellers would emerge once again as this $170 price point was now suspect, having failed before. All the folks who had bought the initial breakout above $170 back in March had waited for their losses to diminish and the QQQ to rise back close to their buy point. They would potentially be itching to sell at the slightest hint of weakness around $170 – shown by the purple line in the chart above. And so it has been thus far. The rise in the QQQ stopped right at the line and has struggled to find enough fresh buying to push past the overhead supply of stock as sellers still control the $170 price.
There is reason to believe buyers will ultimately prevail however. That optimism comes from the performance of the small-cap Russell 2000 (IWM). Whereas the QQQ’s initial breakout above $170 failed, the Russell 2000 has held last week’s breakout for several days now. Note that it took four efforts for the small-cap index to break to new highs, four months for buyers to gather enough force to overcome the selling that kept occurring in the $158-160 area. Now that price level has been overcome, we would expect $160 to act as support for the index. The support comes from potential buyers who may have missed the initial breakout and are looking for a slight pullback to buy into the new uptrend.
In this age of computer program trading, buying and selling based on charts and rules such as we examine above has become ever more common. The herd behavior of humans makes trading based on charts a self-reinforcing phenomenon that works very well as long as some event doesn’t override the natural tendency to let the charts do the trading work for us. Our models are completely driven by this tendency in the markets to follow charts and technical trading cues. They don’t always work, of course, but the long-term success of our models confirms their usefulness.
With corporate earnings largely in the books, investors returned to focusing on the ongoing geopolitical issues of the day. Monday’s +0.7% rally was driven by news of a thaw in the China-U.S. trade tariff dialogue. Investors backed away from their positive read of the trade issues in Tuesday’s session, with indexes giving back half of the prior day’s advance. Initial losses on concerns that the summit between the U.S. and North Korea might be slipping away got turned positive Wednesday as minutes from the Federal Reserve’s most recent meeting came across as less aggressive. That sentiment pushed interest rates lower and reversed stocks to a positive +0.3% close. The surprise cancellation of the summit meeting Thursday rattled investors, sending the market lower by -1% early before buyers stepped in during the last couple of hours to pare the loss to -0.2%. Oil prices fell for a fourth straight session Friday on reports OPEC is weighing pulling back from their strategy of supply reductions. Those reductions have been key to the surge in prices over the past year. The drop in oil prices took the legs out of the rally in energy stocks, a sector which had been a support for stocks over the past 3 weeks. With oil prices falling and the Fed’s minutes suggesting a less aggressive posture, interest rates continued pulling back Friday, with the 10-year Treasury bond yield falling back under the closely-watched 3% level. Stocks managed to hold to a -0.2% dip while the Nasdaq closed slightly positive.
For the week the S&P 500 (SPY) held to a +0.30% move while the Nasdaq 100 (QQQ) pushed higher by +1.35%. Small-cap stocks (IWM), the market leader over the past month, was flat at -0.08% as energy stocks fell back to offset gains elsewhere.
Warm wishes and until next week.