Lessons from the Pros


Is The Market Going To Drop?

In past articles, “Modified Odds Enhancer,” and “Use the 60-40 Bounce or Break for greater Profits,” I discussed using a common technical indicator in an atypical method. I was modifying the RSI indicator to use it as an odds enhancer to help identify whether trend would continue or if the supply and demand zones were strong enough to hold.

While discussing the indicator in my Minneapolis futures class last week, I decided to apply it to the broad markets to see if it had any use as a market trend predictor. Sure enough, the modified indicator did prove its worth.

As with any technical indicator, the RSI should be used as a confirming indicator, not a decision making tool. Price and supply and demand should be the only thing you use for your decisions to enter or exit the markets.

The RSI offered both positive and negative divergence signals to warn of trend changes before the 2008 credit bubble burst and the 2009 bottom. The trend changes were confirmed with the RSI moving below 40 (bearish) or above 60 (bullish).

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Looking at the current S&P 500 chart shows a negative divergence that could be preceding a drop in the markets.  The RSI has not dropped below 40 to confirm the reversal.

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The large cap S&P 500 index may not be the best indication of potential market weakness. The Russell 2000 is an index made up of small cap stocks that generally have no international exposure. These companies are usually more sensitive to changes in the US economy and will turn faster than the large cap stocks.

Looking back to the 2008 market drop, you can see that the Russell 2000 warned and dropped before the large cap indexes did.

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So looking at the current Russell 2000, we can see the weakness in the index from the negative divergence in the index and the indicator.  This is a bearish sign for the equity markets.

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So while the RSI indicator isn’t the Holy Grail, it can be useful to help find which supply or demand zones are more likely to work. To learn more odds enhancers, join us at one of our local centers and sign up for a class today.

Brandon Wendell

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.