Last week I discussed the method we can use to chart the four major indexes and determine which one is leading the equity markets in the current direction. The reason behind this technique is to help predict the major turning points in price that will affect our trading.
In the recent market rise, the Dow and S&P indexes have been enjoying new highs and therefore do not have any overhead supply to indicate where the top could be. However they are not really leading the markets. Looking at the following chart, you can see that the Nasdaq 100 index has been the strongest and is leading the others.
Notice how the QQQ (the Nasdaq 100 ETF) has been the strongest out of the four? This shows that it is the leader in this upward trend and should be the one to indicate when trend will change. The fact that it is diverging (moving further away from the others) is also an indication of potential trend change coming.
In order to establish where prices may reverse, we need to look back in time to find the QQQ’s supply zone. Back in 2000, the QQQ formed a few daily and weekly supply zones that may offer turning points for us in this current market environment. It doesn’t seem like it will work, but I used the same method to trade the drop in the indexes in February to April of this year.
Another interesting note is that the same pattern developed before the market collapse in 2008. The Nasdaq 100 was the leading index. The index turned downward from its high in October 2007 after leading the market charge higher and the collapse began.
Another noteworthy event is the price action of the Russell 2000 index in both the 2007 market peak and also in the current market environment. In both instances the Russell showed weakness well before the other markets peaked. The Russell 2000 peaked in July 2000, not October like the large cap indexes did.
The reason I am concerned about this index is that it is comprised of small cap companies that generally do not have international exposure for their business. Without the international income, they are more responsive to changes in the United States economy and can be a better barometer for the health of our US economy and markets. When this index is ill, it is a bad omen for the stock market as a whole.
The Russell made all time highs in early July but has been weak since. Fortunately for the bulls the IWM has recently bounced from a daily demand zone. If it can make new highs, this could signal the bullish trend still has life. But if we instead make a lower high and lower low, the trend has changes and the bears may be growling.
So while it is not an exact science, we can use this technique of market comparison to increase our chances for success in our trading and investing. Come join us in the Extended Learning Track at Online Trading Academy to hear the latest analysis on the broad markets and individual securities. Hearing and learning educational information could be the most valuable thing you can do for your portfolio.