Brandon Wendell, CMT
Brandon Wendell
Investors and traders have been watching in amazement as the equity markets have been steadily rising and reaching all-time price highs nearly every week. The big question on most people’s minds is, “When will it stop?” Or more importantly, “Is there a crash coming?”
Professional traders use price action to determine where future prices will likely go. This is difficult now because with the new highs, we do not have any supply to mark the probable top. Last week, the FANG stocks, (Facebook, Amazon, Netflix, and Google) caused the Nasdaq index to retreat quickly from highs. This may not be the peak of the market, however. It could be a small profit taking period or the start of a large correction. So how are traders supposed to know or react?
In past articles, I have highlighted the use of the Relative Strength Index (RSI) as a tool for measuring price momentum and changes in trend. We can apply this indicator to our index price charts and even individual securities to assist us in identifying future movement. 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.
Looking at the chart below of the market crash in 2008, we can see that the RSI gave us several signals before prices dropped. The negative divergence of price and the indicator was a powerful signal, warning investors of weakness in the market.
Looking now at the current weekly chart of the S&P 500, we do not have such a signal yet. The momentum is still strong while prices are making new highs. This suggests the trend will continue for now.
Turning to the Nasdaq index, we see a different picture. While prices have been moving to new highs, the momentum is dropping. This negative divergence is a warning for those invested in tech stocks.
The Dow Jones Industrial Average is following the path of the S&P 500 and moving higher on increased momentum suggesting continued bullish movement.
The proverbial canary in the mine shaft for the indexes is usually the Russell 2000 index. Since the index consists of smaller US based companies without as much international exposure, it usually reflects the American economy better than the other indexes. It was the first index to drop in the 2008 crash, and also the first to recover.
Currently it is also exhibiting negative divergence like the Nasdaq. This is a bearish sign. Don’t panic though. The warning is only on two of four indexes. We are likely to continue to see higher prices and new highs. The divergence is only a warning, not the signal to sell or sell short.
To know when the time is right to short the markets, you need to understand how to identify the dominant trend in price. This is critical, because if you try to short in an uptrend you will likely suffer losses. When it comes to trading in the trend, you do not always have to be first, but you do not want to be wrong.
Visit your local Online Trading Academy office today and discover how you can learn to read price and trends the professional way in small classes taught by active, profitable traders.
Neither Freedom Management Partners nor any of its personnel are registered broker-dealers or investment advisers. I will mention that I consider certain securities or positions to be good candidates for the types of strategies we are discussing or illustrating. Because I consider the securities or positions appropriate to the discussion or for illustration purposes does not mean that I am telling you to trade the strategies or securities. Keep in mind that we are not providing you with recommendations or personalized advice about your trading activities. The information we are providing is not tailored to any individual. Any mention of a particular security is not a recommendation to buy, sell, or hold that or any other security or a suggestion that it is suitable for any specific person. Keep in mind that all trading involves a risk of loss, and this will always be the situation, regardless of whether we are discussing strategies that are intended to limit risk. Also, Freedom Management Partners’ personnel are not subject to trading restrictions. I and others at Freedom Management Partners could have a position in a security or initiate a position in a security at any time.
Editors’ Picks
EUR/USD: US Dollar to remain pressured until uncertainty fog dissipates
Unimpressive European Central Bank left monetary policy unchanged for the fifth consecutive meeting. The United States first-tier employment and inflation data is scheduled for the second week of February. EUR/USD battles to remain afloat above 1.1800, sellers moving to the sidelines.
GBP/USD reclaims 1.3600 and above
GBP/USD reverses two straight days of losses, surpassing the key 1.3600 yardstick on Friday. Cable’s rebound comes as the Greenback slips away from two-week highs in response to some profit-taking mood and speculation of Fed rate cuts. In addition, hawkish comments from the BoE’s Pill are also collaborating with the quid’s improvement.
USD/JPY gathers strength to near 157.50 as Takaichi’s party wins snap elections
The USD/JPY pair attracts some buyers to around 157.45 during the early Asian session on Monday. The Japanese Yen weakens against the US Dollar after Japan’s ruling Liberal Democratic Party won an outright majority in Sunday’s lower house election, opening the door to more fiscal stimulus by Prime Minister Sanae Takaichi.
Editors’ Picks
USD/JPY gathers strength to near 157.50 as Takaichi’s party wins snap elections
The USD/JPY pair attracts some buyers to around 157.45 during the early Asian session on Monday. The Japanese Yen weakens against the US Dollar after Japan’s ruling Liberal Democratic Party won an outright majority in Sunday’s lower house election, opening the door to more fiscal stimulus by Prime Minister Sanae Takaichi.
Gold: Volatility persists in commodity space
After losing more than 8% to end the previous week, Gold remained under heavy selling pressure on Monday and dropped toward $4,400. Although XAU/USD staged a decisive rebound afterward, it failed to stabilize above $5,000. The US economic calendar will feature Nonfarm Payrolls and Consumer Price Index data for January, which could influence the market pricing of the Federal Reserve’s policy outlook and impact Gold’s performance.
AUD/USD eyes 0.7050 hurdle amid supportive fundamental backdrop
AUD/USD builds on Friday's goodish rebound from sub-0.6900 levels and kicks off the new week on a positive note, with bulls awaiting a sustained move and acceptance above mid-0.7000s before placing fresh bets. The widening RBA-Fed divergence, along with the upbeat market mood, acts as a tailwind for the risk-sensitive Aussie amid some follow-through US Dollar selling for the second straight day.
Week ahead: US NFP and CPI data to shake Fed cut bets, Japan election looms
US NFP and CPI data awaited after Warsh’s nomination as Fed chief. Yen traders lock gaze on Sunday’s snap election. UK and Eurozone Q4 GDP data also on the agenda. China CPI and PPI could reveal more weakness in domestic demand.
Three scenarios for Japanese Yen ahead of snap election Premium
The latest polls point to a dominant win for the ruling bloc at the upcoming Japanese snap election. The larger Sanae Takaichi’s mandate, the more investors fear faster implementation of tax cuts and spending plans.
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