Equity Market Snapshot 08-21-2014

There has been a lot of confusion lately regarding the direction of the market and the risk of a major correction.  The following article applies several different technical indicators to the Russell 2000 Index (RUT) in both the daily and weekly time frame.

RUT Daily Analysis through 08-21-2014 (intra-day)

The top panel in Figure 1 below is a daily candlestick chart of RUT.  The blue and violet lines are 21-day and 40-day moving averages respectively. The red line represents the CBOE Skew Index (axis not shown).  The blue line in the second panel is my proprietary cumulative relative-strength market timing indicator (RSMTI).  The violet line represents an intermediate-term moving average of the RSMTI.  The red and green  histogram bars depict the daily changes in the cumulative RSMTI. The blue line in the third panel represents the accumulation distribution indicator and the violet line illustrates a moving average of the accumulation distribution indicator.

The blue line in the fourth panel represents the cumulative advance-decline line for the combined NYSE, NASDAQ, and AMEX exchanges.  The other lines in the fourth panel represent moving averages of the advance-decline line.  Finally, the blue line in the bottom panel represents the normalized short-term deviation of the advance-decline line and the violet line depicts its moving average.  The red and green horizontal lines identify overbought and oversold thresholds that frequently identify probable reversals or consolidations.

Now, let's draw some conclusions from the chart.  First, RUT has been trading below its moving averages until very recently, possibly indicating a potential trend change and a return to a bullish environment.  The Red vertical line denotes the point where the cumulative RSMTI dropped below its moving average. RUT prices have recovered recently, but the RSMTI has not yet crossed its moving average, although it is very close (see black circle in second panel).  In order for RUT to mount a sustained bullish move, it would need to be supported by the RSMTI.

Unlike the RSMTI, the accumulation distribution and advance decline lines have already crossed above their moving averages (third and fourth panel) and are consistent with a bullish environment.  However, the advance-decline line has accelerated very rapidly recently (red circle in bottom panel), which typically leads to a short-term period of consolidation or even a modest pullback.

Figure 1: RUT-Daily-20140821

Figure 1: RUT-Daily-20140821

RUT Weekly Analysis through 08-21-2014 (intra-day)

The weekly candlestick chart for RUT is depicted in Figure 2 below.  The five panels contain the same indicators as Figure 1. The weekly snapshot highlights the performance of RUT for 2014. As you can see from the chart, RUT has shown no clear trend for 2014 and has bounced above and below its moving averages.  However, the RSMTI has been much weaker than price.  It crossed below its moving average in early 2014 and has remained below it for almost the entire year. Until the weekly RSMTI moves above its moving average, it is unlikely that RUT would be able to sustain a significant upward price move.

The accumulation distribution indicator in panel three showed two significant areas of weakness in 2014, which coincided with pullbacks in RUT.  The most recent pullback also saw the advance decline line drop below its moving average temporarily.  Both of these weekly indicators have crossed back above their respective moving averages.

Finally, it is interesting to note that the weekly normalized deviations in the advance decline data correctly identified bullish and bearish turning points in RUT earlier this year (green and red circles).

Figure 2: RUT-Weekly-20140821

Figure 2: RUT-Weekly-20140821

Conclusion

There is some disagreement in the RUT data. The weakness in the daily and weekly RSMTI are troubling, but the accumulation distribution and advance decline data are showing signs of improvement.

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About Brian Johnson

I have been an investment professional for over 30 years. I worked as a fixed income portfolio manager, personally managing over $13 billion in assets for institutional clients. I was also the President of a financial consulting and software development firm, developing artificial intelligence based forecasting and risk management systems for institutional investment managers. I am now a full-time proprietary trader in options, futures, stocks, and ETFs using both algorithmic and discretionary trading strategies. In addition to my professional investment experience, I designed and taught courses in financial derivatives for both MBA and undergraduate business programs on a part-time basis for a number of years.
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