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Chart Advisor: Essential Signs of Market Exhaustion

Posted June 11, 2024 at 7:19 am
Investopedia
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By David Keller. CMT

Recognizing Bearish Trends: Essential Signs of Market Exhaustion

Investopedia is partnering with CMT Association on this newsletter.  The contents of this newsletter are for informational and educational purposes only, however, and do not constitute investing advice. The guest authors, which may sell research to investors, and may trade or hold positions in securities mentioned herein do not represent the views of CMT Association or Investopedia. Please consult a financial advisor for investment recommendations and services.

When the market’s going up, I often get questions about why I sound so bearish. Why am I posting about the Hindenburg Omen and other signs that the market’s potentially rolling over?

Your goal as an investor should be threefold: identify the trends, follow those trends, and look for signs of trend exhaustion. That’s where the Hindenburg Omen and signs of a market top come into play.

Identify the Trend

The trend overall for the market is going up. I know this, you know this. I own plenty of stocks, mostly through ETFs, in my own accounts. The market trend overall has been positive since the end of March 2023. My medium-term model, which I rely on as my main risk-on-risk-off indicator, has been bullish since early November 2023. The short-term model has been consistently bullish since mid-April. So as progress through the 2nd quarter of 2024, I’m not disagreeing with the positive trend.

Follow the Trend

If you have been following these trends, you’ve been riding this market uptrend. But, of course, following the trend alone isn’t enough.

Anticipate Potential Turns

This brings us to the third and arguably most important step: looking for signs of trend exhaustion to anticipate potential market reversals. Trends can change, and you don’t want to be caught off guard. This is why I talk about bearish indicators when the market’s going higher. The goal is not to be surprised or confused by a market top but to see it coming. So, what are the three signs of the bear that I’m watching?

BEARISH MOMENTUM DIVERGENCES

Step one is spotting a bearish momentum divergence and not just one but a group of them. As the market pushes higher, it typically has strong momentum — buyers outnumber sellers. However, interestingly, in the last four weeks from mid-May to mid-June, while the S&P 500 made higher closes, the momentum, as measured by the RSI, has been trending downwards. This can be an early sign of bearish momentum divergence. Amazon and Eaton Corp have already exhibited this pattern with higher highs in price but lower peaks in momentum, so the S&P 500 may just follow suit.

BREADTH FAILING TO CONFIRM NEW MARKET HIGH

The second sign is when breadth fails to confirm a new market high. Look at the advance-decline line for the New York Stock Exchange: while the S&P touched new highs, the advance-decline line trended lower. This means fewer stocks are pushing the market higher, which isn’t a sign of a healthy bull market. Similarly, the advance-decline lines for large caps, mid-caps, and small caps are all showing lower trends. This divergence indicates that the broad market participation is weak, often a precursor to a weakening trend.

BREAKDOWN OF THE LINE IN THE SAND

The third sign of a bear is the breakdown of a critical support level, what I call a “line in the sand.” For me, a simple trendline originating from the October 2023 low has held up through mid-April, late April, and early May lows. If the price breaks this trendline, that will signify a change in market character. A breakdown through that line indicates that the uptrend’s pace and structure are starting to shift.

So, those are the three signs of a bear that I keep an eye on: bearish momentum divergences, breadth failing to confirm new highs, and breakdowns of critical support levels. Keep your alerts updated and remain vigilant as we observe the market climbing but with potential signs of underlying weaknesses.

Remember, as an investor, embracing both the bullish trends and the cautious signs of a potential bear can help you navigate the complexities of the market a little better. Stay vigilant, stay informed, and you’ll be well-prepared for whatever the market throws your way!

About the author:

David Keller, CMT is a former CMT Association President. He is now a Chief Market Strategist at StockCharts.com, where he helps investors minimize behavioral biases through technical analysis. Dave is a CNBC Pro Contributor, and he recaps market activity and interviews leading experts on his show “The Final Bar” on StockCharts TV.

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Originally posted on June 11th, 2024

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2 thoughts on “Chart Advisor: Essential Signs of Market Exhaustion”

  • Naresh Babu R

    Thanks.

    • Interactive Brokers

      Thanks for engaging!

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