Thursday, August 21, 2014

A Short Term Watch Out For High RSI and Low Trin

In our weekend post (here), we specifically warned how a break back above the 50-dma for SPX has been a momentum kick off in the past. This has been when the long win-streaks have taken place (yellow). This remains the big picture view for SPX.

SPX has since risen 4 days in a row. There are two studies indicating that short-term (1-2 days) weakness is ahead, followed by at least one higher high.

Recall that on August 7, Trin closed over 2, which was a probable indication of a washout low (here). Trin is a breadth indicator. It is derived by dividing the advance-decline ratio for issues by that for volume. A close over 2 meant that down-volume was twice down-issues; in other words, that stocks had fallen on relatively high volume. In the event, that marked the exact low.

On Wednesday, Trin closed at the other extreme: 0.5. That means participation was light relative to volume.

The chart below looks at similar instances in the past two years. There were more than 10 of these; in all but one, SPX gave back all its subsequent gains over the next few days. That means either SPX fell the next day or, if it rose, that it gave up those gains in the days ahead. The latter situation now applies.

In only three instances did the low Trin mark a top of some significance. In most cases, SPX continued higher.

Today (Thursday), SPX has risen further. The hourly RSI (5) closed above 95 in the morning. This is quite unusual; since 2013, it has happened only 13 times. An RSI this high indicates a very hot market. That strength usually leads to further gains in the days ahead, but it is also followed by some softness.

The chart below looks at similar instances since 2013. In each case, SPX fell and then continued higher. The most recent case was just last Friday (recall the market's large fall in the morning and then its afternoon rebound).

The chart below looks at similar instances in 2011 and 2012, with the same conclusion. Twice, the high RSI occurred very close to significant top but SPX was not at a 52-week high (like now) in either case.

Again, in the big picture, SPX should continue higher. If past is prologue, SPX should experience some weakness first. In many cases, the 5-dma (green line in the last two charts above) is reached. That implies a retest of the 198 support level (yellow band).  An hourly RSI below 30 should be a useful indicator to watch.