Monday’s huge downside reversal finally poured some much-needed cold water on this very hot bull market.
The rest of the week was near perfect as Tuesday’s upside reversal was followed with some tight action the rest of the week.
We start with a day-by-day analysis of the Nasdaq composite in search of hidden clues of accumulation or distribution in the daily price action.
Then we step back and put the puzzle pieces together. Our mission is to give you an edge in the market.
If this is your first time with us, or you are new to candlesticks, please read the Stock Market Update: Your User Guide.
Monday, July 13: Raging Bull Out Of Ammo
Facts: Down 2.1%, 5% closing range on higher volume.
Good: At least it held the lows of last week.
Bad: Gap ups are scary. But a 1.1% gap up on a Monday is even worse. If it holds, it’s great. But if it fades, it sets a negative tone for the entire week.
Nearly all stocks were up strongly. The Nasdaq ran up another 0.8% before hitting a wall two hours into the day.
By lunchtime, we had taken out the morning gap up. Then it went straight down without stopping. The selling was relentless, nothing was spared.
There wasn’t a bull to be found and the bears were done hibernating.
Candle: Horrible. Huge negative body with a medium-size top wick and very small bottom wick.
Tuesday, July 14: A Beautiful Day
Facts: Up 0.9%, 97% closing range on lower volume.
Great: A classic raging bull upside reversal, like: May 4, May 14, May 27, June 15 and June 29.
When the raging bull was needed, he came back.
After a weak open and a trip near the 21-day, the bulls were back in charge and supporting with full force. They stepped in right after the 50% retracement was hit.
Bad: Not much. It would have been nicer to make back a little more progress.
Candle: Perfect. Large positive body with a medium-size bottom wick.
Wednesday, July 15: Resting Day
Facts: Up 0.6%, 71% closing range on higher volume.
Great: It might not look like much, but this was a “key” day.
Monday was a day for the bears and Tuesday a day for the bulls.
A trip back to new highs would have looked abnormal. A break of Tuesday’s low would have surely led to an intermediate correction.
What was needed was a time out. That’s exactly what we got on Wednesday. Just enough power to signify the bulls were back in town.
Bad: Not much.
Candle: Good. A very small negative body that sat on top of Tuesday’s body. The long bottom wick showed a positive bias and a successful test.
Expectation: Higher or sideways.
Thursday, July 16: Take It Easy
Facts: Down 0.7%, 81% closing range on lower volume.
Great: There’s a time when a down day is healthier than an up day. This was that time, and this was a near-perfect day.
The candle really tells the whole picture. While we were down, we had a positive body that sat within the prior bottom wick. This shows a mild positive bias but also containment.
Next, we successfully undercut the prior day’s lows while staying well above Tuesday’s open.
If you exclude the extremes from Monday and Tuesday, it stayed in that same trading range since July 6.
Bad: Nothing. The high closing range balanced out the mild loss.
Candle: Excellent. (see above).
Friday, July 17: Exactly What The Doctor Ordered
Facts: Up 0.3%, 74% closing range on higher volume.
Great: Everything. A tiny spread with a high closing range. Higher high and higher low. Marking time.
Going into a weekend at the beginning of earnings season, the dramatically low volatility signaled that the bulls were back in charge but finally plugging in for a recharge.
Candle: Excellent. A positive sliver body right at the highs from Thursday. A longer bottom wick than top.
Expectation: Higher to sideways.
SMU’s 50% Retracement (Slight Return)
Trend Line: Trend lines can be drawn on all chart time frames. From short to long.
While longer trendlines have more value, don’t ignore the short ones. They can give you a little edge.
Observing how the market acts at the trend lines will give you a sense of the market’s health.
In last week’s Stock Market Update, we drew the short-term trend line (yellow).
Notice how we quickly accelerated to the downside as we breached this line.
That was a “tell.”
It lets you know this bull market is paying attention to these clear and obvious short-term trendlines. This gives us an edge moving forward as many bull markets ignore short-term action.
50% Retracement: The Stock Market Update recently introduced the 50% retracement rule.
This simple rule of thumb states that a stock, or index, can give up half its gains and still be healthy.
You can use it on multiple time frames.
We ran up 12% from the June 29 low of 9663 (red line) to Monday’s high of 10,824 (blue line).
Using the 50% retracement rule, we knew a pullback to the midpoint of 10,244 (white line) could easily be in the cards.
We quickly fell to 10,182 just slightly below the 50% level, before finding support.
While it was fast, it was very healthy and normal.
As we’ve mentioned previously, anything significantly below 50% is a sign of weakness.
Stock Market Update: Take A Step Back
Weekly charts are critical for context and the character of a trend.
Since the lows in March, we’ve had ten positive bodies. This week was the seventh negative body. While it was on the larger side for a negative body, most of the positive bodies have been larger.
Facts: Down 1.1%, 50% closing range on higher volume.
Weekly candle: Mixed. The medium-size negative body looks bad. But the very long bottom wick shows how much progress it made. The nice recovery after closing the small gap from two weeks ago adds to the positive look.
Expectation: Sideways or down.
Stock Market Update: Moving Averages
Take another step back and focus on the moving averages.
Power Trend: Excellent: The power trend remains on and in a very healthy position. It will turn off when the 21-day moves below the 50-day.
21-day moving average: Excellent. Friday was the day 14 of consecutive closes above the 21-day. The Nasdaq closed 2% above the line.
The low has been above the line for 13 days.
June 26 was the first close below the 21-day line in 57 straight days. On June 29, we retook the 21-day with a classic and powerful upside reversal.
The 21-day has remained above the 50-day line for 58 days and above the 200-day line for 53 days.
50-day moving average: Great. We closed 7% above a steadily rising 50-day.
The 50-day has been above the 200-day for 33 days.
200-day moving average: Great. The 200-day continues to rise, and we closed a whopping 18% above the 200-day line.
Stock Market Update: Webby’s RSI
There’s a very popular Relative Strength Index (RSI). This has nothing to do with that indicator; it’s just a fun play on words.
On May 30, Stock Market Update introduced Webby’s Really Simple Indicator (Webby’s RSI). There we explained the details and showed how it behaved during the 2017 bull market.
In the June 6 Stock Market Update we went over Webby’s RSI during the 2003 bull market. You should review both to understand how to use this indicator.
It’s simply the percentage of the low vs. the 21-day moving average. That’s it!
As a bull market starts you want to see very high levels on Webby’s RSI. That shows the lows are well above the 21-day. A sign of power.
Eventually, bull markets level out to a more sustainable pace.
In prior bulls, the ideal spot has been 0.5% to 2% (the green lines). For reference, yellow is at 4% and red at 6%.
All bulls have their own character and volatility. This may end up with a higher or lower ideal range; the Stock Market Update will adjust the levels further into the bull market.
Current Webby’s RSI: Excellent. Two weeks from its last test of the 21-day we saw another one on Tuesday.
This time rather than falling below the line, the market firmed up as its low was 0.2% from the 21-day. This additional test is normal, classic and healthy.
Friday’s value was a powerful 1.6%.
While we were running much higher than a normal bull market range of 0.5% to 2%, this week we returned to the historic norms.
The blue line is a 10-day moving average.
Friday’s value was a healthy 2.5%, but heading lower. It would be great to see it flatline under 2%.
We’re Back In the Channel Again
Lower Channel Line: Great. We remain well above our new lower channel line since the successful test of the 21-day on June 29.
A test of the lower channel line would be healthy.
To draw the current lower channel line (blue) connect the low of April 13 with the June 29 low.
For details read “Another New Channel Line Is Born” from the July 3 Stock Market Update.
Upper Channel Line: Good. On Monday we broke back below the upper channel line (red) which was the ideal thing to do. Doing it a little slower would have been nice.
We are now in the ideal area above the mid-point (white), but below the upper channel.
For details on the upper and mid-point channel lines, read The Who inspired, Meet The New Line; Same As The Old Line.
Regression Lines? I Was Told There Would Be No Math
I know what you are thinking. Standard deviations and regression lines, do I need to break out my college stats book? No.
Let’s keep this simple. A regression line (white) is just the best fitting line through a bunch of numbers.
Here we are using the daily price data starting with the April 6, Tom Petty “Won’t Back Down” follow-through day to Friday.
From there we are looking at a half and a full standard deviation (SD) above (red dashed and solid, respectively) and below (green dashed and solid, respectively).
Think of the SD as just an additional channel lines.
Going forward, we will use this tool to let us know if things are normal or abnormal. Notice how the 21-day (blue) is hugging the half SD below. At the same time, the 50-day is catching up to the full SD below.
More on this in future Stock Market Updates.
Shaken Not Stirred, The 007 Index May Still Be The Key
The S&P 500 (0S&P5), commonly referred to as “the spy” or SPY, appears to be the key index for the moment.
On July 6, the SPY gapped up through the prior resistance within the handle of the cup-with-handle base. Then it went sideways for the week.
On Monday it gapped up again. This time it looked like it would clear the standard pivot highs of 3233 (323.41 for SPY). But of course, we had the major downside reversal.
Unlike the Nasdaq, which is taking a much-needed vacation, the S&P 500 was able to inch back up to Monday’s highs.
In last week’s Stock Market Update, we mentioned how the tiny week closing near the highs was a setup week. It left you with the expectation of a much higher move the following week.
Friday’s tight spread closing near the highs left the impression of a setup day again.
Also, in contrast to the tech-heavy Nasdaq, the lows for the week held above last week’s lows.
The SPY has clearly been the laggard vs. the Nasdaq, so a mean-reversion trade would be very logical.
Stock Market Update: Better Not Look Down
Sun Tzu said: “Whoever is first in the field and awaits the coming of the enemy, will be fresh for the fight; whoever is second in the field and has to hasten to battle will arrive exhausted.”
Bill O’Neil said: “There are the quick and the dead.”
Stock Market Update said: “Know your levels.”
Tests of support levels are normal and healthy. Abnormal breaks warrant quick and defensive action.
First Level: Below the mid-point channel line (white trend line). A move back below Tuesday’s open would put us under this line and that would be normal and healthy. It would be ideal to just move sideways and let the line catch up a little more.
Second Level: The 21-day moving average at 10,249 (blue moving average). This is very close to the 10,221 highs from June 23 (green horizontal line).
This is a key level because it has been defended successfully in the past. A break below this without a quick recovery would change the character of the market.
That would warrant defensive action.
Third Level: The highs from June 10 at 10,086 (yellow horizontal line). This is near the lower channel line (blue trend line).
Fourth Level: The February high of 9838 (orange horizontal line) and the key 50-day moving average (red) at 9776.
Fifth Level: June 29 low of 9663 (red dashed horizontal line).
A pullback to this area would be a normal intermediate correction of 9.6%.
The Line In The Sand: Breaking 8807, the current 200-day (red thick horizontal line) would be a massive negative character change.
A break to this line would be an 18% correction. The standard for a bear market is 20%.
Stock Market Update: The Key To The Highway
Sooner or later this raging bull was bound to listen to the Stock Market Update.
This pause may have started with a bit of drama, but in the end, this was a very constructive week.
Monday’s action was a reminder that the stove is still hot.
Translated, don’t get carried away. Stay diversified among sectors and types of growth stocks. Have some slow and steady stocks in your portfolio along with the best of the high-growth names.
It’s great that the week played out the way it did. Next time it might not. When the market has abnormal action, as it did on Monday, it’s your cue to take action.
This time the sell-off was a one-day wonder. The SMU refers to these as the Men Without Hats corrections.
The next large downside reversal could lead to an intermediate correction, so do your homework.
Staying under the upper trend line would be ideal. The longer we wait to take out Monday’s highs, the better.
After that, the next magnet is 11,000.
While we focus on the Nasdaq, right now the key remains the same.
Can the S&P 500 can join the party?
The Dow Jones Industrials and the Russell 2000 (0RUS) were able to poke above their 200-days which was constructive.
Here are the key levels for the S&P 500:
First Level: Move above Wednesday’s high of 3238.
Second Level: High of handle at 3233 made on June 8.
Third Level: The low at 3328 from Feb 21.
Final Level: The high at 3393 from Feb 19.
Homework: SMU Goes DIY
Since the Raging Bull finally listened to the Stock Market Update and slowed down, we are going to do the same.
While there will not be an SMU next week, we want to leave you with some homework assignments until we come back.
For the first two assignments, pull up the index chart for the given dates in MarketSmith.
Advance through them a couple of weeks at a time. Toggle back and forth between daily and weekly charts.
Pay attention to how the market handles itself around the 21-day and 50-day moving averages. Study the intermediate-term corrections (8% to 12%).
Homework #1: Pull up the Nasdaq Composite (0NDQC) and do a change date for the following bull markets:
December 31, 1974
April 25, 1980
August 27, 1982
November 16, 1990
January 13, 1995
October 16, 1998
March 21, 2003
March 27, 2009
December 28, 2012
July 8, 2016
Homework #2: Same thing using the Dow Jones Industrials (0DJIA) for the following dates:
June 13, 1924
August 17, 1928
April 7, 1933
April 5, 1935
June 5, 1942
July 8, 1949
October 16, 1953
April 18, 1958
November 2, 1962
Don’t rush through these. I’d suggest doing just one bull market a day.
Really transport yourself back in time. Ask yourself how you would handle some of the trickiest times. Where are your lines in the sand?
Always be intellectually honest. Otherwise, this will hurt more than it helps.
Remember, it’s OK to be wrong. You’re not trying to predict the market. You’re trying to stay in-line with the trend.
Homework #3: Since there won’t be an SMU next week, it’s your chance to do-it-yourself.
Go through the entire format. Start with the daily candles and finish with the levels. Write down as much as possible. You will learn a ton.
Remember the old saying: The trend is your friend, until the end when it bends.
As always, be kind to one another, keep an open mind and stay flexible.
You can do it!
See you in two weeks, stay safe.
Mike Webster is IBD’s Head Market Strategist. Follow Mike on Twitter under @mwebster1971. This weekly column was formerly named What Would Webby Do (#WWWD) available on Mike’s Twitter Feed.
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