The Day The Summer Rally Ended
by David Yu
I wrote, in my August 4, 2005 Thursday Update that "There's no question about the completion of this market top because the fear factor has finally returned." And, "The only question is how extensive this decline is going to be." Subsequently, in my August 8, 2005 Monday Update, I also wrote: "In fact, 8/3/2005 may be marked as the day the "Summer Rally" of 2005 ended."
I used the ratio of the Wilshire 5000 Index and the Total Put/Call option ratio to underline the Fear Factor then, and the update of the Wilshire 5000 chart below (Chart 1) verifies that the market did top out on August 3, 2005. The question now is indeed how extensive this decline is going to be.
The blue horizontal line on Chart 1 connects 2 previous peaks in March and June (red circles 1 & 2). These two peaks (approx. 12110) became important supports for the Wilshire 5000 index, which is the broadest market index that includes over 6,000 publicly traded companies headquartered in the States. Red circle 3 shows that Wilshire 5000 just dipped below this support on Friday. However, this was not a confirmed breakdown since part of Friday's action still took place above this support line. And, Friday's low trading volume (not shown here) certainly provides no confirmation of this breakdown either. Let's check on one of the volume indicators, TRIN Index, for further clarification.
Chart 1
This is the NASDAQ TRIN Index chart (Chart 2) that you probably won't see anywhere else. TRIN Index is an excellent contrarian indicator of the market's internal strength. It has an inversed correlation with the market. TRIN reading below 1 (blue line) is considered positive as the advancing issues are getting their fair share of support from the volume. And, the reading above 1 indicates deterioration of this relationship between the price and the volume. For more information on TRIN Index, please see my July 31 Sunday Chartmentary.
The 9-day moving average (thick black curve) of the TRIN Index began to trend higher since August 3 (red circle), and it's been staying above 1. I use the 9-day moving average instead of the standard 10-day MA to increase its sensitivity. The gray curve is the daily fluctuations of the index. This gray curve has recently formed a symmetrical triangle pattern - see red arrows.
A Symmetrical Triangle means indecision or consolidation. This indecision had recently stopped the uptrend of the 9-day moving average and pushed it back towards 1. This, of course, has everything to do with the pre Labor Day holiday low trading volume. And, as long as the volume continues to stay low, the market should continue to stay afloat with a mixture of up and down days in between. In fact, that's exactly what happened to the NASDAQ recently. The AROON indicator had thus formed a very interesting pattern. We'll take a look at that right after we're done with the NASDAQ TRIN Index here.
Now, if the NASDAQ TRIN Index continues to stay above 1 when the volume begins to pick up next week, the real breakdown may ensue. Technically, this symmetrical triangle is a "bullish" triangle, which is a negative for a contrarian indicator such as TRIN Index. If we apply the symmetrical triangle breakout target count to this TRIN Index, we'd obtain the target of approx. 2.23. NASDAQ TRIN Index is currently at about 1.10, so there's still quite a way to go before this downtrend is done. This target may seem relatively high, but it's nothing unusual. The NYSE TRIN Index reading reached the intraday high of 2.72 when the market bottomed in April.
For those interested, the target is derived from adding the difference between the two points on the left side of the triangle to the breakout point. The breakout point appears to be somewhere around 1.10.
Chart 2
Here's that interesting AROON pattern (blue circle) on Chart 3. Incidentally, Aroon means Dawn's Early Light in Sanskrit language - a classical language of India. It's an excellent indicator for anticipation of trend changes.
In any case, I've seen this type of wavy pattern before, but I've never seen it lasted over 15 trading days, and counting. The Aroon Down is going no where but tip-toeing up and down between 88.88 and 100. This means that over the most recent 9-day period it repeatedly dropped to the lowest price one day, and then came off that lowest low the very next day. This complies with the consolidation or indecision mode as per the NASDAQ TRIN Index. It would be most intriguing to see what happens next.
Chart 3
Before the market participants return from the Labor Day weekend holiday, it's most probable for this type of consolidation mode to continue. Technically speaking, the market's currently in a bearish consolidation mode, but there's no confirmation of the breakdown yet. And, as long as there's no confirmation of the breakdown, there's little resistance to stop the market from rallying. A bullish reversal could easily occur given a couple of big volume up days plus the Fed's injection of massive liquidity into the system.
And, if you had followed the Fed's open market operations link that I provided on my Friday's site, you'd see last week's repo total of $53 billion was the highest I've seen thus far. Somebody sensed the danger of the market and our economy going down. Now, that increase of the money supply may also serve as another contrarian indicator.
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