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These Are Classic Signs of a Rally Losing SteamBy Tom Dyson, editor, S&A Penny TrendsThursday, November 12, 2009 It's been one of the greatest stock market rallies in history.
In just the past nine months, the S&P 500 is up 62%. This is the most widely followed American stock index in the world.
Small caps, as represented by the Russell 2000 index exchange-traded fund, are up 72%. And you want foreign stocks? All of the major foreign stock funds – like India, Brazil, and China – are up between 75% and 100% in the same time.
These are the kinds of gains most investors make in three or four years. They have happened in just nine months... in what many folks would call a beautiful rally. But I wouldn't be doing my job as a trend analyst if I didn't point out some smudges in this masterpiece...
Three weeks ago, on October 19, the S&P 500 reached a peak at 1,098, then fell into a powerful 6% selloff.
This selloff coincided with massive selling volume and was led by market bellwethers like banks and emerging-market stocks. What's more, this huge selling volume came after a period of weak buying volume during July and August. Sellers greatly overwhelmed buyers during the decline. Which brings us to the recent action...
Last week, the market bounced and recovered some of its losses. The S&P 500 climbed over 1,100.
But if you look at the "internals," it's obvious this rally has no power behind it. The buyers have no conviction.
One important "internal" measure of the market is the amount of buying or selling power present at any given time. So we watch the volume action in the market.
The chart below displays trading volume for the benchmark American stock fund, the S&P 500 fund (SPY). This is one of the most widely traded stock instruments in the world.
 Notice the heavy volume during declines (the red bars) and sickly volume on the rallies (black bars). Notice the Relative Strength Index (RSI) pane at the bottom. RSI is a sort of "heart rate monitor" for stocks. We use it to judge internal market health. It's trending lower in a series of lower highs and lower lows. This is a flagrant bearish divergence from the price.
I don't like delivering bad news. I'd much rather see a healthy market rising on plenty of volume... backed by a healthy economy with moderate amounts of debt.
But this week, I have to note we're seeing classic signs of a rally that's losing steam and wants to turn into a decline... backed by what will go down in history as one of the most recklessly spending U.S. administrations ever.
My conclusion is, the market's internals peaked in mid-September. And its price is peaking this week. Mutual-fund tracking expert TrimTabs reports investors have actually pulled money out of domestic mutual funds in the past two months.
We should expect lower prices ahead. Traders comfortable trading on the short side should be ready to act. Those who are long should keep a close eye on their trailing stops.
Good trading,
Tom
Further Reading:
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