Scott Pluschau:  There are multiple reasons to be bearish in the Nasdaq Composite Index from a technical standpoint. Let’s look at the 2011 daily chart of the Index. View the rising channel noted with blue trend lines .

The daily chart of the Nasdaq Cumulative Advance Decline Line shows a downward sloping channel marked with blue trend lines. In fact, the advancing issues minus the declining issues were off approximately 8,000 from the February 2011 peak in the Composite Index to the recent low in May. This can be a major red flag. Throughout history this has been a sign of a market running out of gas.

There are multiple reasons to be bearish in the Nasdaq Composite Index from a technical standpoint.

Let’s look at the 2011 daily chart of the Index. View the rising channel noted with blue trend lines.

The daily chart of the Nasdaq Cumulative Advance Decline Line shows a downward sloping channel marked with blue trend lines. In fact, the advancing issues minus the declining issues were off approximately 8,000 from the February 2011 peak in the Composite Index to the recent low in May. This can be a major red flag. Throughout history this has been a sign of a market running out of gas.

Next are two charts featuring the Nasdaq McClellan Oscillator. 

The first is a daily chart, which shows in 2011 the oscillator making new lows recently.  (Insert chart titled “Nasdaq-McClellanDaily”) The Nasdaq McClellan Oscillator is a market breadth indicator that is based on the “difference” between the number of advancing and declining issues within the Nasdaq.  Usually, a small number of stocks making large gains signal a weakening bull market. As the Nasdaq makes new highs, it gives the perception that the overall market is healthy, but in reality it isn’t, as rising prices are being driven by a smaller number of stocks.  The weekly chart of the McClellan Oscillator shows how since the bull market rally began in early 2009; it finds support near the zero level which is highlighted with a horizontal blue trend line.

Only once since then did the McClellan Oscillator break down from this support area finding resistance in this area before rallying through on the next attempt in 2010.  Now the oscillator is in the support area and heading south.  Will it bounce from here, or will it break down, and if so, will it fail to retake the zero level?   In 2008 the McClellan Oscillator would often find resistance at the zero level as the Nasdaq Composite Index was in a bear market.  It’s logical to think bulls would want to see this zero support area in the McClellan Oscillator not only hold, but strongly breakout to the upside from the downward sloping blue trend line noted on the weekly chart.

Another daily chart of the Nasdaq Composite Index shows blue trend lines drawn across the peak in February 2011 to the peak this May. This is paired with another blue trend line drawn across the peak in March 2011 and the early peak in April.

When comparing the daily chart of the Composite Index to the Nasdaq Cumulative Up Minus Down Volume chart you can again clearly see these rallies in price action are losing steam. This is noted by the down sloping blue trend lines marking the same two respective peaks in the price action on the Up Minus Down Volume chart.  This is another red flag indicating these rallies are unsustainable due to the lack of demand for higher prices.

Lastly, is the chart highlighted with red ovals is the Nasdaq Cumulative New Highs – New Lows Index, which measures the number of stocks making new 52 week highs minus the number of stocks making new 52 week lows. These specific areas indicate the Nasdaq had more stocks making new 52 week lows than new 52 week highs during the year 2011.  With the Composite Index itself much closer to its 52 week high is another caution flag.  In a healthy uptrend we should be seeing more stocks making new highs, not new lows.  This has been a warning sign throughout history.

In conclusion, being subject to human emotion, analysts and money managers are prone to apply optimism with positive market action and vice versa as they become pessimistic with poor price action. The Valence Effect is also the tendency for people to simply overestimate the likelihood of good versus bad things happening. However when looking “under the hood” so to speak, using technical analysis as a guide, there are multiple reasons to be cautious toward the Nasdaq.

Tickers: Technology Select Sector SPDR ETF (NYSE:XLK), Vanguard Information Technology ETF (NYSE:VGT), POWERSHARES QQQ TR SER 1 (NASDAQ:QQQ), ProShares Ultra QQQ ETF (NYSE:QLD), ProShares UltraShort QQQ ETF (NYSE:QID), SPDR S&P 500 ETF (NYSE:SPY), SPDR Dow Jones Industrial Average (NYSE:DIA), iShares Russell 2000 Index (NYSE:IWM).

Written By Scott Pluschau From ETF Digest  

ETF Digest writes a subscription newsletter focused on technical analysis of exchange-traded funds. ETF Digest was founded in 2001 and was among the very first to see the need for a publication that provided individual investors with information and advice on ETF investing.  Even if you’re not a fan of chart analysis, ETF Digest provides insight and commentary into which global markets are “working” and why.

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