Chris Vermeulen: Last week on October 8th the financial market experienced a broad based sell off. Every sector was down with utilities being the only exception.
The individual leadership stocks, which are typically small to mid-cap companies (IWM – Russell 2K) that have a strong history and outlook of earnings growth, were hit hard as well.
Whenever the broad market experiences a price correction, one of the most important factors I analyze is how well leading stocks hold up and show relative strength to the broad market.
So, where does this leave us going forward?
When stocks that have been leading the market higher and only pausing during market corrections in the Dow Jones Industrial Average (INDEXDJX:.DJI), S&P 500 (INDEXSP:.INX), and NASDAQ, it’s a positive sign. This tells us investors and big money continues to flow into the risk on assets (stocks).
Conversely, when these leading stocks/sectors begin succumbing to the selling pressure of the broad market, it quickly grabs my attention and tells us it’s time to be aware that a major top may be forming.
It looks as though the broad market rally is just barely hanging on. If the leading stocks and sectors begin breaking below their 50-day moving averages, my proprietary S&P 500 Market Timing & Trading System will shift to sell mode and things could get ugly for those who do not know how to trade a bear market.
Weekly Relative Strength Showing Negative Divergence
This chart has two important things I would like to point out. First is the fact that the RSI has being overbought twice in the past three years with the most recent one taking place a few months ago. The last time this took place the SP500 had a very strong correction.
The second insight the RSI is providing us with is the diverging price and relative strength as shown with the purple lines on the chart below. This is telling us that the power/momentum behind the market is slowing.
Daily Bullish Percent Index – Shows Negative Divergence
I always prefer to watch and analyze the NYSE as it’s the big board where all the HUGE money is flowing from traders and investors. The chart below clearly shows that less stocks are moving higher as seen with the purple bullish percent index line.