A Closer Look at Market Internals

In case you’re not familiar with intraday trading techniques, don’t be alarmed by the concept of Market Internals. It’s just a fancy phrase for saying non-price based indicators. Market breadth is measured uses advancing versus declining issues in order to determine who has control of the markets; the bulls, or the bears?

Unless you are fortunate enough to have access to historical data for indecies, you’ll find all of the advance / decline data is based on the NYSE or the NASDAQ in most trading platforms. The reason this is important to note is due to the recent addition of Short based ETF’s, which advance when equities in these exchanges decline. Sadly, these instruments do have some effect on these indicators.

Note, if you would like to access historical advancing versus declining issues data for several indicies, go to MasterData.com.

All of the proceeding indicators are shown on a 15 day – 30 minute chart of the SPY below

NYSE Advancers vs. Decliners Line

The first internal indicator we’ll examine is the simple Advance / Decline line. The A/D line is defined on Investopedia as

“Advance/Decline Line – A/D
What Does It Mean?
What Does Advance/Decline Line – A/D Mean?
A technical indicator that plots changes in the value of the advance-decline index over a certain time period. Each point on the chart is calculated by taking the difference between the number of advancing/declining issues and adding the result to the previous period’s value, as shown by the following formula:

A/D Line = (# of Advancing Stocks – # of Declining Stocks) + Previous Period’s A/D Line Value”

As you can see this is a very simple indication of how many stocks move up versus how many moved down each day. Divergences between the A/D line and price tend to indicate the existing price movement is weakening, and a reversal could be imminent.

In the chart below, the AD line is the third indicator below volume. You can see a clear divergence between the A/D line market in red, versus price movement marked in yellow.

Trin – Arms Index

The TRIN is the advance/decline ratio divided by the advance volume/decline volume ratio:

[(Advancing issues/declining issues) / (advancing volume/declining volume)]

Looking at the formula, it is important to note that a rising Trin is Bearish, and a falling Trin is Bullish. I tend to think this is confusing, so I’ve modified my Trin indicator to reverse the formula (ie, Trin * -1).

I really like the Trin indicator in concept, as it is volume weighted, and thus takes volatility into account. Taking a look at the last indicator in the chart, you can see a clear divergence between the TRIN and price, but more importantly you can see a very clear bearish cross of the 0 line just before the close of the markets on Wednesday.

Advancing Versus Declining Volume

This simple indicator subtracts the total volume of all declining issues from the total volume of all advancing issues. Again, this indicator attempts to determine who has control of the market. Divergences and 0 line crosses provide your signals. You can see a huge divergence leading up to the early week rally on Monday and Tuesday.

Confluence of Indicators

Despite all of these massive and obvious divergences, each of the indicators is now in confluence with one another, and the news is all bearish. I have thrown in Squeeze Indicator, one of my favorite indicators, to backup what the internals are showing us. The Squeeze Indicator is a volatility based trading system that compares Bollinger bands to Keltner Channels. The indicator is fairly simple to read. When the centerline is red, the bollinger bands are squeezing, and are inside the Keltner Channel, indicating volatility is low. As a trader, you would want to wait on the sidelines while the sideways trading range worked itself out. Once the center line turns green, the bollinger bands have begun expanding outside of the Keltner Channel, indicating volatility is increasing. The direction you trade depends on the color bar of the histogram. A red bar means short, a green bar means long. You stay in the trade until you see 2 consecutive darker bars.

As you can see, the Squeeze Indicator pretty much nailed the pullback and subsequent continuation of the bearish trend, and fully supports the market internal studies above! Finally, I drew in the Fibonacci Retracements. A pullback that reaches the 38.2% retracement level but fails to reach the 50% level indicates trend continuation. As you can see, this week’s early pullback found resistance right at 38.2%, and quickly turned back down.

click to enlarge

Longer Term Forecast

Of course, the question you’re probably asking is, how far down can this thing go. Once again, I think the very long term prospects for this market are very negative, and could retest the early 2008 lows. Yes, it could be THAT bad.

I went ahead and drew in the fibonacci extensions on the 30 min chart,and for short term traders, a break below 105.6 could signal a quick move to the $102.54 within the next couple of days.

On the longer term chart, I can show you massive divergence, and finally a 1-2-3+4 bearish trend reversal. The 1-2-3 trend reversal is a concept my friend John Lansing at Trending123.com created which utilizes the PPO, Aroon, and Williams %r indicators to spot trend reversals. I’ve add the +4 by implementing On Balance True Range into the equation. I think volatility plays a huge predictive roll in price forecasting, and the OBTR indicator works magnificently well. Let’s take a look at this:

Taking a look at the PPO (similiar to MACD), we can see a HUGE divergence starting in mid-July, 2009. this type of divergence is not only abnormal, but frankly I’ve never seen anything like it. You can also see as of late January a bearish cross over and 0 line cross on this indicator, which has only happened once during the 11 month rally.

Now for the 1-2-3+4 bearish trend reversal. The 1-2-3 trend reversal happens when the Arron indicator has a cross, the PPO has a cross or 0 line corss, and the Williams %R crosses the -50 level.

In this case, we’re looking for a bearish reversal. You can see the Aroon Down crosses above the Aroon Up on the 29th. Aroon crosses are considered to be more significant when the occur above the 50 level, which as you can see in this instance, occurred at around 70.

Second, the PPO must have a bearish signal line cross, or a bearish 0 line cross. In this case, we have both!

Third, the Williams %R must cross below the -50 level. Check!

Finally, we see a clear bearish cross on the OBTR indicator, and a clear reversal of the OBTR moving average.

Taking a look back at the past 11 months of trading, these 4 indicators have never been bearish in sync with price momentum divergence. Combine these indicators with a massive increase of daily trading volume, a 20 / 50 day simple moving average bearish cross over, and you have a very bearish outlook for the markets.

click to enlarge

Possible Support Levels.

Another important point to mention is that today’s price action broke the long term upward trend line. It appeared this line would be a strong support after Monday and Tuesdays price action, but clearly did not hold.

The first area of minor support could come in at the 23.6% Fibonacci retracement level drawn from the market lows in February 2008, at 1035.

The second level of support I’ve drawn in with the white box, which coincides with the previous swing low between 1020 and 1029, and the 200 day SMA (currently 1017.75).

The final level of support before a massive market meltdown begins is the 1000 level.

click to enlarge

Final Words

Tonight, I’m just going to quote Adam:

“Make no mistake about it, today’s action is not positive for the equity markets. However, providing the levels we mentioned above hold, then you could say we’re in a broad trading range and we expect the lows to be tested. I, for one, am cynical that this is going to happen.”

To Profitable Trades,

Here’s what Adam had to say:

It’s the first time I’ve looked at this market this year and one thing jumped out at me right away and I wanted to share it with you.

It appears as though crude oil has an amazing cyclic quality that can be timed quite accurately with MarketClub’s “Triangle” technology. In this new short video, I showcase this cycle and how you can take advantage of it.

As always our videos are free to watch and there are no registration requirements. All we ask for is that you comment on this video if you find it interesting and informative.

Enjoy the video and let us know what you think.

Adam Hewison
President, INO.com
Co-creator, MarketClub

Watch The Video

In my new video I will show you how the NASDAQ index has broken a very important trend line and what the ramifications are for this index.

We can all learn from the simplicity of this approach and how effective it is in the long run.

As always our videos are free to watch and there are no registration requirements.

Enjoy the video and please feel free to comment on blog about this simple yet effective way of trading.

All the best,

Adam Hewison
President, INO.com
Co-creator, MarketClub