foxex: Reversal Signal

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Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Tuesday, September 08, 2020 Headlines

1. Tech selling marks a potential change in trend

2. A quick look back

3. What has changed this time around?

Market Moves

The Nasdaq 100 index fell nearly five percent today, with most of the drop happening before the opening bell. Some headlines point to comments made by President Trump over the weekend about a possible "decoupling" between the U.S. and China as the impetus for the selloff. Even so, the selling hit the tech sector harder than other areas of the market.

The chart below compares how Invesco's Nasdaq 100 ETF (QQQ), Microsoft (MSFT), AAPL (AAPL), and Amazon (AMZN), traded in comparison to the position of the currently drawn trendlines originating from late April. It seems to be a scary signal for those who want to buy, hold and forget. Only Apple hasn't closed below its trendline, though its current position looks weak anyway.

These kinds of signals are typical before a change from an upward trend to a downward trend. However, there is no guarantee that stocks showing this signal will follow through and go lower. For example, tech stocks rebounded nicely after a bout of similar selling in June of this year. Still, the current degree of selling seems more severe three months later. After all, this is the first time Tesla (TSLA) has ever fallen over 20 percent in a single day!

A Quick Look Back
Dow Theory is a concept within technical analysis that some traders employ to identify turning points at the end of a trend. It may not be an exact science, but over the years experienced chart watchers have found the method to be particularly useful.

An oversimplified version of the concept is that both the Dow Jones Industrial Average (DJI) and the Dow Jones Transportation Average (DJT) need to change direction in order to expect a major trend reversal to occur. The chart below demonstrates the last time both of these indexes signaled a move lower. This preceded the COVID-19 pandemic.

This chart compares State Street's S&P 500 index ETF (SPY) with iShares Transportation Industry index ETF (IYT) with an equal weighted portfolio that consists of the five most heavily traded stocks in the transportation industry (blue line). Last year both the transportation sector and the top five stocks within it began to move below SPY and to continue to do so right up until that fateful February most investors would like to forget. It was a perfectly reasonable warning signal for chart watchers to see. So if the market is about to turn lower, should this signal again be visible? Surprisingly, the charts look different today.

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What Has Changed This Time Around?

A quick look at the chart below alerts any curious student of markets that conditions do not appear to be the same today as one year ago. Notice how the top five stocks in the industry (blue line), and IYT (orange line), are both strongly leading above the S&P 500 index.

This signal suggests that investors don't like the idea of staying in big tech companies for very much longer. However, they do like the idea of staying in the market over the months to come. From this signal chart watchers could infer that investors have changed their opinion about the economic prospects for the year ahead. That could mean that the current swoon in stocks may be short lived.

The Bottom Line

Stocks fell lower and sold off further in trading today. Some stocks even signaled that they may begin a new downward trend. On the other hand, the DJ Transportation index seems to signal that investors are not ready to panic and that stocks could regain an upward trend before long.