Deliver Us From Divergence

Last week I discussed the rally we experienced two weeks ago in an attempt to put things into perspective. I said that if intermediate term resistance of 1232 on the S&P 500 and 11,720 on the Dow were not taken out in the next few sessions, the odds favored a near term top was in place. Those levels were not exceeded in trading early last week. The support levels I suggested to focus on were 1200 for the S&P 500, 11,400 for the Dow and 2600 for the NASDAQ. When those short term levels were taken out I suggested to focus on the intermediate term support levels of 1135/10,820/2437. Based on the strength of the rally two weeks ago I felt these levels would hold.

That was the playbook I handed out. When the S&P and Dow failed to join the NASDAQ above intermediate term support the top was in place and the sellers took over. With just one of the major indexes going above support a negative divergence was in place and it signaled another round of selling would ensue. Those intermediate term support levels did not hold for the S&P and the Dow. When people began to panic the one area of strength was the NASDAQ. The intermediate term support level for the NASDAQ of 2437 did not give way, on a closing basis, on Thursday. Since all major indexes did not fall beneath support a positive divergence was put in place and it signaled a respite from the selling.

When I give any support/resistance levels I will always give numbers for at least three of the major indexes. It is extremely important that you use all the major indexes when attempting to gauge the next move in the market. Every trading floor uses these levels to gauge the near term strength of the market. If some, but not all, of the indexes close below support then a positive divergence is being put in place. If all major indexes cannot confirm a move higher, this is a negative divergence, and signals a selloff. 

So, since the NASDAQ held intermediate term support a positive divergence is shaping up. Here are the short term resistance levels for the S&P 500, Dow and NASDAQ: 1142/10810/2500. With the vicious selloff last week it would be a very troubling sign if we do not see these levels exceeded. If ALL THREE of these levels are taken out ON A CLOSING BASIS a rally will likely begin. The technical textbook says the rally will begin to run out of gas in the 1175 range of the S&P and could retest the 1200 level. If you see things stalling out below those levels and we see closes below 1114/10595/2420 then watch out! This will tell us that people are no longer willing to play these short term rallies. This will signal that a full assault on long term support will soon begin. The long term support levels for the major indexes are 1100/10,595/2315. 

So, remember look at the support/resistance levels I give for the major indexes. If some, but not all, of the resistance levels are taken out that is a NEGATIVE DIVERGENCE and prepare for selling. If some, but not all, support levels give way then a POSITVE DIVERGENCE is developing and a rally often ensues. 

All major trading desks and hedge funds know these levels and trade them. So, when you pick up the paper and they summarize the events of the prior day, sharp reversals often occur as these divergences develop. There will be a test give on positive/negative divergences at some point down the road.

The levels I gave earlier will be battle zones closely monitored across Wall Street. Selling/buying will accelerate when traders see how things go at these crucial levels.

Gold had a major selloff last week. For the first time in quite a while both the short term and intermediate term trend on gold is negative. Massive support for gold is in the 1550-1600 range. The first level of near term resistance is in the 1710 area.

So, while there have been several contra-trend rallies, we remain in a bear market. The longer term support levels for the major indexes are 1100, 10,595 and 2315. Until we can get out of a trading range we will continue to see sharp rallies and selloffs as the divergences described above take shape. The bottoming process I began speaking of several weeks ago continues. The bottoming process leads to nerve rattling volatility in the markets. Until this process plays out there can be no sustained rally in the market. Remain defensive.

P.S. – The market just concluded Monday trading. The three short term resistance levels I gave were exceeded. The positive divergence from last week led to a rally. Let’s see how this contra-trend rally plays out. The textbook says 1175 will see buying slowdown. We could see the S&P trade as high as 1200 in this advance. Certainly, we need to be aware of any macro announcements coming from Euro that could have a large impact on the markets.