Divergences Give Warning Signs Of U.S. Stock Market Reversals

Corey Rosenbloom
updated | Author's Website

I frequently post updates on NYSE Market Internals positions when looking at the S&P 500 because knowing what’s “Under the market’s hood” is extremely important just just for day traders, but also for swing traders.

This post takes a look at the three market turns in June 2010 and specifically highlights the market internal divergences that forecast these turns.

Let’s first start with the June 8th bottom:

Rather than make this a text-filled post, I am going to let the charts speak for themselves.

All charts will show the S&P 500 15-min chart (candles) and then the ADD (Breadth) along with VOLD (Volume difference of Breadth).

While you may not be able to view VOLD in your charting platform, you can certainly view Breadth, which is the difference in NYSE Advancing Stocks minus Declining Stocks – it’s $NYAD in StockCharts.com.

Divergences occur when price goes one way and internals goes the other – and divergences are warning signs of a likely reversal.

They don’t guarantee a reversal, and it’s often best to wait for a break in an established trendline before shifting your trading strategy, but if you do not incorporate market internals into your short-term trading strategy, you are missing valuable clues that you can’t get anywhere else.

Both Breadth and VOLD bottomed on June 4th, though the S&P 500 formed its final swing low at 1,045 on June 8th, which marked a short-term swing low and tradeable long (buy) opportunity that produced a strong upside move.

However, that upside move itself ended in a massive negative divergence in internals as seen in the major market turn on June 21.

If you look extremely closely, market internals actually peaked on June 10th – a technicality – but one worth noting.

We had a second, lower peak in internals at the close of June 15th, where I began the arrow.

Notice the crystal clear drop-off in internals – actually turning negative on June 16th’s up day – that is a MAJOR warning sign of caution.

However, the SPX did not reverse as was forecast by the market internals divergence – internals are not magic indicators that work 100% of the time – nothing does.

So the market rallied higher and higher, to peak on a “Finger” or “Exhaustion” gap at 1,130 on June 21st.

Look closely to see that Breadth and especially VOLD formed crystal clear negative divergences – traders caught long – or who bought on this peak – did so on extremely thin ice… and when the ice broke, the avalanche began.

Market Internals Matter!  The longer a market is stretched thinly higher on declining market internals, the higher the probability for a major downward resolution of the divergences – we’re talking mini-crash/reversal as opposed to a typical retracement.  And that’s exactly what happened.

However, even that multi-down day series ended on its own crystal clear positive internals divergence on July 1:

Looking closely at the chart, we see the massive down-day on June 29th resulted in new lows for Breadth and VOLD – lows that held despite the market falling to the 1,010 level.

When the market hit 1,010 – a confluence support area – Breadth and VOLD both showed higher lows in a classic positive internals divergence.

And the market rallied exactly as expected from this divergence in internals.

Now, we’re facing declining market internals as the market continues its rally, which signals caution for the bulls and potential upcoming opportunity for the bears.

Save this post and reference it often – Market Internals Matter!

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