Wikipedia defines an inside job as colloquially refering to a crime, usually larceny, robbery or embezzlement, committed by a person with a position of trust who is authorized to access a location or procedure with little or no supervision. In technical analysis, a similar term has a different meaning.
An inside day is one where trading is contained within the trading range of the previous day. Not only did the Dow Industrials fall 38 points to close at 10,636.38, but today’s high and low were completely contained within yesterday’s high and low. The same pattern emerged in the S&P 500 Index, which was down .48%. The Nasdaq Composite, down .52%, made a lower higher than yesterday but also a slightly lower low, so it was not an inside day.
In Japanese candlestick terminology, today was a harami bar for the INDU and SPX. Investopdia gives a great definition of how to interpret a harami (inside day) bar:
“An inside day is often used to signal indecision because neither the bulls nor the bears are able to send the price beyond the range of the previous day. If an inside day is found at the end of a prolonged downtrend and is located near a level of support, it can be used to signal a bullish shift in trend. Conversely, an inside day found near the end of a prolonged uptrend may suggest that the rally is getting exhausted and is likely to reverse.”
ETFs for the most part were quiet today – you know it’s a quiet today when 3x levered ETFs like FAZ, the Financial Bear, only rises (or falls) 2.56%, and CZI, the China Bear, is up only 2.55%. IIH, the internet infrastructure HLDR, added 2.52%. Oil was over $82 a barrel today so UCO, the levered crude oil ETF, gained 2.29%. Please click on the symbols for details.
I’m seeing a bearish divergence between SPY, the S&P 500 SPDR, and several technical indicators. The daily chart below shows SPY with ADX, RSI, stochastic, and the forecast oscillator. The ADX is well below 20 which indicates the SPY is non-trending (ADX greater than 30 and rising is indicative of an asset that is trending. Below 25 and falling is indicative of an asset that is non-trending). You want to concentrate on non-trending indicators like RSI and stochastic when the asset is non-trending.
So if three indicators – RSI, stochastic, and the forecast oscillator – all show signs of a bearish divergence, does that mean SPY is three times more likely to fall lower? Not at all.
Technicians are careful to avoid multicolinearity when applying indicators. Multi-what? John Bollinger, president and founder of Bollinger Capital Management, explained it very well years ago in an article he published in Technical Analysis of Stocks & Commodities magazine: “Multicolinearity is simply the multiple counting of the same information. The use of four different indicators all derived from the same series of closing prices to confirm each other is a perfect example.”
Put another way, if four different people all tell the same lie, it doesn’t make it truthful. The reason I put three oscillators into the chart is so that you can see how these three indicators are interpreting a potential bearish divergence. Again, this doesn’t make the divergence three times stronger or three times more likely to happen. Please click on the chart below if you’d like to see it full-screen:
Research by Andrew Cardwell and Constance Brown, two of the leading authorities on RSI, suggested that a bear market will oscillate within a range marked by a support zone between 20 to 30 and a resistance zone between 55 and 65. SPY’s RSI fell to 30 back in early July and made a high of 62 yesterday. The RSI’s inability (so far) to get above the mid-60′s, even though SPY’s price is making higher highs, is a bearish divergence.
The stochastic oscillator made a lower high. Developed by George Lane back in the late 1950′s, the stochastic oscillator follows the momentum of price. According to Lane, momentum changes direction before price. On July 26 the %K was 96.51 and SPY closed at 111.56. Today the %K was 85.90 while the close was 112.37. The stochastic made a lower high while SPY closed at a higher high. That is a potential bearish divergence. Unsure what %K is? Click on Stochastic Oscillator for an explanation.
The Forecast Oscillator (FO) was developed by Tushar Chande. It plots the percentage difference between the forecast price (which is generated by an x-period linear regression line) and the actual price. The oscillator is above zero when the forecast price is greater than the actual price. Conversely, it’s less than zero if it’s below. Actual prices that are persistently below the forecast price suggest lower prices ahead. Likewise, actual prices that are persistently above the forecast price suggest higher prices ahead. Chande also suggests plotting a three-day moving average trigger line of the FO to generate early warnings of changes in trend. When the oscillator crosses below the trigger line, lower prices are suggested. When the oscillator crosses above the trigger line, higher prices are suggested.
While the FO in the SPY chart (the black line) is above zero, it has been making lower highs. The FO isn’t forecasting lower prices ahead yet but it is suggesting a weakening of the current trend.
Today’s inside day may be nothing more than a pause or it may be the start of a deeper pullback. There is support just below today’s close around 111.67, the 200-day SMA. Whether or not SPY holds or pulls back is something we will know in the fullness of time.
