Relative Strength Divergence Signals a Stock Market Bottom ~ The Risk Averse Alert

Thursday, March 27, 2008

Relative Strength Divergence Signals a Stock Market Bottom

Having mentioned in yesterday's commentary "the stock market's multi-month decline since last October ... has been but part of a larger corrective pattern that began last June" I wanted to present you this view. I am not about to explain the details about this "larger corrective pattern." Not that it isn't important. But for the task at hand — identifying low-risk OEX options plays — there really are better things to elaborate (if only for the sake of brevity).

I will say this, though, and again, this is for the record. Yesterday, I mentioned that, "following any significant advance over the weeks ahead there could be another steep decline taking major stock indexes (the S&P 100 included) right back down to present levels, or even a bit lower." Well, I believe this possibility has only a 20-30% probability of occurring. Again, I am not going to delve into the reasons why I believe this. It simply does not serve the task at hand. Someday, though, it will.

Yesterday, too, I shifted gears in my analysis of where the S&P 100 might likely go from here. Previously I had been anticipating a return to the area of recent lows set on Monday, 3/17. However, I no longer suppose this is the likely path of least resistance. I should mention the McClellan Oscillator for both the NYSE and NASDAQ support this alternate view that the stock market has, indeed, bottomed.

Furthermore, the volume of shares traded on both stock exchanges over the past three days also supports this view. Volume has noticeably declined. This, while indexes have more or less marked time, modestly declining. I view this as indicative of accumulation, particularly given the moment. Consider all the pressure the stock market has been under so far this year. Were there an overwhelming conviction the stock market had further to fall, the volume of shares traded this week would have come in somewhere much nearer its recent average. Quite the contrary has happened instead. So, the money that drove the stock market higher last week belongs to strong hands. They're holding on, and not selling, despite this week's lack of follow-through to last week's rally.

Further evidence can be seen in the above chart. Take a look at the mark-up I have drawn.

The red line under RSI is meant to provide a like comparison of the July - September '07 period to the January '08 - present period. The black ticks mark RSI lows. The second tick in each period points out RSI divergence (this was ever so slight in '07). The picture, I think, speaks for itself. The S&P 100's path of least resistance over the weeks ahead appears to be up.

The blue line you see drawn above RSI's high last October is a benchmark. The coming stock market advance should carry the S&P 100's RSI above this level.

Now, the important question is when will this rally happen? Is it imminent, or has this week's trading set an indecisive tone for some days to come? It seems to me strong hands might wish to create conditions that rattle weaker hands to give up more of their shares.

OEX 5-min
It looks like the stock market probably will bounce at Friday's open, but then what? Well, we will just wait and see. It probably is not yet time to consider taking a position.

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© The Risk Averse Alert — Advocating a patient, disciplined approach to stock market investing. Overriding objective is limiting financial risk. Minimizing investment capital loss is a priority.

Analysis centers on the stock market's path of least resistance. Long-term, this drives a simple strategy for safely investing a 401(k) for maximum profit. Intermediate-term, investing with stock index tracking-ETFs (both their long and short varieties) is advanced. Short-term, stock index options occasionally offer extraordinary profit opportunities when the stock market is moving along its projected path.

Nothing is set in stone. Nor is the stock market's path of least resistance always known. More often than not, there are no stock index option positions recommended.

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