Probability Of A Short-Term Downside Move Just Increased

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Includes: DIA, IWM, QQQ, SPY
by: Andrew Crowder

The market, particularly the tech-heavy Nasdaq 100 (NASDAQ:QQQ) continued to push higher last week. The rally that began on December 19th has barely paused for a breather. But, if you look closely at the last four trading days it seems as though we are setting up for a move lower as the ETF seems to be struggling with strong overhead resistance.

Most of the highly-liquid ETFs I follow have pushed into a short-term overbought extreme, with several actually reaching a very overbought extreme. Typically, when we see this type of price action, that is an upside gap (1/3) into overbought to very overbought territory at strong overhead resistance, a short-term reprieve is to be expected.

However, if you recall, I expected to see a reprieve last week, but the gap in the tech-heavy Nasdaq 100 has yet to close. But, now that we have seen the all of the major ETFs (SPY, DIA, IWM and QQQ) fail at major resistance levels (as witnessed over the last four trading days) the probability of a short-term downside move has increased. Again, couple a failure at strong overhead resistance with short-term overbought readings in over half of the ETFs I follow and the probability increases even further. And, if the aforementioned bearish leanings weren’t enough, the market is entering a period of seasonal bearishness.

Beginning around the latter part of the second week in January, the market has had a consistent tendency to weaken. Especially technology.

Since the day honoring Martin Luther King, Jr. became an exchange holiday in 1998, the performance of QQQ, is highlighted as it was the most extreme. It was positive only 1 out of 11 years into the end of January with some fairly steep declines..

If that wasn’t enough talented sentiment analyst Jason Goepfert of Sentimentrader.com recently stated,

Mostly what we’ve looked at over the past couple of weeks has been either market-neutral or positive. We’re starting to see some negatives now. We looked at one of those yesterday, the ratio of speculative Nasdaq volume to NYSE volume. That’s a minor indicator, but it’s at extreme levels.

Another negative is the spike in the OEX Put/Call Ratio. This means that traders have been busy trading put options on the S&P 100 index, the largest companies in the S&P 500. These options are normally traded by more experienced traders. With that put/call ratio high and the Equity Put/Call Ratio low, the spread between the two is at an extreme. This is kind of a poor man’s proxy for smart money (OEX options) versus dumb money (equity options). Such a wide disparity between the two has not been a good sign.

Combine everything above and you can quickly see why I expect to see a short-term decline that closes the 1/3 gap.

Disclosure: I am short SPY, QQQ.