TomAspray's  Instablog

Without a sharply stronger close on either side of Memorial Day, the likelihood of a deeper correction will grow, further delaying the window for new buying until a short-term bottom is formed.

Just a couple hours before Thursday's close, the S&P 500 E-mini futures were trading down almost ten points and near the day's lows. But as was the case on Wednesday, when the futures closed 20 points above the day's lows, stocks finished on a firm note.

This is typically the type of market action that would be expected prior to the completion of a short-term bottom. There are also some encouraging signs from market leader Apple Inc. (AAPL) that suggest that it may be closer to completing its correction.

Heading into the long holiday weekend, the major averages need a solidly higher close to set the stage for a rebound that could take us to the end of the month. The technical damage from the sharp recent market decline will take some time to repair, so buyers will have to be selective with any new positions.

Click to Enlarge

Chart Analysis: The daily chart of the Sypder Trust (SPY) shows that the daily Starc- band was tested early in the week while prices have been trying to stabilize over the past few days.

• A daily close above the resistance at $134 would be a short-term positive. There is more important resistance in the $135.50-$136.50 area
• Major resistance is in the $137 area, line a
• The daily Starc- band and the still-rising 200-day moving average (MA) are both in the $128-$127.50 area
• The NYSE Advance/Decline (A/D) line has risen slightly from the lows but is still well below its declining weighted moving average (WMA) and resistance from the April lows
• A/D line is still holding above the longer-term uptrend, line c, and important support from the November highs
• The A/D line needs to surpass major resistance at line b to signal that the market's decline is over

The weekly chart of Apple Inc. (AAPL) shows that the weekly Starc- band was tested last week with the 38.2% support level at $516.

• The more important 50% support level, as calculated from the 2011 lows at $310.50, is at $477
• Relative performance, or RS analysis, is holding above its weighted moving average and has turned higher this week
• The chart shows that a similar corrective pattern in the RS last year (see ellipse) preceded the powerful rally in early 2012
• Weekly on-balance volume (OBV) has also just pulled back to its rising weighted moving average
• OBV staged a major upside breakout last year when it overcame resistance at line f
• Daily OBV (not shown) is still negative and below its weighted moving average
• The 50% retracement resistance, as calculated from the high at $644, is at $582.50 with stronger resistance at $594-$600

Click to Enlarge

The decline seen in the PowerShares QQQ Trust (QQQ) has been more severe than that of the Spyder Trust (SPY) since the start of April. Very weak earnings from Dell, Inc. (DELL) this week and the resulting plunge in its stock price did not help.

• A week ago, QQQ closed below the weekly uptrend, line b, and violated the support from the 2011 highs, line a
• There is now additional support in the $59.50-$60.50 area
• The Nasdaq 100 A/D line formed a slight negative divergence at the early-April highs and now shows a well-established downtrend, line c
• A/D line has broken its uptrend, line d, and is still acting weaker than prices
• The declining 20-day exponential moving average (EMA) is now at $63.66

The hourly chart of the PowerShares QQQ Trust (QQQ) shows a slight uptrend from Monday's lows, line f.

• A move above the hourly resistance at line e is needed to suggest that this week's action is not just a pause in the downtrend
• From the high at $68.55, the 38.2% Fibonacci retracement resistance is at $63.74 with the 50% level at $64.66
• There was a sharp surge in volume on Thursday and QQQ was up during that period
• A move in the OBV above resistance at line f would be positive
• Key support now stands at $61.30, and if violated, it would complete the flag formation (lines e and f) and signal a move to the $59.50 area

What It Means: A week ago, the technical evidence suggested that a rebound was likely. Without a stronger close either Friday or next Tuesday, however, the chance of another drop to new correction lows would increase. This should create a short-term low that will set the stage for a more significant rebound in stock prices.

The bottom line is to not get too negative at current levels, and be looking for new stocks to buy on a drop below the recent lows.

For Apple Inc. (AAPL), there should be another decline back to or below the recent lows before its correction is over, and this should set up a good buying opportunity.

How to Profit: For Apple Inc. (AAPL), our previous buy level at $519.28 was just missed. Now, go 50% long at $521.48 and 50% long at $508.64 with a stop at $473.30 (risk of approx. 7.9%).

For the PowerShares QQQ Trust (QQQ), go 50% long at $59.74 and 50% long at $59.34 with a stop at $56.78 (risk of approx. 4.6%).

Portfolio Update: Buyers should be 50% long the ProShares Short S&P 500 ETF (SH) at $36.26 and 50% long at $36.06 with a stop now at $36.88. Sell half the position at $38.86 or better.

More: View the Complete "Charts in Play" Portfolio

Once the market bottoms, sector rotation could give rise to new market leaders, including a pair of sector ETFs that are now looking to rally off potential bottom formations.

Though some industry groups are outperforming the S&P 500, as tracked by the Spyder Trust (SPY), there are also quite a few that are acting weaker.

Some analysts are looking for the weakest industry groups to become the new leaders once the market finally bottoms out. The iShares PHLX SOX Semiconductor Sector Index Fund (SOXX) and the SPDR S&P Oil & Gas Exploration ETF (XOP) underperformed during the first-quarter rally and have been much weaker since the start of April. This makes these funds and their respective industry groups ones that should be watched closely.

Both funds reversed nicely alongside the stock market on Wednesday, but the volume and relative performance analysis needs to improve sharply to signal that an important low is in place. One looks attractive for a short-term trade, although longer-term investors should wait for more evidence before buying.

Click to Enlarge

Chart Analysis: The percentage change chart shows the relative performance of the iShares Barclays 20+ Year Treasury Bond Fund (TLT) and the Spyder Trust (SPY) along with the iShares PHLX SOX Semiconductor Sector Index Fund (SOXX) and the SPDR S&P Oil & Gas Exploration ETF (XOP) since the start of April.

• In less than two months, the difference in performance is striking, as TLT is up 9.9% while SOXX is down 14.8%, a difference of 24.7%
• XOP is now down just over 13%, and both it and SOXX have bounced from the lows last week, as XOP was briefly down more than 17% and SOXX 16.8%
• These two ETFs have been twice as weak as SPY, which is currently down just over 6%
• On the chart, also note that in early April, TLT (in pink) dropped below both SPY and XOP but surged back above them on April 5
• This resurgence was a positive sign and reflected the sharp improvement in the relative performance for TLT
• The relationship of SOXX and XOP to SPY should be watched closely for signs of a legitimate turnaround

Click to Enlarge

The iShares PHLX SOX Semiconductor Sector Index Fund (SOXX) retested the resistance from the spring of 2011 in the $60 area, line a, in March before turning lower.

• SOXX closed decisively below its uptrend (line b) last week. Next support is in the $46.60 area, which represents the lows from late last year
• In October 2011, SOXX traded as low as $43.54
• Relative performance, or RS analysis, dropped below its weighted moving average (WMA) in early April and has now broken more important support at line d
• Weekly on-balance volume (OBV) has also broken its uptrend, line e, and is below its declining weighted moving average
• XOP rebounded on Wednesday to close up for the day on the best volume seen in several weeks

The daily chart of the SPDR S&P Oil & Gas Exploration ETF (XOP) shows that the fund made marginal new highs on March 19 at $61.81, line f, before reversing to the downside.

• The break below the March lows at $57.64 completed the top. This level also acted as resistance in early May
• RS analysis formed a negative divergence in March (line i) when it did not make new highs with prices
• RS line completed its top on March 21 when support at line h was violated. The RS has continued to make lower lows and shows no signs yet of a bottom
• Daily OBV also formed a negative divergence at the highs (line k) and then broke important support (line j) in April
• Volume was heavy in early May, and the OBV has dropped to significant new lows
• The December lows at $48.38, line g, were broken last week
• Wednesday's daily reversal is a short-term positive sign with initial resistance now in the $52-$53 area

What It Means: Both of these oversold ETFs reversed from their early lows on Wednesday to close higher for the day. This suggests that a short-term bottom may be in place, and the volume did pick up on the buy side.

The relative performance analysis does not yet indicate that a sustainable low is in place, but a decent rally is now likely. A very strong rally could form the basis for a sustainable bottom formation.

How to Profit: Short-term traders could buy the SPDR S&P Oil & Gas Exploration ETF (XOP) at $49.06 or better with a stop at $46.93 (risk of approx. 4.3%). If longs are established, sell half the position at $52.26 or better for a 6.5% profit and raise the stop to breakeven.

Cancel the order if $50.40 is hit first or if this order if not filled by the close on May 25.

Technical weakness in four key global ETFs preceded, or even predicted, the current decline in the US market, making their latest price action especially crucial.

The early-April decline in the German DAX Index below the March lows was a warning to me that stronger world markets, including the US, also had the potential to violate their March lows.

Earlier this week, I was discussing relative performance (RS analysis), or what some refer to as "comparative relative strength analysis," with veteran trader and old friend Linda Raschke. She suggested that I also look at the recent action of some key global ETFs like the iShares MSCI Brazil Index Fund (EWZ), the iShares FTSE China 25 Index Fund (FXI), the WisdomTree India Earnings Fund (EPI), and the iShares MSCI Japan Index Fund (EWJ).

Linda's analysis of these funds last month confirmed her hypothesis that the US markets were also ready to move lower. For those looking to learn more about relative strength analysis, I think you will find this Webcast segment from Linda very informative.

Linda also shared some additional insights "When you want to trade the short side, pick the weakest. If the markets build a bit of a base and look poised for upside again, then you want to buy the relative strength leaders. If there is no confirmation from the other indexes, than the upside is not going to get very far. On this last selloff, all global indexes were making new momentum lows, so one could have traded the short side with added confidence."

These funds often lead the US market both lower and higher, and the relative performance analysis of the iShares MSCI Brazil Index Fund (EWZ) bottomed two months ahead of the US market in January 2009. Let's look at what these funds are telling us now.

Click to Enlarge

Chart Analysis: The weekly chart of the iShares MSCI Brazil Index Fund (EWZ) shows the rally from the October 2011 low at $49.25 to the high of $70.74 in early March. Through last Friday (May 18), EWZ has dropped 27.1% from its highs versus just an 8.8% decline in the Spyder Trust (SPY).

• If the October lows are broken, next good support is in the $44-$45 area
• RS analysis rebounded above its weighted moving average (WMA) late last year but failed to start a new uptrend
• The RS dropped back below its weighted moving average in March (line 1) and then dropped below support at line c. This was a sign of weakness and forecast an even more serious decline
• The RS line is in a clear downtrend and would need to move through its downtrend and above the March highs to turn positive
• Weekly on-balance volume (OBV) just tested its downtrend, line d, in March before dropping below its weighted moving average
• OBV made lower lows in October and was acting weaker than prices
• First strong resistance for EWZ is now in the $56-$57 area

The iShares FTSE China 25 Index Fund (FXI) reached a high of $40.67 in early February and was unable to make it much higher even though the US market continued to make higher highs.

• The break below support at $36 (line e) on May 9 completed the top formation and gave downside price targets in the $30-$31 area
• RS line failed to start a new uptrend while FXI was moving higher in early 2012, and it was unable to move above the October highs
• RS dropped below key support, line g, on March 17 (line 2), which was almost seven weeks before prices broke support
• RS line shows no signs of bottoming. Longer-term resistance is at line f
• OBV was stronger than prices in April, and the break of its support, line h, coincided with the price break
• The former support, line e, at $36 is now the first key level of resistance

Click to Enlarge

The WisdomTree India Earnings Fund (EPI) peaked at $21.59 on February 21 and is now down 26% from those highs. EPI is now very close to the late-2011 lows at $15.44. In 2009, the low was $8.81.

• RS analysis bottomed in January 2012 when the downtrend, line a, was overcome
• RS line stayed above its weighted moving average until February 24 and soon formed a pattern of lower lows
• RS line rebounded back to its now declining weighted moving average on March 13 (line 1). The daily downtrend, line b, is still intact
• OBV shows a similar formation, as it also peaked in February and has been weaker than prices since April, line c
• There is a band of resistance now in the $17-$18 area

The iShares MSCI Japan Index Fund (EWJ) gapped below support on April 4, which completed the daily top formation, lines d and e. EWJ is now down over 12% from the high at $10.21. A violation of weekly chart support in the $8.75 area would be much more negative.

• The RS line started to diverge from prices in early March when it made lower highs (line g) while prices were making higher highs
• In early April, the RS line broke support, line f, which was a negative sign and forecasted that prices would follow lower
• The RS is still in a well-established downtrend, line g
• OBV was much stronger than the RS, as it confirmed the price highs in late March and stayed above its uptrend, line h, until early May
• There is near-term resistance now in the $9.50-$9.70 area

What It Means: I generally use relative performance (RS analysis), or comparative relative strength, as a tool to find market-leading sectors, industries, or stocks. It is an important tool that can help you find the best places to invest, as well as those to avoid.

As Linda pointed out, it can also be a useful tool in supporting or contradicting other methods of analysis.

By April, the RS analysis of these four global ETFs had turned negative while the Dow Industrials, Nasdaq 100, and S&P 500 all continued to move higher. Each of these ETFs still look negative, which suggests that the decline in the US stock market will continue, although I do not expect to see the US indices drop as much as these ETFs.

How to Profit: No new buy recommendations at this time.

Portfolio Update: Buyers should be 50% long the ProShares Short S&P 500 ETF (SH) at $36.26 and 50% long at $36.06. Use a stop at $36.88 and sell half the position at $39.22 or better.