In observing market behavior, I truly think the stock market should come with the following disclaimer:

“Prices are subject to change without notice.”

After a powerful follow-through day that looked very promising, initially, market action has left a lot to be desired.  Although the market isn’t broken, here in-house we are keeping a sharp eye out for particular signs of weakness.

I recently re-read William O’Neil’s interview in the must-own book, Market Wizards by Jack Schwager.  Although the market environment has changed a lot in the 25 years since the book was published, the core principles that form the CAN SLIM system remain relatively unchanged. One thing that really hasn’t changed is how quickly the market can switch direction. When asked about market tops in his Wizards interview, Bill mentions two key items that correlate with our current market environment.

“Top formations in the market averages occur in only one of two ways. First, the average moves up to a new high but does so on low volume. This tells you that the demand for stocks is poor at that point and that the rally is vulnerable. …If the stocks that have been leading the bull market start breaking down; that is a major sign that the market has topped.”

William O’Neil, Market Wizards

 

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In the latest Stay in Step With the Market webinar, Irusha and I compared a breakout to a space shuttle launch. The last thing you would want to see is that shuttle losing power as it takes off.  A stock that breaks out and then retreats back into the base is often a negative sign. (Sometimes stocks will come back and sit on top of the base, which is normal.)  The same scenario would apply to the overall market as well.  A powerful and meaningful rally will “take off” and not come back into the base. But looking at current market action, the S&P 500 has already broken down back into the base. The NASDAQ, however, has so far held its gains much better than the S&P 500. This is consoling for us, since it is the leading index of growth stocks, but there is another important measure of market health: the action of leading stocks.

SP5

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Although the indexes are faltering, leading stocks are holding up.  Most leading stocks that easily come to my mind are above their 50-day moving averages (or 10-week moving average on the weekly chart).  The 10-week line can be used as a simple gauge to determine healthy action as most leading stocks will find support at or near this line.  Apple (AAPL), Palo Alto Networks (PANW), and Skyworks Solutions (SWKS) are examples of leading stocks that you should be monitoring for signs of abnormal behavior to guide your overall market exposure. (Even if you do not own them personally, their action is vital to your day-to-day market analysis.)

As always, stay flexible.  The market can—and will—change without notice!

Best returns,

Scott St. Clair, Senior Product Coach

MarketSmith