Dow Industrials 2-day RSI and Overbought Volatility Point to Short-term Strength

Stock indexes settled sharply lower Monday amid a near-total absence of
buyers. TICKscore closed at a low -59 as the NYSE TICK spent the entire
session in decidedly negative territory. Breadth ended 5:1 in favor of
decliners on the NYSE, and volume associated with declining issues accounted
for over 80% of total volume. New 52-week lows managed to hold in the high
300's despite the fact that the S&P came within a few points of its intraday
January low at 1270. You may recall that back in January, over 700 issues hit
new 52-week lows, a large number when viewed from a long-term perspective.

The fact that the S&P is in the process of violating the January low with a
much smaller number of individual issues hitting new 52-week lows is a
potentially positive development, but only if the S&P can quickly reclaim the
1300 level. The reasoning is that the market is repeating the same long-term
negative price action seen in January - a major low is in the process of being
violated. As I noted in my 'big picture' review on March 3rd, "...the S&P500
broke down in January below 1400, violating a major double bottom in the
process. I call it 'major' because both the August and November 2007 lows were
accompanied by a big spike in new 52-week lows. Historically, when we see over
500 issues hit new 52-week lows, it ends up relating to a major market bottom
that typically holds for years. The fact that the market didn't manage to hold
those lows and is now running into resistance at 1400 (former support) paints
a fairly bleak picture."

What's noteworthy is that since the August and November lows around 1400, the
next major bottom as defined by a spike in new 52-week lows is the January
bottom around SPX 1300 - the one that's in the process of being taken out.
Just as it was a longer-term bearish sign when the S&P convincingly broke the
August/November lows from last year, it would be yet another bearish sign if
the S&P bottoms out short-term but isn't able to convincingly move back above
1300.

Indications are pointing to a short-term rebound given the extreme oversold
conditions. The S&P100 Volatility Index (VXO) closed more than 10% above its
10-day moving average for a third consecutive session Monday, triggering a
short-term buy setup. Historically, the market has a tendency to rally out of
an overbought volatility environment. Out of the last thirty occurrences,
sixteen led to an OEX +1% or more by the time the VXO closed less than 10%
above its 10-day average, while the OEX lost 1% or more only three times (see
my January 6th column for the track record).

Additionally, the 2-day RSI for the Dow Industrials closed below 2.0 on
Monday, triggering a short-term buy setup. I first heard about the concept of
utilizing a 2-period RSI from Larry Connors over at TradingMarkets.com. Our
own research backs up the notion that a 2-day RSI reading under 2.0 reflects
extreme oversold conditions on a very short-term basis, and price typically
rebounds in the next 1-2 days. On Monday, the 2-day RSI for the Dow
Industrials closed under 2.0, suggesting the potential for a bounce over the
near-term. The table below lists the last thirty instances in which the Dow's
2-day RSI closed under 2.0, along with the performance of the Dow by the time
the 2-day RSI rose back over 2.0. Note that in 26 out of 30 cases, or 87% of
the time, the Dow was trading at a higher level when the RSI rebounded,
typically within two days of the signal...

Dow 2-Day RSI Closes Under 2.0
03/10/08... Dow ??? when 2-day RSI >2
10/19/07... Dow +0.3% when 2-day RSI >2 (one session)
06/07/07... Dow +1.2% when 2-day RSI >2 (one session)
02/27/07... Dow +0.4% when 2-day RSI >2 (one session)
11/03/06... Dow +1.0% when 2-day RSI >2 (one session)
06/13/06... Dow +1.0% when 2-day RSI >2 (one session)
06/24/05... Dow +1.1% when 2-day RSI >2 (two sessions)
03/22/05... Dow +0.2% when 2-day RSI >2 (three sessions)
01/05/05... Dow +0.2% when 2-day RSI >2 (one session)
10/25/04... Dow +1.4% when 2-day RSI >2 (one session)
05/10/04... Dow +0.3% when 2-day RSI >2 (one session)
03/10/04... Dow -0.5% when 2-day RSI >2 (two sessions)
01/22/03... Dow +0.6% when 2-day RSI >2 (one session)
09/03/02... Dow +1.4% when 2-day RSI >2 (one session)
07/22/02... Dow +5.3% when 2-day RSI >2 (two sessions)
07/16/02... Dow +0.8% when 2-day RSI >2 (one session)
04/29/02... Dow +1.3% when 2-day RSI >2 (one session)
01/14/02... Dow +0.3% when 2-day RSI >2 (one session)
09/17/01... Dow -3.4% when 2-day RSI >2 (five sessions)
10/11/00... Dow -2.1% when 2-day RSI >2 (two sessions)
09/18/00... Dow -0.4% when 2-day RSI >2 (three sessions)
01/28/00... Dow +1.9% when 2-day RSI >2 (one session)
01/24/00... DOw +0.2% when 2-day RSI >2 (one session)
09/24/99... Dow +0.2% when 2-day RSI >2 (one session)
09/16/99... Dow +0.6% when 2-day RSI >2 (one session)
07/26/99... Dow +1.1% when 2-day RSI >2 (one session)
05/25/99... Dow +1.6% when 2-day RSI >2 (one session)
08/31/98... Dow +3.8% when 2-day RSI >2 (one session)
07/23/98... Dow +0.1% when 2-day RSI >2 (one session)
04/28/98... Dow +0.6% when 2-day RSI >2 (one session)
01/09/98... Dow +0.9% when 2-day RSI >2 (one session)

I'd also add that the Nasdaq100 14-day RSI closed at 30.45 on Monday. A close
under 30 would trigger the short-term buy setup discussed at the end of my
February 6th column. For this to occur Tuesday, the NDX would need to close
below 1669, or about 4 points below today's settlement.

Categories : Archived EOD Commentary, End-of-Day Commentary

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