KEY
TAKEAWAYS
- Main market peaks typically function a “bearish momentum divergence” the place costs transfer increased on weaker worth momentum.
- A bearish divergence this week suggests an identical lack of upside follow-through after a powerful uptrend part.
- Until we see the divergence negated with increased momentum readings, a tactical pullback could possibly be the almost definitely situation.
With Friday’s pullback after a comparatively robust week, the S&P 500 chart seems to be flashing a uncommon however highly effective sign that’s fairly widespread at main market tops. The sign in query is a bearish momentum divergence, fashioned by a sample of upper highs in worth mixed with decrease peaks in momentum, which signifies weakening shopping for energy after an prolonged bullish part.
In the present day, we’ll share a short historical past lesson of earlier market tops beginning with the COVID peak in 2020. And whereas we do not essentially see a sudden downdraft because the almost definitely consequence, this bearish worth and momentum construction suggests restricted upside for the S&P 500 till and until this divergence is invalidated.
First, let’s overview some traditional market tops, see how divergences are fashioned, and be taught what typically comes subsequent.
The yr 2020 began able of power, persevering with the uptrend part of 2019. However circumstances quickly deteriorated, with weaker momentum and breadth indicators flashing cautionary patterns. Within the chart beneath, we are able to see the upper highs and better lows in worth motion in January and February 2020.
Discover how the RSI was overbought on the January peak however not overbought on the February prime? This sample of upper costs on weaker momentum is what we’re in search of, because it implies an absence of shopping for energy and subsequently restricted upside.
Virtually two years later, the market had been pushed increased because of an unprecedented quantity of liquidity injected into the monetary system. Towards the top of 2021, nevertheless, we noticed the acquainted bearish divergence flash once more.
Right here, we are able to see the upper worth highs in November 2021 by way of January 2022 had been marked by decrease readings on momentum indicators like RSI. It is value noting right here that these divergences do not occur in a vacuum. In different phrases, we are able to use different instruments within the technical evaluation toolkit to guage the pattern and decide if the value is reacting as anticipated to the bearish divergence.
Within the weeks after the 2022 peak, we are able to see that the value broke down by way of an ascending 50-day transferring common. The RSI ultimately broke beneath the 40 stage, confirming the rotation from a bullish part to a bearish part. So whereas the divergence itself doesn’t indicate a specific path within the months after the sign, it alerts us to make use of different indicators to validate and observe a subsequent downtrend transfer.
Extra just lately, the February 2025 market peak featured some traditional momentum patterns going into the eventual prime.
Beginning in August 2024, we are able to see a sequence of upper worth highs that had been accompanied by bettering RSI peaks. As the value was transferring increased, the stronger momentum readings confirmed the uptrend part. Then, beginning December 2024, the following couple worth peaks had been marked with weaker momentum readings. This bearish divergence with worth and RSI as soon as once more signaled waning momentum going into a significant market peak.
That brings us to the present S&P 500 chart, that includes yet one more bearish momentum divergence. And primarily based on what we have reviewed up to now, you possibly can in all probability perceive why I am a bit skeptical going into subsequent week!
To be truthful, I’ve highlighted worth and momentum divergences from important market tops, a lot of which got here after prolonged bull market phases. On this case, we’re nonetheless solely two months off a significant market low. Nonetheless, I might argue the fundamental premise nonetheless holds true. With Friday’s pullback, the S&P 500 seems to be flashing this identical sample of upper costs on weaker momentum. Contemplating this unfavorable rotation on momentum, I might anticipate a minimum of a retest of the Could swing low round 5770.
What would change this tactical bearish expectation? The one approach for a bearish divergence to be negated is for the value to proceed increased on stronger momentum. So, till we see the value make a brand new peak mixed with the RSI pushing again as much as overbought ranges, a pullback stands out as the almost definitely situation within the coming weeks.
RR#6,
Dave
P.S. Able to improve your funding course of? Take a look at my free behavioral investing course!
David Keller, CMT
President and Chief Strategist
Sierra Alpha Analysis LLC
https://www.youtube.com/c/MarketMisbehavior
Disclaimer: This weblog is for academic functions solely and shouldn’t be construed as monetary recommendation. The concepts and methods ought to by no means be used with out first assessing your individual private and monetary scenario, or with out consulting a monetary skilled.
The creator doesn’t have a place in talked about securities on the time of publication. Any opinions expressed herein are solely these of the creator and don’t in any approach signify the views or opinions of another individual or entity.
David Keller, CMT is President and Chief Strategist at Sierra Alpha Analysis LLC, the place he helps lively traders make higher choices utilizing behavioral finance and technical evaluation. Dave is a CNBC Contributor, and he recaps market exercise and interviews main consultants on his “Market Misbehavior” YouTube channel. A former President of the CMT Affiliation, Dave can be a member of the Technical Securities Analysts Affiliation San Francisco and the Worldwide Federation of Technical Analysts. He was previously a Managing Director of Analysis at Constancy Investments, the place he managed the famend Constancy Chart Room, and Chief Market Strategist at StockCharts, persevering with the work of legendary technical analyst John Murphy.
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