Well, That Got Their Attention

 | Mar 05, 2012 | 6:00 AM EST
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It certainly took long enough, but the Russell 2000 finally broke down Friday. For nearly four weeks this index was been rocking back and forth between 830 and 810, and ultimately the lower end gave way -- so let's take another look at what we might expect from this point.

As you might recall, a few days ago I noted that a move out of this range would yield a 20-point move rather quickly. To get the basic measurement, we take the net of the range -- 20 points -- then subtract that from the breakdown level, 810, to arrive at 790.

You might notice that 790 is where the 50-day moving average lies. However, 50 trading days ago was Dec. 20 -- just before the Russell made the low and lifted off. That means this 50-day line is rising, and quickly. By my calculations it will be at nearly 795 by Wednesday. There is also a gap around 793 from late January.

If all of that isn't enough for you, the media finally started to notice the Russell's weakness Friday. How long will it be before they become breathless over it?

Based on the past few weeks of poor performance there, it will come as no surprise that this index will read as short-term oversold this week. Rather than view this via the oscillator, let's look at what it will take to turn the McClellan Summation Index from a downward to an upward direction. At present it would require a net differential of +2300 (advancers minus decliners). As you can imagine, it wouldn't take much to reach a reading of well over +3000, and anything past +3000 would indicate an oversold condition. If it nears +4000, we'll know the market is grossly oversold.

McClellan Summation Index

If I had to come up with a scenario and draw it out on the chart, I could envision it something like this: The Russell breaks under 800 and the media becomes hysterical (much they way they first paid attention to the Dow Jones Transportation Index when it broke 5200, having failed to see it dying for weeks on end). Then that's followed by an oversold rebound to resistance, which is now in the 810-to-815 area. Once they calm down, that is followed a trip back down.

I have drawn it in blue how it might transpire:

Russell 2000 -- Daily

If you prefer a template, please refer to the chart of the transports. Here, market players ignored the decline from 5500 to 5200, but the break of 5200 got folksfretting until the index rebounded -- which as followed by another decline.

Dow Jones Transportation Index -- Daily

Now, a word about the oscillator: You can see below that it's getting oversold. Do not kid yourself -- the oversold reading is the sign of a weak market, not a strong one. Many have inquired how the index can be trading so high while the oscillator is so low. It's because the latter reflects what individual stocks are doing, not what the index as a whole is doing. Indices are skewed by market capitalization (in the case of the S&P 500 and Nasdaq) and by price (in the case of the Dow).

I have often noted that higher highs and lower lows need to be retested at some point, and that applies to the higher highs in the intermediate-term indicators. But, on a shorter-term basis, this lower low in the oscillator will also need to be retested. For the oscillator to be revisiting the December lows while the indices are still near their highs is not bullish. The market might be getting oversold, but with Consensus Inc's bullish percentage now at 77%, I would still look for limited upside.


Overbought/Oversold Oscillator -- NYSE

Overbought/Oversold Oscillator -- Nasdaq

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