That was quite a rally on Friday, wasn't it? I say quite a rally because for the second time in two weeks we saw over 90% of the volume on the upside. Typically that is bullish for stocks. I'll just leave it that it's rare to see and a welcome change.
This coming week is the week we finally get back to an overbought reading. My own Oscillator, which finally moved over the zero line on Friday, will be back to an overbought reading on Thursday. This indicator is based on the breadth of the market.
The Nasdaq Momentum Indicator, which had done a terrific job navigating the ups and downs until it missed by an entire week in late December, will move into an overbought condition after Tuesday's trading.
Finally, the "what if" for the McClellan Summation Index is now into overbought territory. For this indicator I plug in what it will take to turn the Summation Index from the current up to down. Considering there are approximately 3,000 stocks that trade on the NYSE once we get to the point where we need a net differential of -2,000 advancers minus decliners we're into overbought territory so you can see that the current need of -4,000 is extremely overbought. The last time it needed -4,000 was November 7, the day we peaked after the late October rally. In October 2015 and again in February 2016 it waited until it needed -5,000 (or more) before reaching an overbought reading.
So as you can see, it's not easy to pinpoint the exact day but this is the week we get overbought. I think that means we're likely to see a pullback once we get overbought.
Now let's keep that in the back of our minds while we look at some downtrend lines. The QQQs are now sitting at what I consider to be a short-term downtrend line, dating back about five weeks. What are trend lines? They show the rate of ascent or descent. Fundamentalists might want to equate it with earnings growth. If a company's earnings are growing at 20% that's good. If they slow to +10% that's still good but not as good. So consider going from 20 to 10% like breaking an uptrend line: it's still growing but not at the same rate it was. Crossing downtrend lines shows moderate improvement; it's still declining but not as much as it was.
The QQQs have been descending at this rate for five weeks. If they cross that black line they are still descending but not quite at the same rate they have been. The red lines are resistance so even a crossing of the black line will see resistance all the way up. In other words, crossing the downtrend line is like a baby step in repairing the chart. There is still a long process ahead, with that blue downtrend line much more serious. So it makes a big difference if we cross the downtrend line before we get overbought, or if it opts to stay under it.
Let's take a look at Facebook (FB) as an example. It has been in a downtrend since August. Every attempt to cross that line has failed. So let's say it crosses it. That's a change. But is it an all clear? How can it be since there are layers of resistance all the way up? But isn't crossing it a baby step in a bottoming process? And what if it fails to cross it? It tells us the downtrend is still intact.
The way I see it, this upcoming overbought reading is the first real test for this rally. Will downtrend lines be crossed? Will the overbought reading give us a severe pullback? I'm in the camp that we'll pull back but not severely.