As the market has started to find resistance over the last week, momentum has started to wane. A look at the chart for the SPDR S&P 500 ETF (SPY), which tracks the S&P 500, is at risk of a MACD reversal which usually precedes a move lower. One very common trading strategy is to short a stock/index on a negative MACD reversal as it usually means sellers have come in control.
One way to measure momentum is by using the Moving Average Convergence Divergence (MACD). When positive, it is a sign that the market has upward momentum, and when its negative, momentum is pointing down. Watching for reversals in the MACD is also a good way to spot key reversals in a stock, and momentum reversals on a daily chart are usually a good indicator for price action for the next week or two. If one were to short on a negative MACD reversal, usually the stop on the trade would be the subsequent positive MACD reversal.
Chart source: TradingView
Both the S&P 500 and the Nasdaq are about to go through a negative MACD reversal. This has a couple ramifications: First, it is a potential sign of a market top for the next couple of weeks; second, any rallies are likely to be sold if the MACD is negative and trending lower. While a shift in the MACD doesn’t have to mean a sell-off is imminent, it does mean that the odds of a continuation in the rally are less. The SPY has been in a upward channel since March with resistance at $248 and support at $242. A reasonable target on a pullback would be for the SPY to fill the gap at $242, which would alleviate the market's overbought condition and set up for a decent rally after.
Along with the negative MACD reversals in the indices, the VIX, the volatility and fear gauge of the stock market, has seen a positive MACD reversal. The VIX is negatively correlated with the market, so this is to be expected, and it confirms the recent dip in tech stocks.
The Bottom Line
In the grand scheme of things, the minor drop in stocks over the last week is miniscule compared to the rally we have seen this year. For trading on a short-term basis, however, watching this reversal is important and may foreshadow a flat to moderately down August. To top it off, there have been negative divergences in the S&P 500, as relative strength and momentum have both made lower highs.
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