On the monthly chart, the S&P 500 broke below its 12-month moving average for the first time since July 2009. Even though moving average crossovers do not pick exact bottoms or tops, this moving average cross captured the major moves over the last eight years. As with all moving average crossover systems, success depends on a strong trend or sustainable move. A trading range or choppy market will produce whipsaws. For now, the S&P 500 broke below the 12-month SMA with a sharp decline in May-June. This is bearish until proven otherwise. There was a rebound in July, but the index needs to close above 1100 to negate this latest signal.

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The indicator window shows MACD(5,35,5) moving back into negative territory and below its signal line. This is also a long-term bearish development. First, momentum favors the bears when MACD is negative. Second, MACD is also moving lower and getting more negative. A move back into positive territory is needed to turn momentum bullish again. Why use MACD(5,35,5)? Monthly charts are already long-term oriented. Monthly price data is also smoother than daily or weekly price data. Changing the MACD settings from (12,26,9) to (5,35,5) increases sensitivity.

Stocks turned in a strong performance Thursday. The three major stock
indexes shown below closed back over their 50-day moving averages. The
S&P 500 (Chart 2) and the Nasdaq Composite (Chart 3) did so for the
first time since early May. Another positive sign is the ability of
all three indexes to close above the down trendline drawn over their
April/June highs. The next hurdle to overcome is their July highs and
200-day moving averages. The short-term stock picture does appear to
have improved with the growing possibility of a rebound to the mid-June
peak. The rally in stocks was supported by a rally in most
commodities, most notably copper prices which hit a three-month high.

Divergences are among the most misused technical analysis tool anywhere, in my opinion.  The first step in successful trading using divergences is understanding both their strengths and their limitations.  My preference is to focus on divergences as they relate to the Moving Average Convergence Divergence (MACD).  Others use divergences on bound momentum oscillators like the RSI and stochastics.  The word "bound" refers to the physical limitations of both of these oscillators.  They cannot print a reading higher than 100 nor lower than 0.  That's a fact.  By definition, a "positive" divergence occurs when you have lower equity prices and a higher oscillator reading.  So think about this for a minute.  If a stock is selling off and prints a stochastics reading of 0, what is the likelihood that stochastics will be lower the next time prices move to new lows?  I'd say there's a 0% chance.  So if prices do move lower, you're guaranteed to have a positive divergence.  To me, that's an absolutely worthless piece of technical evidence.  RSI is also a bound oscillator, but it rarely moves below 20 or above 80.  Therefore, it's a bit more reliable in terms of suggesting slowing momentum.  I may check the divergence on the RSI occasionally, but it's never a primary indicator for me.

 

That brings me to the MACD.  Let's start with the definition.  The MACD is the difference between any two moving averages.  Are they converging (moving closer together) or diverging (moving further apart)?  It gives us a sense of momentum in an underlying stock or index.  The "standard" MACD is the difference between the 12 period EMA and the 26 period EMA.  StockCharts allows the printing of a simple chart to provide the calculation.  Check out this S&P 500 daily chart:

 





As prices move higher or lower, it's very typical for the shorter-term moving average to change more abruptly in the direction of price.  But after a period of rising or falling prices, the difference between these moving averages begin to "converge" and that's the signal that momentum is shifting.  While many technical indicators lag, the long-term positive and negative divergences that form on the MACD actually precede trend reversals.  Last Tuesday, we issued three stock setups and one was flashing a buy signal based on a long-term positive divergence that had formed.  Take a look below at the result since:

 





There are definitely rules to follow when buying a stock with a positive divergence or selling one with a negative divergence.  If you're interested in divergences and would like to learn more about them, feel free to join me on Tuesday, July 27th as I lead the fourth in our monthly Online Traders Series events. 
CLICK HERE
for more details on this event and for additional trading candidates with long-term positive divergences currently present.

 

We are also featuring another stock with a powerful long-term positive divergence in place as our Chart of the Day for Monday, July 26. 
CLICK HERE
for more information.

 

Happy trading!