Stock Meltup Continues but Chart Warning Flags Wave. What Should Investors Do?

The Nasdaq 100 ETF set an all-time high today and Diamonds and Spiders will likely follow. My call is to reduce holdings at risky levels on momentum warning flags.
Author:
Publish date:

The major stock market averages last week set intraday highs. While records remain the call on Wall Street, the strength has been periodically interrupted by coronavirus-related volatility. Here's what investors should do. 

Weekly market charts are showing technical warnings, and investors should take note.

The SPDR Dow Jones Industrial Average ETF  (DIA) - Get Report, the SPDR S&P 500 ETF Trust  (SPY) - Get Report and the PowerShares QQQ Trust ETF Series 1  (QQQ) - Get Report represent the Dow Jones Industrial Average, the S&P 500 and the Nasdaq 100.

The Dow ETF is known as Diamonds. The S&P ETF is known as Spiders. The Nasdaq 100 ETF is known as QQQ.

The Dow Jones Industrial Average set its record intraday high of 29,408.05 on Feb. 6 as Diamonds traded as high at $294.14. Both remain below their annual and semiannual risky levels.

The S&P 500 set its intraday high of 3,347.96 on Feb. 6 as Spiders set their record intraday high at $334.19. Both are above their semiannual risky levels but are below their annual risky levels.

The Nasdaq 100 set an intraday high today. The prior high of 9,453.24 was set Feb. 7, before the slump on the spreading coronavirus. QQQ also set its record intraday high today. Its prior high was set Feb. 7 at $230.40. Both are well above their semiannual and annual pivots.

The Weekly Chart for Diamonds

The Weekly Chart For Diamonds

The Weekly Chart For Diamonds

Courtesy of Refinitiv XENITH

The weekly chart for Diamonds begins the week neutral with the ETF above its five-week modified moving average at $287.48. DIA is well above its 200-week simple moving average, or reversion to the mean, at $234.47.

The 12x3x3 weekly slow stochastic reading is projected to decline to 78.47 this week, so the warning flag is that DIA is now below the overbought threshold of 80. 

In mid-January this reading was above the 90 threshold, putting Diamonds in an inflating parabolic bubble formation. 

Weakness during the last week of January caused by the coronavirus resulted in this negative divergence.

Trading Strategy: Reduce holdings on strength to its annual and semiannual risky levels at $299.53 and $303.59, respectively. This begins at the upper horizontal line. 

A weekly close below the five-week modified moving average at $287.48 indicates risk to the quarterly value level at $273.94. 

A weekly risky level sits at $294.16, which would be a new high if tested.

The Weekly Chart for Spiders

The Weekly Chart For Spiders

The Weekly Chart For Spiders

Refinitiv XENITH

The weekly chart for Spiders begins the week positive but overbought, with the ETF above its five-week modified moving average at $326.04. 

SPY is well above its 200-week simple moving average, or reversion to the mean, at $261.82. This average held at $234.71 during the week of Dec. 28, 2018.

The 12x3x3 weekly slow stochastic reading is projected to slip to 84.5 this week, still above the overbought threshold of 80. But SPY is now below 90, so Spiders are no longer in an inflating parabolic bubble formation.

Trading Strategy: Reduce holdings on strength to its annual risky level at $345.73. This is the upper horizontal line. 

There are weekly and monthly risky levels at $335.69 and $336.86, respectively, which would be new highs if tested. 

A weekly close below the five-week modified moving average at $326.04 indicates risk to the quarterly value level at $308.92. The semiannual pivot should be a magnet at $329.37

The Weekly Chart for QQQs

The Weekly Chart For QQQs

The Weekly Chart For QQQs

Courtesy of Refinitiv XENITH

The weekly chart for QQQs begins the week positive but overbought with the ETF above its five-week modified moving average at $220.55. 

QQQ is well above its 200-week simple moving average, or reversion to the mean, at $158.03.

The 12x3x3 weekly slow stochastic reading is projected to slip to 91.62 this week. That's still above the overbought threshold of 80. And it's still above 90, so QQQ remains in an inflating parabolic bubble formation.

Trading Strategy: Reduce holdings on strength to its weekly risky level at $233.14. This is the upper horizontal line. 

The ETF is above its monthly pivot at $227.64. The annual, semiannual and quarterly pivots are $215.71, 211.98 and $211.41, respectively. 

How to use my value levels and risky levels:

The closes on Dec. 31, 2019, were inputs to my proprietary analytics. Quarterly, semiannual and annual levels remain on the charts. Each uses the past nine closes in these time horizons.

Monthly levels for February were established based on the Jan. 31 closes.

New weekly levels are calculated after the end of each week.

New quarterly levels occur at the end of each quarter. Semiannual levels are updated at midyear. Annual levels are in play all year long.

My theory is that nine years of volatility between closes are enough to assume that all possible bullish or bearish events for the stock are factored in.

To capture share-price volatility investors should buy on weakness to a value level and reduce holdings on strength to a risky level. A pivot is a value level or risky level that was violated within its time horizon. Pivots act as magnets that have a high probability of being tested again before its time horizon expires.

How to use 12x3x3 Weekly Slow Stochastic Readings:

My choice of using 12x3x3 weekly slow stochastic readings was based on back-testing many methods of reading share-price momentum with the objective of finding the combination that resulted in the fewest false signals. I did this following the stock market crash of 1987, so I have been happy with the results for more than 30 years.

The stochastic reading covers the past 12 weeks of highs, lows and closes for the stock. There is a raw calculation of the differences between the highest high and lowest low versus the closes. These levels are modified to a fast reading and a slow reading and I found that the slow reading worked the best.

The stochastic reading scales between 00.00 and 100.00 with readings above 80.00 considered overbought and readings below 20.00 considered oversold.

A reading above 90.00 is considered an inflating parabolic bubble formation, which is typically followed by a decline of 10% to 20% over the next three to five months.

A reading below 10.00 is considered as being too cheap to ignore, which typically is followed by gains of 10% to 20% over the next three to five months.

Disclosure: The author has no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.