There are those who view the break of a trendline or an important level as a serious development. Typically, I would agree, but when it comes to breaking a previous low, I tend to be on the lookout for potential positive divergences--where a stock or index and a relevant indicator are moving in opposite directions. A positive divergence is a lessening of downside momentum, something you want to see at the lows.

When an underlying index--in this case, let's use the S&P 500 as an example--breaks to a lower low versus a previous low, we should look to see if there are positive divergences. Two real world examples of a positive divergence include fewer stocks at new lows, or a higher low in the Overbought/Oversold Oscillator--both against the backdrop of the S&P 500 breaking to a low lower than the 741 intraday low seen in November 2008. Overbought and oversold is what we use to test the momentum in the market. So a higher low means we had

less

momentum on the downside, thus a positive divergence.

In November 2008, we had such a positive divergence. Notice how the low appeared in the oscillator in October (point A), while the oscillator was at a higher low in November, when the S&P 500 made a lower low (point B).

Source: Helene Meisler, as of market close on February 20, 2009.

Now, take a look at the number of stocks making new lows in the chart below. In October, there were about 2,900 stocks making new lows on the NYSE, but in November, there were about 1,900--about 1,000 fewer stocks making new lows during the S&P 500's lower low of 741 in November.

Source: Helene Meisler, as of market close on February 20, 2009.

So now we are once again approaching the November lows on the S&P 500. I won't consider it a test of any sort unless and until we break the November lows. Should we hold above the November lows, folks will likely tell us we had a successful test. In my view, this is not a test--we simply came down and held. There's a difference.

Passing the test

To pass the test, or have a successful test, we would need to see positive divergences. In my view, we will not have positive divergences if we don't break the previous lows, which would likely kill hope and rid the market of weak buyers. It is not bullish if we revisit the lows but not break them, and I would not call that a positive test.

There is another way for a test to succeed: Let's say the Dow Jones Industrials Average (DJIA) makes a lower low versus its November low (7,552) and the S&P 500 does not. That would likely be a successful test, provided we had a higher low in the oscillator and fewer stocks at new lows.

Saving versus breaking the market

My point is that there will likely be a lot of talk in the coming days about whether or not we're testing the lows. Keep in mind that I consider a successful test one where the major averages break the previous lows, with positive divergences accompanying that break. If everything holds at a higher low, then all we did was "save the market." In other words, I think a break in the indices to a lower low would shake folks out, while holding at a higher low would help keep hope alive.

So, watch the number of stocks making new lows; they need to be fewer than the 1,900 we had in November. While the oscillator I show you is my own creation, you can use any momentum indicator to monitor the oversold level of the market. If we break the S&P 500's November low (752) and the momentum is less than it was then, we will have a positive divergence in momentum, too. If we don't get positive divergences, I believe any rally will be short-lived and only of the oversold variety.

¿ There will likely be a lot of talk in the coming days about whether or not we're testing the market lows from November 2008. ¿ A break in the indices to a lower low would shake folks out, while holding at a higher low would help keep hope alive, which is like saving the market. ¿ If the Dow Jones industrial Average makes a lower low while the S&P 500® Index does not, that would likely be a successful test--provided we have a higher low in the Overbought/Oversold Oscillator and fewer stocks at new lows.