Last week was an interesting week. The Fed convened in a 2-day FOMC meeting and announced they are likely to taper before the end of the year. Stocks rallied soon as the post-Fed meeting. It may have been a short-covering rally or professional money managers rushing in to deploy excess funds ahead of the end of the third quarter.
Stocks may continue to rally into the end of the quarter this week and possibly into the start of the new quarter. However, the fact that the Fed will soon taper its QE programs will lead to uncertainties and hence an increase in market volatility and market risks.
Why would investors buy stocks when the Fed is reducing liquidity by the end of the year?
Since the Fed is unlikely to taper until November’s FOMC meeting, this can lead to many money managers and professional traders pouring money into the marketplace to try to outperform before the Fed moves to taper. But once the Fed officially reduces liquidity, money flows may begin to reverse direction and flow out of the passive index funds, mutual funds, and individual stocks.
It is difficult to predict the actual turning point in the marketplace, but the transition from a bull trend to a bear trend is often subtle and often fraught with indecision and erratic price movements.
So, what are the technical signs to look for that indicate a trend reversal toward lower stock prices?
As mentioned before, trend changes tend to be subtle. A primary uptrend is often denoted on the charts by a series of higher-highs and higher-lows. On the other hand, a primary downtrend shows lower-highs and lower-lows. A trend reversal from an uptrend to a downtrend will transition from an uptrend to a sideways trend, and toward a downtrend.
Rolling of the moving averages and death-cross sell signals are often used to confirm the transition from uptrends to downtrends. Shorter-term moving averages (i.e., 50-day, 10-week, 10-month, etc.) can cross below the longer-term moving averages (i.e., 200-day, 30-week, 30-month, etc.), generating death-cross sell signals. The crossing of the two moving averages does not necessarily confirm the sell signals. It is when the moving averages begin to trend lower or rolls over that confirm a major trend change.
Major market tops are often associated with various distribution type technical patterns such as head and shoulders tops, rounding tops, double/triple tops, descending triangles, bearish rectangles, etc. Some patterns are more accurate and reliable than others. The head and shoulders patterns are one of the most accurate price action patterns, reaching their projected targets nearly 83-83.5% of the time once confirmed via neckline breakdowns or breakouts. A convincing move above the left and right shoulders and preferably above the head would negate the distribution tops and reaffirm the resumption of the intermediate-to-long term primary uptrends.