Chart of the Day – How to Predict Intraday Reversals like Yesterday

by Enis May 24, 2012 7:39 am • Commentary

Yesterday’s intraday reversal higher was a very high probability event, far before any news headlines about Europe hit the tape.  It was the rare event where almost all of my intraday signals line up to point in one direction for the stock indices – higher.  It was a fat pitch, and I didn’t swing.  You have to swing at the fat pitches since they’re so rare.  If you’re patient enough to wait for only setups like yesterday, you’ll be a much better trader for it.

Why was it so likely that we would reverse higher?  And why didn’t I trade it?  For those of you who follow our QuickHits live chat room, you’ve become familiar by now with my constant remarks about intraday signs of potential cross-market strength or weakness.  My main assessment for future intraday strength or weakness comes from the following:

  1. Are defensive sectors outperforming or underperforming the market?  How has their outperformance or underperformance shifted over the course of the day?
  2. Are small-cap stocks outperforming or underperforming large-cap stocks?  How has their outperformance or underperformance shifted over the course of the day?
  3. What is the underlying breadth of the market?  In other words, are more stocks inching higher even as the broader indices remain at the same or lower price levels, or vice versa?
  4. How are currencies, bonds, and commodities moving, gaining strength or turning weaker?

Let’s look at yesterday as an example.  At 10:00 am yesterday, SPY was trading at $131.63, and by 3:00 pm, it was trading at $131.36, with many worried about a potentially weak close.  But the indicators showed the potential for a very strong close.  Today’s chart shows the price change of the major sector ETFs between 10:00 am and 3:00 pm yesterday:

So all 3 defensive sectors (utilities, health care, and consumer staples) were much lower from 10:00 am to 3:00 pm, while 3 of the cyclical sectors were higher (XLB, XLF, XLE), and 3 were lower (XLK, XLI, XLY), though by much less than the defensive sectors.  Money managers were assuming a more aggressive posture, and that usually implies higher prices.

In addition, IWM (my proxy for small-cap stocks) was flat between 10:00 am and 3:00 pm, while SPY (my proxy for large-cap stocks) was down 0.2%, and IWM at 3:00 pm was actually down less than SPY, more confirmation that money managers were getting more aggressive.

Finally, underlying breadth was much better at 3:00 pm on the NYSE than it was at 10:00 am, even though the SPY was 0.2% lower.  Here is the intraday chart of NYSE advancers to illustrate my point:

As you can see, Advancers moved from below 800 to above 1000 between 10:00 am and 3:00 pm, but SPY was actually lower at 3:00 pm.  It is quite rare that you get such a large divergence.  It is also quite rare that you get such a large intraday underperformance in the defensive sectors vs. the offensive sectors.  And rare indeed when you get both signals together.

Yes, the dollar and bonds were still strong and commodities were weak, but the magnitude of the above signals were too large to ignore.  Keep an eye on intraday price developments like the ones above to have a bird’s-eye view of how large money managers are shifting their investments over the course of a day.  Price signals will often give you the heads up to a potential move before you can make sense of the 20 headlines coming at you over the course of a trading day.  And at times you’ll see a fat pitch.  Yesterday was a fat pitch.  And I should have swung.