3 Charts Show Stocks Could Be In For A Nasty Downturn

All three major stock indexes fell over 3% on Friday with the Dow 30 Industrials down over 1,000 points or 3.02% to 32,283, the S&P 500 down 141 points or 3.4% to 4,057 and the Nasdaq down almost 500 points or 3.9% to 12,141. The downdraft was due to Fed Chairman Powell reminding investors that the Fed was serious about fighting inflation and that a pivot to a dovish stance shouldn’t be counted on anytime soon.

Stocks were poised to fall

The S&P 500 hit intra-day and closing highs of 4,325.88 and 4,305.20 on August 16, respectively. As seen in the chart below on that day the Index touched the green line, or its 200 daily moving average, but did not cross it. At the same time, and for a few days before, the Index’s Relative Strength Index or RSI as shown in the top portion of the graph, was above 70, a very overbought condition.

S&P 500 220826 AUGUST UST 26, 2022 1 YEAR AR CHART.png

Momentum has shifted to the downside

Jim Cramer on CNBC sometimes highlights a chart from the Fibonacci Queen, Carolyn Boroden. She uses the 5-day (blue line) and 13-day (red line) exponential moving averages to show upward and downward trends in the markets. When the lines cross it tends to show that the market has bottomed or topped and could reverse direction. And as seen in the chart below these trends can last for a few weeks. Note that while this chart shows a discernable pattern, no chart is perfect for investing.

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When the 5-day is below the 13-day the market is moving lower, and it tends to stay in that trend until the lines cross, as they did last week. Looking at the far right portion of the chart below the 5-day moving average is 4,139.97 and the 13-day is 4,166.77. While it is entirely possible that this trend will reverse itself, if the markets show weakness early next week it would appear that sentiment will have changed. And program trading could only add to the downward move.

Gaps indicate a potential 18% decline

Carter Braxton Worth, founder of Worth Charting and frequent CNBC contributor, emailed charts to clients on Sunday, August 14, showing that there are multiple unfilled gaps on the S&P 500 chart. The S&P 500 Index closed at 4,280 the Friday before, which is where the chart below ends. I published an article on Thursday, August 18, outlining his concerns. Since then the Index has fallen almost 250 points from its high or 6%. While not all gaps are filled and there is no timeframe for this to happen, there is a strong likelihood that they will.

Worth’s chart shows that there are seven unfilled gaps ranging from a high of 4,137 to a low of 3,330. Additionally, there is a declining high line that the S&P 500 hit on August 16 but failed to cross. With the Index not able to break this resistance filling more of the gaps should come into play. The lowest gap indicates that the Index could fall around 725 points or 18%.

Worth added in an email to me, “The S&P 500 has rallied sharply to a well-defined downward resistance line in effect since the January 4th all-time high and is judged likely to falter here and head lower – prospectively as low as the 3300+/- level where unfilled gaps from two years ago, come into play.”

Note that a gap was created between approximately 4,200 and 4,220 last week. If it is filled quickly it may not mean much. However, if the markets continue to decline it means it will be filled in the future when the markets recover.

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