3 charts show stocks can experience a nasty downturn

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All three major stock indices fell more than 3% on Friday, with the Dow 30 Industrials falling more than 1,000 points or 3.02% to 32,283, the S&P 500 fell 141 points or 3.4% to 4,057 and the Nasdaq lost nearly 500 points or 3.9% to 12,141. The downdraft was due to Fed Chair Powell reminding investors that the Fed was serious about fighting inflation and that a pivot to moderation should not be counted on anytime soon.

Shares were about to fall

The S&P 500 reached intraday and closing highs of 4,325.88 and 4,305.20, respectively, on Aug. 16. As can be seen in the chart below, the Index touched but did not cross the green line, or its 200 daily moving average, that day. At the same time, and several days before that, the Index’s Relative Strength Index or RSI, as shown in the upper section of the chart, above 70, was in a very overbought state.

S&P 500 220826 AUGUST
UST
26, 2022 1 YEAR
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The momentum has shifted downward

Jim Cramer on TBEN sometimes highlights a chart of 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 intersect, it tends to show that the market has reached a bottom or top and may be changing direction. And as can be seen in the chart below, these trends could last for a few weeks. Note that while this chart shows an observable pattern, no chart is perfect for investing.

When the 5-day is below the 13-day, the market moves lower, and it tends to stay in that trend until the lines cross, like 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, it appears that if the markets show weakness early next week, sentiment will have changed. And program trading could only contribute to the downward movement.

Gaps indicate a possible 18% decline

Carter Braxton Worth, founder of Worth Charting and frequent TBEN contributor, emailed charts to clients on Sunday, Aug. 14, revealing multiple unfilled holes in the S&P 500 chart. The S&P 500 Index closed at 4,280 the previous Friday, where the chart below ends. On Thursday, August 18, I published an article outlining his concerns. Since then, the Index has fallen nearly 250 points from its all-time high of 6%. While not all gaps will be filled and there is no timetable for this to happen, chances are they will.

Worth’s chart shows there are seven unfilled holes ranging from a high of 4,137 to a low of 3,330. In addition, there is a bearish high that the S&P 500 reached on August 16, but did not cross. With the Index unable to break through this resistance, filling more of the gaps should come into play. The lowest difference indicates that the Index could fall about 725 points or 18%.

Worth added in an email to me: “The S&P 500 has risen sharply to a well-defined downward resistance line that has been in place since its all-time high on Jan. 4 and is considered likely to waver and move lower here — in the future as low as the 3300 +/- level where unfilled gaps from two years ago will come into play.”

Note that a gap formed between about 4,200 and 4,220 last week. If it fills up quickly, it may not mean much. However, if the markets continue to fall, it means that it will be filled in the future when the markets recover.