'Stochastics' suggest upside momentum building
NEW YORK (MarketWatch) -- While periods of low-volume, directionless trading may be discouraging to some market technicians, a turn higher in the "stochastics" indicator suggests the S&P 500 is still trading with a positive bias.
The worst nightmare for technical-trend followers is when the market stops trending. Many momentum-based technical indicators tend to flatten out and can give the appearance that a prior uptrend, or downtrend, is ending when it is actually just on hold.
In addition, as Brean Murray Carret technical analyst Frank Longman said, analysis can also be "problematic" during low-volume environments "because many of our indicators are volume driven."
Over the past three weeks, the S&P 500 (SPX) has gained just 0.6% and has been stuck in a narrow 1402 to 1418 range. In July, the range was much wider at 1335 to 1385.
In addition, average daily NYSE composite volume for August is on track to be the lowest for a month since May 2007.
But there are some technical indicators that can still be useful in this type of trading environment.
The stochastic indicator, developed several decades ago by George Lane, is a two-line measure of momentum. One line, referred to as "%K," tracks a stock's or index's closing price relative to the trading range, and the second line, or "%D," is a moving average of that line. It is an oscillator, which means it fluctuates within set boundaries, in this case, from zero to 100.
A "buy" signal occurs when the %K line crosses above the %D line. The signal is seen as stronger if that crossover appears after the %D line has already bottomed.
The idea behind the indicator -- the term "stochastic," according to Merriam-Webster, refers to random variable -- is that, when momentum is strong during an uptrend, closing prices should cluster near the highs of each trading day; nearing downtrends, they should bunch toward the intraday lows.
"The [indicator] attempts to determine when prices start to cluster around their low of the day in an uptrending market, and cluster around their high in a downtrend," according to the Market Technicians Association. "[Lane] theorizes these conditions indicate a trend reversal is beginning to occur."
Stochastic followers also believe that buy signals during slow and directionless markets are a sign that momentum is beginning to build to the upside.
For the S&P 500, the "%K" line crossed above the "%D" line as of the Aug. 27 close, just as "%D" bottomed at a one-month low. The S&P 500 had closed in the upper half of the trading range in eight of the previous 11 sessions, although the index had gained just 0.6% during that stretch.
The S&P 500 was up one point at 1410 in midday trading Wednesday, and has traded within an intraday range of 1406.55 to 1411.70.
Upside levels to watch start with the April 2 closing high of 1419.04, as closing above that level would put the S&P 500 at the highest level seen since May 2008.
Once the index rises to new highs, trend followers will have something to follow again.
On the downside, there should be support around 1395-1398, where there were several intraday lows earlier this month.