Weathering the Storm

Pullbacks Happen

Over the past few weeks, the market rally that commenced in November 2023 has shown signs of losing momentum. The NASDAQ (QQQ) has been forming lower highs and facing persistent rejection around the $450 mark.

An even more pronounced decline is evident in the Russell 2000 (IWM), which tracks small-cap stocks. Last week, we witnessed an almost 5% decline, with the IWM breaking below its 10-day exponential moving average (EMA) on the weekly timeframe.

During periods characterised by sideways movement in the broad market and major indices, or, in the case of the IWM, a breakdown below significant moving averages, the market environment becomes less favourable for swing traders.

With heightened volatility and market leaders uncertain of their direction, it's crucial to adopt a defensive stance and avoid standing in the way. Traders often fall into the painful trap of imposing their views on the market, a tendency more common among amateurs. Professionals, on the other hand, ride the market's momentum in a clearly defined direction, typically an uptrend, and during uncertain periods like this, they prefer to remain on the sidelines.

Our approach during the past trading week has been one of patient observation. Several stocks have shown signs of range breakouts only to retract and retreat into their bases. While the leaders (stocks demonstrating the highest relative strength to the broad market) have yet to experience a complete breakdown into a stage 4 decline, the looming pressure from major indices makes the upcoming week pivotal.

Still A Healthy Uptrend

QQQ Weekly Chart

Interpreting Recent Trends

The technology-heavy NASDAQ, which tracks some of the most innovative companies in the market, is currently finding support at the weekly 10-day exponential moving average (EMA), with its daily 50-day EMA also serving as a robust line of defence.

Over the past seven weeks, the QQQ has been trading sideways and consolidating, a pattern indicative of normal and healthy market behavior. Contrasting this with the correction observed from July 2023 to November 2023, we note a significantly sharper pullback in the QQQ during that period, where it breached the weekly 20-day EMA.

Stan Weinstein Stage Analysis

Insights from Stan Weinstein's Stage Analysis

Considering Stan Weinstein’s Stage Analysis, the current behavior of the QQQ suggests that it remains within a stage 2 uptrend. Pullbacks, such as the consolidation observed over the past seven weeks, are typical characteristics of a market uptrend according to Weinstein's methodology.

In stage 2 uptrends, it's common to witness periods of sideways movement and consolidation as the market gathers momentum for its next leg up. This phase allows for healthy corrections and provides opportunities for investors to accumulate positions before the upward trend resumes.

Examining historical corrections, such as the one from July 2023 to November 2023, we note that the QQQ experienced a more pronounced pullback during that period. However, it managed to maintain its overall upward trajectory, indicating resilience within the broader uptrend.

A Key Level For Growth Names

The recent performance of the IWM has caught the attention of market observers, signalling a notable shift in sentiment. With a sharp decline accompanied by significant trading volume, the index has plunged below key technical indicators, including its weekly 20-day exponential moving average (EMA), as well as the daily 10, 20, and 50-day EMAs, all within a remarkably short span of three trading days.

The Russell 2000, tracking small "growth" companies with market capitalisation typically ranging from $300 million to $2 billion, holds a special allure for momentum-driven swing traders. These stocks, characterised by their propensity for high volatility, offer enticing opportunities for traders seeking to capitalize on dramatic movements in the market's more speculative names.

IWM Weekly Chart

Interpreting IWM's Significance

The performance of the IWM often carries broader implications for the market's overall trajectory. Historically, movements in small-cap stocks have served as leading indicators of market direction. When small caps outperform, it tends to reflect confidence in economic growth and a willingness among investors to embrace risk. Conversely, underperformance in small caps may signal apprehensions about economic prospects or a flight to safer assets.

IWM Weekly Chart

Navigating Current Trends

Despite recent declines, readers are advised against succumbing to panic. The weekly 20-day exponential moving average has displayed robust support during the IWM's previous encounters, often preceding significant upward movements. While the anticipated rally hasn't yet materialized, the IWM finds itself at a pivotal support level, suggesting potential for a turnaround in the coming weeks.

Resistance and Potential Breakouts

Notably, the $198.50 level presents a formidable barrier, representing a zone of significant resistance dating back to April 2022. Despite facing rejection on four prior occasions, this level was eventually breached in mid-February 2024, accompanied by surges in trading volume.

Looking Ahead

This week is poised to offer critical insights into the length of this market pullback. Should the IWM successfully defend its current level and attract buyers to step in, this pullback will be short and likely lead to a continuation of the market rally seen since November 2023.

Breadth Continues to Deteriorate

Percentage of stocks in NASDAQ above 20 SMA & 50 SMA

The breadth indicator provides a visual representation of the percentage of stocks trading above different moving averages. When the percentage of stocks above a selected moving average exceeds 50%, the histogram displays a positive (blue) bar. Conversely, when the percentage falls below 50%, the histogram adopts a negative (red) bar.

Observing the data, we note that as of early February 2024, the volume of stocks trading above the 20-day simple moving average (SMA) has declined. Nonetheless, they managed to maintain support above the 50-day SMA right up until mid-March 2024, right when the breadth began indicating the initial stages of deterioration in underlying stock performance.

Pullbacks- A Hidden Gem

Credit: IBD/Glenn Larkin

Relative Strength

Swing traders should keep in mind that in periods of market breadth deterioration and pullbacks, the emergence of future market leaders becomes apparent in the subsequent rally.

The concept of relative strength (RS), pioneered by William O'Neil, the creator of Investor's Business Daily (as pictured above), holds significant importance for swing traders. Understanding RS is paramount when crafting watchlists and analyzing stocks that have demonstrated resilience amidst the market's decline. Identifying stocks with strong RS can provide valuable insights into potential out performers as the market begins to rebound.

How to identify

During market pullbacks, observe price performance closely to identify stocks exhibiting relative strength. Look for stocks that demonstrate resilience by continuing to outperform their peers and the broader market despite the downturn. Focus on stocks with minimal price retracements usually to the key moving averages, namely the 10, 20 & 50 EMAs.

Next Week

As you've likely gathered, our primary focus for the upcoming trading week is on maintaining a defensive stance and closely monitoring the behavior of the market, particularly the leading stocks exhibiting the greatest relative strength. Should we witness a breakdown in these leaders, it suggests a potential prolongation of the market pullback beyond our initial expectations. Nevertheless, it's imperative, now more than ever, for swing traders to exercise patience and discipline. By diligently observing which growth momentum stocks demonstrate resilience amidst market downturns and breadth deterioration, we can identify the likely leaders poised to lead the market once it resumes its upward trajectory.

Our Market Leaders

This week, our attention is squarely on a select group of companies poised to lead the market. Each of these stocks boasts exceptional revenue growth, robust support above key moving averages, and a track record of leadership in previous market rallies. As market dynamics continue to evolve, monitoring the performance of these key players offers valuable insights into broader market trends and potential opportunities for swing traders once this pullback ends.

SMCI: Super Micro Computer, Inc.

 DAVE: Dave Inc.

MYO: Myomo Inc.

COIN: Coinbase Global, Inc

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