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One of the strengths of technical analysis is its ability to warn investors when market conditions start to turn.
 
It does not promise to pinpoint the exact top of a rally, but it does let us know sooner, rather than later, that defensive measures are warranted.
 
Trading action over the past few days made the bulls a little nervous, but so far very little technical damage is on the table. Indeed, major indexes traded at all-time highs just two days ago. That’s not exactly a bearish condition.
 
Still, it never pays to be complacent with a bull market, so a periodic review of some of the technicals that could signal problems is probably due.
 
Two weeks ago, I briefly mentioned a few of these possible signs. Moves below short-term moving averages or trendlines would be a subtle indication. A blow-off rally with sudden reversal could be a more dramatic event.
 
Moving Averages

Arguably, the most important moving average is the 50-day average, as it gives us a good idea of the short-term power of the market. Right now, the Standard & Poor’s 500 index is about 1.7% above that metric—a bullish posture (see Chart 1). A dip down to the average or even perhaps 1% below it would not raise any red flags for me. It is the normal ebb and flow in the market, and since the election, the index has dipped below the average on at least six occasions.
  

Chart 1


On an individual stock level, 69% of NYSE stocks still trade above their 50-day averages, and that is fairly good.
 
When we move down to the very short term, the 20-day average does make a case for vigilance. The index touched it Wednesday for the first time in a month. Vigilance doesn’t mean fleeing the market wholesale.
 
Trendlines

 The trendline supporting the very steep rally from late August is indeed broken to the downside (see Chart 2). It is the first real bit of evidence that a corrective decline is underway. Still, it does not indicate a very deep decline—at least not yet.

Chart 2


Should the S&P 500 continue lower from here, the next trendline, which supports a much more important market move from February 2016, is a key level of support. That line is currently in the 2505 area—viewed on a log-scaled chart—and will rise to about 2520 in about two weeks.

(The index traded at 2550 Wednesday afternoon.) That would be a total decline of 2.2% from the intraday peak set just Monday.

That’s not exactly a reason to panic. But a move below that major trendline would be a more serious event.

Breadth 

In a typical market-topping process, the number of stocks moving higher starts to diminish. The indexes can still forge higher, but sector after sector stops participating. It is the origin of the old market saw, “A top is a process while a bottom is an event.”

Currently, the NYSE advance-decline line, which keeps a running tab of stocks going up each day minus stocks going down, is only three days removed from an all-time high. In other words, there has not been much in the way of breadth deterioration on the Big Board. The Nasdaq advance-decline is a bit less bullish: It peaked in early October.

Why is breadth important? It tells us if the soldiers are following the generals higher. Big stocks tend to have more importance in the calculation of most market indexes. Stocks such as Apple (ticker: AAPL) have undue influence, while stocks such as Equifax (EFX), even with the huge bearish news of its data breach, barely make a dent.

If the number of stocks participating shrinks as the indexes rally to new highs, it tells us that the market is far weaker than it looks. So far, breadth is still good overall.

I am a bit concerned, however, as the number of new 52-week lows on the NYSE swelled to 95 Wednesday.

That is 3% of all stocks traded and a higher percentage than I’d like to see in a healthy market.

Right now, I still think breadth is a net positive, although it deserves further monitoring.
 
Price Action

On Monday, the S&P 500 and the Nasdaq both jumped to new highs but closed below Friday’s lows.
 
This pattern is called a key outside-day reversal, and it typically tells us that something big has changed for the worse. Was it the slate of corporate earnings? Hangover from the positive news on the budget from the Senate last week?
 
Whatever it was, it got analysts scrambling. Wednesday’s decline hammered home the message, so we do have a more substantial warning for a pullback in place at this time.
 
Volume

The evidence here is still good, as money continues to flow into index-tracking exchange-traded funds such as the SPDR S&P 500 (SPY). If we finally see indicators such as on-balance volume start to decline, then we can worry that the pullback is driven by the urgency of sellers and not just the tiredness of buyers.
 
The Bottom Line

The market finally shows some signs of cracking, with the possibility of a small pullback on the table.

Yet the first real correction of 5% or more since the election is still not quite upon us.

Further, we cannot say the bull market is over just yet, when we’ve only seen two days of selling without any breaks of important trendlines or averages. We can’t even say that any short-term supports on major indexes are broken.

Bumps in the road happen. It’s just been quite a while since we’ve had one.
 
 
Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.