Look at what the SPX did on 1/20/2016. While most market participants were watching for the last October low and the breakdown of the improperly formed head and shoulder pattern, it fell right through the October low.
(click on the chart to enlarge)
What the SPX did was it fell couple points below the April 11, 2014 low and then reversed. In addition, it set up a potential anchor for the formation of the right shoulder of a possible properly formed head and shoulder pattern. The formation of the right shoulder could be the relief rally for the recent selloff.
Now let's take a closer look and see what the A/D line was doing while the SPX closed at a new low off its 5/21/2015 all time closing high. In order to gauge the health of the market, we will focus on the closing prices to eliminated the distortion from the intraday noise.
One thing that stands out from the A/D line is it has been trending downward since the SPX closed at an all time high on 5/21/2015. Prior to 1/20/2016, there were a few times the A/D line made subtle lower pivot low while the SPX did not, and those were hints from the market alerting us to prepare for lower pivot low.
Now turn our attention to 1/20/2106. Look at where the market closed, just slightly more than 3 points lower than 10/15/2015 close. While the SPX closed lower than the 10/15/2015 close, look where the A/D line is relative to 10/15/2015, higher. This presents a positive divergence from the A/D line. Does this divergence indicate the bottom is in for this meltdown. Not necessary, this is only one incident of divergence. There are other breadth indicators confirming the new closing low off high. Furthermore, there are other market indexes continue to make new low, and that is not a sign of an established market bottom. What the A/D line divergence could be telling us is to watch for a possible near term rally off this low, and last Thursday & Friday could be the beginning of that rally. The question is how long will this rally last and to what extend is the move, one possible answer could be extracted from the weekly chart presented earlier. The potential right shoulder formation could be the result from this rally. But again, this is only a scenario based on price action possibility. We can postulate as much as we like but at the end, the market is the ultimate arbiter and it will do what it will do. It could easily reverse and the SPX could drop another 50 points on Monday or next week. As a student of the market, one is taught to listen for market messages. That requires one to be alert on watching the market breadth. The market internals are the pulse of the market, they provide an accurate sense on the health of the market then simply price.
