The NASDAQ indicators are close too fully matured now, and we are at one of those times in history where the market is ready to roll over. NASDAQ is about to change direction.
Most people have identified the potential rising wedge on the Nasdaq Composite since the bottom Aug 2004. A rising wedge, while often negative, is not in itself a certain indication of a decline. To be able to determine in which direction the wedge will be broken we have to look at how the breadth indicators are developing within the wedge.
Unfortunately the breadth indicators for the Nasdaq Composite are negatively influenced by a large number of low quality stocks and issues. The cap of these issues are fortunately low and they doesn't effect the index, but they put some of the breadth indicators, like the Advance/decline line, in perpetual decline. To be able to get a better look at how the market actually are behaving we have to turn to the NQ 500, the top 500 stocks on the Nasdaq market. The NQ 500 Index has a very high directional and wave correlation with the Nasdaq Composite, higher then the NDX, and its breadth indicators are not effected by the low quality issues on the Nasdaq market.
The Advance/Decline line for NQ 500 peaked already in Dec 2004 and has broken down with lower and lower tops while the index has risen. A declining AD line within a rising index wedge is an indication with high reliability that the wedge will break to the downside. The Advance/Decline line for the Up Volume adds another indication.
This shows that also the AD line for Up Volume has a negative divergence and that each up-move in the wedge has been made with lesser and lesser up volume, also a sign that we will break to the downside.
NDX is often leading Nasdaq and a look at its AD lines gives further clues.
NDX shows a even greater breakdown in its internals and that the weakness is spreading from the NDX to the broader market.
The breakdown of the AD lines for stocks and volume, in addition to the further breakdown of the NDX indicators is a very clear sign that the wedge will break to the downside.
Looking at the last leg up from October, short term divergences has already developed showing that we are in the later parts of this advance. It is not unusual that we get a overthrow in a formation like this, and some of the divergences within the leg are still quite short. So it is possible that the advance will continue a little bit further before we set the peak. This advance will with a high degree of likelihood end during the month of December and most likely within the next 1 to 2 weeks. And it is even possible that we already has set the high.
The fact that we have a wedge which will break on the downside does not in itself make the wedge a terminal formation to end the rally from Oct 2002. But the longer term indicators are providing us with some clear clues.
The number of stocks over their MA 100 has also been declining, both within the wedge but also longer term. This shows a long term deterioration and a more and more narrow advance, typical for a larger top. We now only have 73% of the stocks above their MA100, a weak number considering the new high for the index.
But even more incriminating is the development of new 52 week highs and lows, and here is the final clue.
This shows a very dramatic deterioration of the rally with fewer and fewer new highs for each new peak. The fact that the last high was only created 45 new highs is showing how few stocks that actually are participating in the rally.
The even more damaging indication is the rising new lows, which shows that even though the index is having a higher low in October 2005 the new 52 week lows are increasing. This indication often comes at the very end of an long term advance showing that the market is rolling over.
During the last low we actually had more or less as many 1 year New Lows as the last high had 1 year New Highs. A very dramatic indication how large part of the market that has rolled over.
Very often we also get a short term divergence at the peak of an advance in the form of falling new highs. (Shown by blue circles). The last advance has already created such an warning, indicating that the last leg is close to its end.
All this is a textbook example of how a market is rolling over with fewer and fewer stocks participating in the advance, and more and more stocks already started the decline ahead of the index.
The combination of the wedge, and the clear deterioration of the market is a very clear indication that the wedge is a terminal formation finishing the wave up since Oct 2002.
There is an possibility that the wedge continues , after an short term decline, further into 2006. But the sharp decline in new highs and the rise in new lows makes this scenario quite less likely, and even if it can't be ruled out this would only create a marginally higher top in the index. In regards to the advance from Oct 2002, we are at the end of the rally whenever the final high is set in December, most likely, or early 2006, less likely.
The next question of cause is how severe the decline will be. This will depend if the move is an correction of the rally since Oct 2002 or a new down wave. At the moment there is possibilities to speculate over this, but it will remain speculations. During the decline there will be ample of evidence what kind of decline it is and how far it will go. At the moment it is more prudent to determine how deep it at least will be.
The first target area is around the 1830 range, and it is unlikely that the wave down will end before this area. Even more likely is that it will continue down to the 1760 levels and beyond that the 1700 level.
The 1700-1760 range is actually the most likely retracement level for the down move if it is an correction. And it could go further down then that.
At the moment it is enough to say that the move down is likely to be at least 23-25%, with a possibility for further decline. The move down will likely be pretty fast and volatile, especially the latter parts, and is not likely to end before early fall 2006, with potential for an even longer term decline.
The Nasdaq market is currently showing a textbook example of an ending rally with a terminal wedge as its last move up. The rally from Oct 2002 is with an high likelihood at its end, and the next large move will be down. The decline will likely least be 23-25% and not end before early fall 2006. With possibility for a more severe decline.