I had the pleasure of being woken up this past Saturday by what was yesterday revealed as the strongest earthquake in recorded history in Oklahoma, a magnitude 5.8 on the Richter scale. My door was going back and forth in the doorframe, some of my drawers were pulled out by an inch or two, but no damage.
It does, however, present yet another reminder of what could be coming if fracking, assumed to be the primary cause of increased tectonic activity in Oklahoma, continues. It's this kind of foreshock that we're starting to see in some technical indicators.
One tool I took to playing around with is the Fibonacci retracements tool from teletrader.com . In a nutshell, there's a significant amount of mathematics behind the Fibonacci sequence and associated 'golden ratio', to the point where scientists generally agree the Fibonacci sequence is found commonly throughout nature in many forms. One of these forms just happens to be the stock market.
I began this retracement from the valley of the Dow Jones Industrial Average during the 2008-2009 financial crisis. I didn't begin the retracement from the lowest point, as you can see, since there is some apparent support right around where I placed the 100.0% line, and that support stuck around from September 2008 until roughly April 2009. I then placed the 0.0% line around where we are now, again right around an area of resistance that the Dow appears to be encountering, and where we are meandering right now in the upper 18,000's.
The cool thing about TeleTrader is when you decide your bottom and top points, it outlines the Fibonacci retracement levels automatically, a nice bonus for those who may be somewhat math-inclined (I was formerly a meteorology major, after all) but don't have the time to calculate all of those levels, like myself. So, when the retracement levels are all drawn out, it becomes apparent that the Fibonacci retracement concept does actually work. I've annotated areas of resistance and support to show how the Dow stuck around areas between two retracement levels, and it's no coincidence how these areas of support and resistance line up incredibly well with the Fibonacci retracement levels. It's not a perfect correlation, as you can see by the 2013 period where support and resistance levels were a little bit away from the Fibonacci levels, but for the remainder of the graph, the shoe more or less fits.
If we're to trust this Fibonacci retracement set, we should be at or just past the peak of our bull market. I personally believe the peak came a handful of months ago, and we're starting to see a slowdown in momentum in equities, as well as remarkably low volatility signaling a level of investor complacency that could cause big trouble if/when a negative surprise shock hits the markets. But that's a whole other post to write about.
This meat-and-potatoes graphic comes from tradingview.com , which has a cornucopia of technical analysis indicators and indexes and all that fun stuff. We're taking a look at the Dow Jones Industrial Average since around 2002-2003 until present day at the top, the Dow's Momentum index values in the middle, and the Relative Strength Index on the bottom.
As far as this graphic is concerned, at quick glance, things seem just fine and dandy. We're near record highs, the RSI is in a comfortable range (albeit gradually inching upward), and momentum remains positive. However, this is all a bit deceiving, and to illustrate this, we bring in volatility.
In the above image we see the Dow Jones Industrial Average from mid-2011 to present day, with the CBOE's Volatility Index superimposed in blue. The horizontal aqua line illustrates the lowest point that the VIX hit this past summer on a weekly scale, closing the week of August 15th at 11.34. For some perspective, that level was last breached in July 2014, and although the index frequently drops near this line, it's rather uncommon to see it go as low as it did this past August.
That tells us that the markets are complacent, as we briefly discussed earlier. This complacency makes for a significant problem in the RSI, which is defined by Investopedia as an index that "compares the magnitude of recent gains and losses over a specified time period to measure speed and change of price movements of a security."
The key phrase there is "recent gains and losses over a specified time period". You'll notice that American equities are trading in a pretty narrow slot right now, as confirmed by low volatility. Hence, recent gains and losses are going to be low, likely artificially lowering the RSI and making it appear that equities are not overbought, when in fact they very well may be.
This volatility issue also hurts the momentum indicator to some degree, as the same issue about recent gains and losses pops up. With minimal movements day-to-day in equities, it's no surprise that the momentum index in the last month or so is oscillating around the zero-line.
These oscillations can give some clues, however. Note how we've started to see lower highs and deeper lows in the momentum index from about 2015 onward, especially back in 2015. We've lately seemed to buck that trend, but I'll be darned if there's no concern over the momentum index hitting levels not seen since the financial crisis, back in 2015. That's a foreshock in a nutshell.
But hope is not lost! We still have the ADX, the Average Directional Index. This index helps identify the strength of a trend. It doesn't identify if the trend is positive or negative, but shows how strong the trend is. While this index is subject to some of the same limitations imposed on the RSI and Momentum indicators, with how equities are overall not too active, the ADX raises a key point in that there really is no clear trend in the current market. ADX values below 25 are seen as the market either exhibiting a weak trend, or no trend at all, and we've been consistently below 20 in this index since late April! Now, since late April the Dow has gained a good 500-600 points, which is nothing to shake a stick at. But it took us close to 5 months to get there, a lot of dawdling, and a clear indication that there is no real trend. The best trend I can think of is stagnation now that we're likely at the peak or just past the peak of our bull market in equities.
To sum all of that up, while the RSI may be flawed due to a lack of movement, the overall picture of the ADX can provide some context. According to that index, we haven't had a clear trend since the first two months of 2016, when the Dow shed a couple thousand points. Since then, it's just been a meandering climb up to where we are now, the upper 18,000's.
This is a foreshock because the longer we continue without a clear trend, the more wary investors will grow, as more questions are asked about the state of the economy, whether we're peaking the bull market or just starting one. It's plausible that this uneasiness will lead to a climb in volatility, which could set off a chain reaction, but that's one of literally hundreds of possibilities in our current market state.
In sum, much like the increasing occurrence of Oklahoma's earthquakes culminating in a record-5.8 magnitude quake this past Saturday, technical indicators are also sending out foreshocks in the form of Fibonacci retracement red flags, the lack of a clear direction in the markets combined with concerningly-low volatility, and possible hints of less positive momentum in the markets, particularly in late 2015/early 2016. There are fundamentals that are also issuing foreshocks, and one day soon we'll discuss those as well, but for now I'll leave you with an all-too-real paraphrased-excerpt I came across while reading Didier Sornette's "Why Stock Markets Crash: Critical Events in Complex Financial Systems":
Much to the contrary of expectations, stock market crashes arise when economists and analysts are the most positive about the economy and the economy's future. That way, everyone's caught even more off-guard when things suddenly turn south.
Andrew
It does, however, present yet another reminder of what could be coming if fracking, assumed to be the primary cause of increased tectonic activity in Oklahoma, continues. It's this kind of foreshock that we're starting to see in some technical indicators.
 |
| TeleTrader |
I began this retracement from the valley of the Dow Jones Industrial Average during the 2008-2009 financial crisis. I didn't begin the retracement from the lowest point, as you can see, since there is some apparent support right around where I placed the 100.0% line, and that support stuck around from September 2008 until roughly April 2009. I then placed the 0.0% line around where we are now, again right around an area of resistance that the Dow appears to be encountering, and where we are meandering right now in the upper 18,000's.
The cool thing about TeleTrader is when you decide your bottom and top points, it outlines the Fibonacci retracement levels automatically, a nice bonus for those who may be somewhat math-inclined (I was formerly a meteorology major, after all) but don't have the time to calculate all of those levels, like myself. So, when the retracement levels are all drawn out, it becomes apparent that the Fibonacci retracement concept does actually work. I've annotated areas of resistance and support to show how the Dow stuck around areas between two retracement levels, and it's no coincidence how these areas of support and resistance line up incredibly well with the Fibonacci retracement levels. It's not a perfect correlation, as you can see by the 2013 period where support and resistance levels were a little bit away from the Fibonacci levels, but for the remainder of the graph, the shoe more or less fits.
If we're to trust this Fibonacci retracement set, we should be at or just past the peak of our bull market. I personally believe the peak came a handful of months ago, and we're starting to see a slowdown in momentum in equities, as well as remarkably low volatility signaling a level of investor complacency that could cause big trouble if/when a negative surprise shock hits the markets. But that's a whole other post to write about.
 |
| TradingView.com |
As far as this graphic is concerned, at quick glance, things seem just fine and dandy. We're near record highs, the RSI is in a comfortable range (albeit gradually inching upward), and momentum remains positive. However, this is all a bit deceiving, and to illustrate this, we bring in volatility.
 |
| TradingView.com |
That tells us that the markets are complacent, as we briefly discussed earlier. This complacency makes for a significant problem in the RSI, which is defined by Investopedia as an index that "compares the magnitude of recent gains and losses over a specified time period to measure speed and change of price movements of a security."
The key phrase there is "recent gains and losses over a specified time period". You'll notice that American equities are trading in a pretty narrow slot right now, as confirmed by low volatility. Hence, recent gains and losses are going to be low, likely artificially lowering the RSI and making it appear that equities are not overbought, when in fact they very well may be.
This volatility issue also hurts the momentum indicator to some degree, as the same issue about recent gains and losses pops up. With minimal movements day-to-day in equities, it's no surprise that the momentum index in the last month or so is oscillating around the zero-line.
These oscillations can give some clues, however. Note how we've started to see lower highs and deeper lows in the momentum index from about 2015 onward, especially back in 2015. We've lately seemed to buck that trend, but I'll be darned if there's no concern over the momentum index hitting levels not seen since the financial crisis, back in 2015. That's a foreshock in a nutshell.
 |
| TradingView.com |
To sum all of that up, while the RSI may be flawed due to a lack of movement, the overall picture of the ADX can provide some context. According to that index, we haven't had a clear trend since the first two months of 2016, when the Dow shed a couple thousand points. Since then, it's just been a meandering climb up to where we are now, the upper 18,000's.
This is a foreshock because the longer we continue without a clear trend, the more wary investors will grow, as more questions are asked about the state of the economy, whether we're peaking the bull market or just starting one. It's plausible that this uneasiness will lead to a climb in volatility, which could set off a chain reaction, but that's one of literally hundreds of possibilities in our current market state.
In sum, much like the increasing occurrence of Oklahoma's earthquakes culminating in a record-5.8 magnitude quake this past Saturday, technical indicators are also sending out foreshocks in the form of Fibonacci retracement red flags, the lack of a clear direction in the markets combined with concerningly-low volatility, and possible hints of less positive momentum in the markets, particularly in late 2015/early 2016. There are fundamentals that are also issuing foreshocks, and one day soon we'll discuss those as well, but for now I'll leave you with an all-too-real paraphrased-excerpt I came across while reading Didier Sornette's "Why Stock Markets Crash: Critical Events in Complex Financial Systems":
Much to the contrary of expectations, stock market crashes arise when economists and analysts are the most positive about the economy and the economy's future. That way, everyone's caught even more off-guard when things suddenly turn south.
Andrew
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