Stocks have certainly outperformed this year…
The historical annualized average return of the S&P 500 is around 10.26%.
Right now, we’re closing in on being up 10% year to date. And it’s only the middle of March.
There’s a lot of trading to go before we close the books on 2024…
And while it’s certainly possible that stocks keep going up, it’s far more likely that we’ve already seen the majority of the gains for this year.
The S&P 500’s price chart (SPX) holds an important clue that savvy traders should be watching like a hawk.
SPX has been trading within a narrowing wedge pattern since December 28.
And as we’ve already mentioned, that pattern has guided stocks higher by nearly 10%.
But now the market is reaching an inflection point.
A Vicious Sell-Off or an Incredible Melt-Up
The pattern is very close to running its course. What happens next could set the tone for the remainder of the year.
We’re either going to get a vicious sell-off or an incredible melt-up.
Let’s check out the chart below so you can see the reasoning behind my analysis.
There are two important things going on with this chart.
First, we have the ascending wedge pattern drawn using the red trendlines.
This pattern is close to completion because prices are nearing the point where the two trendlines will cross.
If prices reach this point, the pattern can’t continue developing, and the market must either break up or down.
Ascending wedges are reversal patterns. If this particular wedge in SPX is for real, we should see the market break hard below its lower trendline any day now.
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A Scary Signal
This brings us to the second important feature of the chart, the Relative Strength Index (RSI).
The RSI is a momentum indicator, and right now, the RSI is flashing a scary signal called bearish divergence.
Notice how the RSI has been making a series of progressively lower peaks (blue arrow) even as actual prices have been making higher peaks.
This is what’s known as bearish divergence.
Bearish divergence is a leading indicator. That means you’ll see bearish divergence pop up on a price chart before the market starts to trade lower.
The limitation of bearish divergence is that it doesn’t tell us when the market is going to reverse.
That’s why we have to combine the chart pattern with the momentum indicator.
If we get a strong break below the wedge’s supporting trendline, that’s a good initial sign that this stage of the market rally may be ending.
On the other hand, if prices break strongly through the upper trendline, we can still expect further upside.
Happy trading,
Imre Gams