Larry’s note: Welcome to Trading with Larry Benedict, the brand new free daily eletter, designed and written to help you make sense of today’s markets. I’m glad you can join us.
My name is Larry Benedict. I’ve been trading the markets for over 30 years. I got my start in 1984, working in the Chicago Board Options Exchange. From there, I moved on to manage my own $800 million hedge fund, where I had 20 profitable years in a row.
But these days, rather than just trading for billionaires, I spend a large part of my time helping regular investors make money from the markets. My goal with these essays is to give you insight on the most interesting areas of the market for traders right now. Let’s get right into it…
Yesterday, I wrote about the correlation between the Nasdaq and S&P 500 indexes.
We saw how much of a premium the Nasdaq trades at compared to the S&P 500, and how quickly it’s increased from the start of 2020.
But after peaking in February, this trend could be about to reverse.
Today, I want to take a deeper dive into just one of those indexes – the Nasdaq-100. This index tracks the 100 largest non-financial stocks listed on the Nasdaq.
It’s a great way to trade the technology sector.
One ETF that tracks the Nasdaq-100 that I follow is the Invesco QQQ Trust (QQQ). Some traders simply refer to it as “the cubes.”
Let’s pull up the chart…
This is a daily chart of QQQ’s price going back to April last year – when the QQQ rally really began to get going.
That’s when the red line (10-day moving average – MA) crossed above the blue line (50-day MA) on the left side of the chart.
Below the price chart is the Relative Strength Indicator (RSI).
The RSI simply shows when a stock is overbought and oversold.
A stock is overbought when the black RSI line crosses above the upper horizontal dotted line (the 70 level). It’s oversold when the black line crosses below the lower horizontal dotted line (the 30 level).
You can see that QQQ has sold off regularly when the RSI indicated it was overbought.
There is another way I use the RSI that goes beyond these two signals (overbought and oversold).
If you go back to the chart, you will see two red lines. One is above the recent price action. The other is above the RSI.
You can see the two red lines are heading in different directions. Meaning, there’s divergence between the two.
As you can see on the price chart, the recent action in QQQ has been weak. It’s struggled to trade higher over the past two weeks.
At the same time, the RSI is trending down – showing declining momentum.
When you see this type of divergence, it’s often a warning sign of an impending change in direction.
To take it one step further, I look for another crossover with the moving averages. This time though, I’m looking for a downwards crossover – when the 10-day MA (red line) crosses down over the 50-day MA (blue line).
If that happens, a down move in QQQ could really gain momentum.
Yesterday, we looked at how the Nasdaq had potentially rallied too far against the S&P 500. So, if the S&P 500 reverses and moves lower, we’d likely see the Nasdaq move even lower.
Add in the price action we looked at today, and one thing seems clear… the Nasdaq is looking vulnerable around these levels.
Editor, Trading With Larry Benedict
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