Following the late 2003 market advance, the stock market resumed a more neutral track at the start of the following year. The stock market started 2004 well, but the price thrust weakened rapidly.
As matters turned out, the relative weakness of the RSI indicator during the cycle presaged the more severe market declme that took place in March 2004.
The cycle was very bullish in its development, with a small dip at the end of an early A segment followed by rising prices right into the end of the period. Sometimes cycles during very bullish market periods show patterns of price movement that make it very difficult to determine the completions of cycles that become more readily discernible in indicators that track the momentum of the price advance.
For example, the RSI dipped a few days before the end of the cycle, failing to confirm new highs made in the Standard & Poor’s 500 Index at the start of 2004.
Cycles that end as strongly as the cycle from November to early January are usually followed by very strong market action at the start of the following cycle, which is what took place in this instance. The RSI indicator, incidentally, clearly indicated the A, B sequence of the November-January cycle, which was not as apparent in the price pattern.
This was a slightly bullish cycle, with prices moving up gradually and more market time taking place in advance than in decline. The division into virtually equal A and B segments is very clear, as was the negative divergence between price movement and the patterns of RSI that closed the cycle with a classic negative divergence. The RSI indicator closed the cycle at its oversold zone, again with a double- bottom formation, confirming the start of the next cycle.
First, you can observe the level of RSI at the market low in early August, where this study begins. As you can see, RSI resided at the time in the 40 area, an oversold region for the 14-day RSI during neutral to bullish market periods. RSI advanced during the new cycle, ultimately peaking right at the cycle midway point. Prices continued to advance into the cycle, but the RSI failed to achieve new peaks along with price. This represented a negative divergence that, as we have seen, carries bearish implications.
Two developments took place as this 36-day cycle drew to its nominal close. First, the RSI, failing to reach a new high along with price (a sign of failing momentum] suggested near-term problems ahead. Second, both price and RSI turned down, price from a maximum peak and RSI from a secondary peak. Key elements were in negative harmony. The cycle was due to move into a low. The RSI had failed to achieve a new high along with price. The price level of the Standard &Poor’s 500 Index turned down as well.
Now, what took place as the cycle reached its nominal low at the end of September? A number of bullish elements supported that low area, indicating the likelihood of a tradeable market advance. For one thing, the cycle was due to reach its cyclical bottom. For another, the RSI had by then descended to the area that had been the launching pad for the September advance. For still another, as the bottoming process moved along, the RSI traced out a rising double-bottom pattern, a type of pattern that tends to be quite significant when it develops within areas that mark oversold levels during bullish market periods.