The Setup Looks Bearish

Besides the put call ratio looking ever more bearish, the McClellan oscillator and summation index continue to show huge divergences. When I noted this a week ago, the NYSE and Dow were not following the S&P and Nasdaq to new highs, though since the have followed to marginal new highs. That said, the divergences are so large my feeling is they must mean something, especially with sentiment at the requisite level where I would begin to expect a trend reversal.

Chart 1: A quick glance and the NYSE

 While the closes are still above .8 standard deviations above the 10 day mean (bullish price action) we can see from the RSI that there is a bearish divergence in momentum. Volume continues to be an issue, and has receded, especially during last two weeks.

The McClellan oscillator and summation index are some of my favorite technical studies to look at. It surprises me to see how little utilized they are considering its predictiveness, especially in combination with just a few other tools. I honestly believe one could trade successfully by looking at this study alone. That said, lets see what it is telling us now.
Chart 2:

Two areas of concern here. One, McClellan is showing us not only a divergence in a daily degree (showing I divergence between this peak and the peak in November), but,  two, also a large divergence between this rise and the rise in August. This could indicate that the entire sideways gyrations for the last several months are corrective in nature, not a break out, and the impending correction could be larger than most expect.

When most people discover oscillators from a book, website or whatever, they note that divergences almost always appear at turns. Well that's because books only show examples of of turns. In practice/reality people discover that divergences appear all the time, then can disappear as prices continue on there way. I would say a high percentage of divergences are meaningless (especially in momentum). The correct way to use them is in concert. When divergences in price, momentum, and breadth occur together, and at a sentiment extreme, then however you have a very high probability setup, and that what trading is all about. Folding the low probability setups, betting on the high ones.

So lets review:
The closes of the major indexes continue to eek out gains. Sentiment by almost any measure is very high. Some measures show sentiment to be at multi-year highs and the put call ratio is generating a sell signal. Momentum is lagging and showing divergences. Breadth is lagging mightily and showing large divergences in both weekly and monthly peaks. Prices may continue higher, but I would not bet on it.