Wednesday, May 13, 2009

The First Big Test of this Rally

Click on Charts to Enlarge

After today's decline the market is in very questionable technical position for a further advance to new highs. Despite the short-term model generating oversold signals yesterday, today was able to pull back deeper with the model never coming out of oversold condition. This type of behavior is one thing I look for to gauge trend changes. Prior to this oversold signal, the other signals had all bounced up by the next day. Also, the S&P has not had 3 straight down days this entire rally until today. So these are signs of a trend change, but there is not much technical damage yet.

The plus side for the bulls is that the S&P and Dow have held their 20 day MAs. The top chart above shows the S&P 500 with green vertical lines indicating times during prior bear market rallies that the RSI(3) has dropped below 30 and the S&P had not yet touched the lower bollinger band since the beginning of the rally. Today's decline has now set things up the same way. Other than in early January, all the other instances quickly led to nice short-term moves up. The January instance led to a further sharp slide for a few sessions before making a decent short-term rally that ever so slightly made it back to positive (if buying on this similar set-up) at the next overbought signal.

Also, the 875-880 level on the S&P is the breakout point from the January highs that many are watching for a re-test (blue horizontal line on the chart). This is only a few points below current levels. I would be surprised if the market did not put in a decent bounce from near the current levels or a little below. Maybe a gap down into that 875ish area tomorrow would be a short-term exhaustion point and would entice buyers, but we'll see.

The lower chart shown above is the VIX with the 63 day TSF study I showed before a few times. Today the VIX closed above that line for the first time since before the March lows. This signal has been so accurate at denoting market peaks and VIX bottoms for this entire bear market that I am paying serious attention to it. This signal last came in January after the market had made its first breakdown and showed oversold signals. However, I mentioned on the blog at that time that the short-term was probably too oversold to be a good intermediate sell point. That proved to be true with much better signals coming 2 and 4 weeks later after the first and second short-term rallies.

From this point I think the two most likely scenarios are a bounce starting tomorrow (maybe after a gap down or early weakness) followed by new highs for the index into next week OR a further slide for the next few days down to the 850 area followed by a nice bounce after that. If the market falls below 850 within the next few days, I would give the S&P basically no chance at new highs for this rally any time soon. That deep a pullback would be greater than all the pullbacks so far this rally and would also retrace what could be the E wave of the possible rising wedge I have shown in recent charts.

As far as the current SSO trade, the first scenario above (which I think is a little less likely) would probably result in a decent gain by the next exit signal. The second scenario would be lucky to breakeven by the exit signal. From my experience I would say that holding and waiting for the next overbought signal is the best thing to do even if there is some more short-term drawdown. I pretty much gaurantee that there are some eager potential buyers waiting for the first significant price break to try to catch a bargain. So even if there is further short-term weakness, I think the odds are good for a sharp bounce after that and would be the best exit point for the trade.


  1. A few more stats, etc. about the current market position....

    Out of 33 times SPY gapped down more than 1% and set new intraday low during mid day, two thirds of the gaps were closed within 3 days. That would suggest probabilities favor a bounce above yesterday's close in the next few days.

    Intraday TICK levels on both NYSE and Nasdaq hit extremely low levels that are typically good for a bounce even during a downtrend. Comparable TICK levels during this uptrend were March 30 and April 20, both great short-term buys. Lack of a bounce tomorrow would be further suggestion of a trend shift.

  2. After 2 straight days of the short-term model being oversold, it closed back in the neutral zone at 11:30 ET. Intraday TICK is turning back toward positive which is necessary for any further upside.