Nearing Confirmation of A Correction- But Short-Term Oversold

Click on Chart to Enlarge

This is a 60 min chart of SPY.  The MACD is oversold indicating the market may attempt a rally.  It would be better to see a bullish divergence develop before considering a new long entry.

Given the momentum set-up with the weekly and monthly stochastics overbought and the weekly now in a sell signal formation, I think the better opportunity is to wait for the likely rally and then look to short/inverse on the next sell signal if price meets resistance at or below the recent highs of 9/14/12.

Click on Chart to Enlarge

The spread between the smart money commercial futures traders and the large speculators is at a 3 year low indicating the smart money is heavily short with a bearish outlook for prices.  The last times the spread was this large were June 2009 before a 4 week correction, around New Year's 2009 before the final plunge into the 2009 bear market low, and the first week of Oct 2008 before "the crash" plunge into the Oct 10th low.  The time before that was late February 2007 just before a surprise 4% plunge day in the markets and an 8% overall correction.

The point being that there is no other real interpretation of this than at least a modestly bearish one.

The correction off the recent high in the SPY etf is now 8 days long.  The prior longest correction since the June low was 9 days.  If the decline continues to 1415 on the S&P 500 cash, the decline will be larger than any other pullback since the June low as well.  So further downside would create an overbalancing of both price and time suggesting a correction of at least the June-Sept leg up is occurring.

Of note is that open interest rose sharply in the last reporting period with an increase in the commercial net short position.  This indicates that there is NEW hedging or commercial short interest coming in at these level.  While this may seem trivial, another pattern which occurs is for commercials to go heavily short, and then cover their shorts on falling open interest as the market pushes higher and puts them at a loss.  That pattern tends to lead to a sustainable price advance.  We are NOT seeing that right now, which indicates that we may be making a very important high here.

Again my suggestion is to exit longs and growth stocks, or trail stops tightly.

Stock Market Analysis 9-16-12

Stock Market Analysis 9-16-12

This video covers multiple time frame technical analysis on stocks as well as CoT data.  Stocks could be making a major top here.  I suggest tightening stops on any long positions and growth stocks.  Check the video out for further details.

Major Stock Index Selling By Smart Money

Click on Chart to Enlarge

The commercial "smart money" traders increased their selling in stock futures this past reporting period making them the most net short in over a year.  The last times they were this heavily short were at the July 2011 and May 2011 tops.  While a signal like this can fail to lead to a major correction, in the context of a double top/failed breakout I wouldn't bet on it.  At a bare minimum I suggest having in the market trailing stops on long positions or growth stocks.  Remember, our goal as individual traders is to observe what the big players are doing, anticipate what they are likely to do next, and to position ourselves with them.  So they are more bearish than in the last year or so.  Are you?

Combined with a failed breakout of the April 2012 high, this reinforces that a correction is likely from these levels.  But as noted in the recent video, it would be out of character for the market to push above the recent August high and then make a correction.  A new high would likely be a continuation point.

Click on Chart to Enlarge

Click on Chart to Enlarge

Notice that the bollinger bands are squeezed tightly on SPY.  Not shown is the ADX/DMI which shows that the daily DMI has been below 20 for 2.5 months.  As it approached 20 two weeks ago, it turned down as the market failed to breakout.  Recall several posts talking about this explosive set up in the past.  Most recently it occurred in gold resulting in an upside breakout.  But the key is the watch for a close OUTSIDE the bands with both bands expanding.  When that happens in this situation it typically leads to a sharp price movement, though it may only last 1-2 weeks.

Click on Chart to Enlarge

The VIX/VXV ratio recent spiked lower again similar to what occurred in March of this year.  What this mean is that short term volatility is out of balance with longer term volatility expectations.  As you can see on the chart, that has often led to substantial corrections in stocks with on overall increase in volatility and a rebalancing of the VIX/VXV.  The other possibility is for volatility to remain low and the longer term volatility shrinks to rebalance the ratio.  If that happens it would likely be in the context of a continuing low volatility market advance.

As an additional note, the VIX has been running high relative to historical volatility.  This also often happens prior to market corrections.  The option market does not believe the current low volatility trade is sustainable.

At this point the US dollar looks set to make a continuation of its advance, and commodities have run very hot for several weeks and are likely to correct.  So I think we are likely to see a deflationary theme type sell off here again with most assets down and the US dollar up.