First Signs of Divergence on This Rally - SPY 10-23-14

Click on Charts to Enlarge

These are hourly charts of SPY and the VIX.  They are actually now showing a reasonable divergence pattern to set up a short trade.  However there are relatively mixed currents of momentum on the different time frames which suggests to me that we are likely to see continued trading mostly within the range of the last 6 trading days for probably a few weeks to come.

Of note on the charts are the divergence in the momentum indicator relative to SPY.  And on the lower chart, the VIX did not confirm a lower low this afternoon as SPY made a higher high.  These VIX non-confirmations are often leading indicators of a reversal attempt.

Not shown is the hourly total put/call ratio chart which nearly touched the bottom bollinger band this afternoon and is further indication that this move is now stretched to the upside for the short term.

That being said there is no downside breakout on this hourly chart to suggest that a significant move is underway.

After similar sell-offs to the recent October plunge, the sharpest portion of the rebounds have occurred in the first few days, likely as short-covering rallies.  Once that initial short-covering is exhausted, we will likely see at least a 1-2 day pullback, possibly quite sharp.  However, a subsequent move to yet higher closing highs, would be indicative of legitimate market interest on the long side in my estimation.

Bought SPXU @ 48.63

Just for FYI and disclosure, I bought SPXU shortly after the open at a price of 48.63.

This effectively is shorting at this mornings gap up opening.  The gap open occurred above the 191.00 level which I thought may be resistance here, and price is also testing the 10 period moving average of the daily highs.  Given that the weekly MACD is down, and the daily momentum is below its moving averages and without divergence, I view this as a high probability set-up for a pullback to occur in SPY.

I don't have a stop on the position, so if you are using this info for trading decisions you need to determine your stops and position sizing, etc.  I find that when trading mean reversion type strategies like this, the overall profitability is higher without using a stop.  So you control risk through position sizing/ capital exposure rather than via the stop price.

If the hourly time trade chart generates an effective sell signal on price action, then I will place a stop on the position and await a short-term extreme pessimism to exit the position at.

Start a comment dialogue below if you desire more information or assistance here.

Pete

SPY Short Trade Set-up

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The top chart here is a 30 min chart of SPY.  The MACD is elevated as price is reaching the 191 area that I have highlighted in recent posts.  I view this level as a shorting set-up and may track some trades here based upon short term technicals and real money sentiment.

The second chart is the VIX on an hourly time frame.  The set-up here would be for the VIX to touch the lower 20 period bollinger band which would be an indication of a potential short term extreme to act upon in contrarian fashion, assuming the larger trend is down, or that a retest of the recent low will occur.  The best set-ups occur when price pushes higher but the VIX fails at least in a very minor way to continue lower as price moves higher.

The bottom chart is the total put/call ratio on an hourly time frame.  Again a move outside the lower bollinger band here would be a possible short term topping signal, though it won't necessarily mark the precise high.

Prices are set to gap up here, and in my opinion a short position at the open would be a reasonable play.  If I go in here it will likely be with SPXU and without a stop on the position.  I will wait for an opposite extreme to develop and exit or place stops when that occurs.

SPY Price Projection for The Rest of 2014

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Over the last couple days I have created what I believe would be a relatively close projection of upcoming market activity  IF...... the bull market high has completed in September here in the S&P 500.

Without spending a lot of time covering everything that I've looked at other than the few posts I've recently made about the subject, I will give a few key summary points.

1. While the current market decline is larger and faster than anything we've seen since 2013 began, it is not larger than the May-June 2012 decline and certainly not larger or faster than the August 2011 decline.  So it is unlikely from a logical standpoint, that the bull market psychology is complete - EVEN IF the price high has already been made.  This makes it more likely that price may consolidate to a lower high before a much larger and faster downward price move occurs which creates logical confirmation of a new bear market.
2. Seasonal tendencies are for market lows to occur in October and to experience rebounds.  Also seasonal tendencies are for markets to rally or hold up well into the Christmas/New Year's time frame.
3. Real money sentiment is clearly stretched to a statistical extreme of pessimism given the bull market trend.  And since the price psychology has not clearly turned down, it seems likely to me that the market will rebound, but the rebound may now take on a more corrective/overlapping character rather than a V-bottom or sustained directional rally off the low.
4. The move down off the September high appear to have an expanding bias, and tops or bottoms are more likely to end with a contraction (like an ending diagonal, etc).  Expanding activity is more indicative of a new pattern or trend.  So I think it is likely that the recent low will be retested or slightly undercut before a more lasting rally occurs.
5. There is not yet daily time frame bullish divergence on this decline, making it more likely that prices will retest the low or remain rather range bound for several weeks as opposed to a V-bottom.
6. The VIX/VXV ratio has been above 1.00 for several days which suggests to me based on past behaviors that prices are likely to stabilize.  The ratio has not tended to stay above 1.00 for weeks, and even if volatility remains higher, it would make more sense here that the initial directional move is largely done and some decline in the ratio is expected.

Click on Chart of LQD/JNK to Enlarge

This chart is the LQD fund divided by the JNK fund.  LQD is a lower interest "safer" fund.  JNK is a higher interest "riskier" junk bond type fund.  The chart has a few notes, and maybe I should have made the chart of JNK/LQD for easier comparison with price, but the obvious point here is that at the September price peak in stocks, the risk behavior did not increase.  In fact there was the most pronounced divergence in several years.  That has now created the largest rise in the ration in 3 years.  If there is a consolidation followed by a new high for this LQD/JNK ratio, we would have added confirmation of a new dominant trend in market psychology and interest rate behavior towards risk aversion and a flight to safety.  This would make sense if stock prices have peaked and headed lower in coming months.

Click on Chart to Enlarge

This chart is similar to the last one but shows the risk behavior divided by the safety behavior.  This chart is the XLY consumer discretionary fund, divided by the XLP consumer staples fund.  From the chart, it is evident that the ratio has expanded as the bull market has progressed.  Then, at the summer highs, the ratio peaked sharply lower than in the spring.  This has now been followed by a break lower in the ratio.  Again, this is a simple measure of risk versus safety investing, with the indication that a new trend towards safety and away from risk is likely at hand.

Now another chart that looks essentially the same but I won't reproduce here, is the Nasdaq volume/NYSE volume which again shows an element of growth versus safety.  That chart also did not make higher highs this summer compared to this spring.  So here again, there is some indication of waning activity in the more risk/growth oriented stocks versus the more stable, lower risk stocks.

All of these indications suggest to me that the shift towards bear market behavior is on and prices have likely peaked.  We currently have an initial price burst to the downside suggesting a top may be in place as well.  So I will move forward under this outlook, with the major goal of identifying high quality times to short the market or purchase put options in anticipation of a major move to the downside in stocks.

Current Action in Market Compares to January 2008

The last 2 trading sessions in SPY were kind of unique in that both saw sizable gap downs of greater than 1% and both rallied to close above the open and above the mid range for the session.  And Wednesday made a 3 month price low.

The only other instance of this I can find going back 10 years is the Jan 22 and Jan 23 of 2008 instance.  That decline really was the kick off of the bear market and made a larger and faster type of decline and undercut existing support from the bull market.  Our market is similar in that regard right now as well.

So based upon that precedent, my last post still is my best projection here.  The specifics of the price action following the Jan 2008 waterfall decline were an initial 7 day rally (after the two gap and reverse days) followed by a month and a half to retest the Jan 22 low.  Then a 2 month rally occurred and gave a great shorting opportunity.

Given our market today has experienced less time since the high and the pattern structure seems different, I think that we are less likely to see a drawn out consolidation at this level and more likely to see a 1-3 week rally followed by substantially lower lows.

I will update as appropriate when action unfolds, but for now it looks like we should be ready to short the market next week for an expected retest of this week's low.

Click on Chart to Enlarge

Here is the chart of the 2007 bull market top and the decline into Jan 2008 and the following retest and rally.

Projections for SPY Based Upon Recent Price Action

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My post earlier today appear to have been timely for the short term trade, as stocks reversed most of the day's losses after this morning's sell off.  It likely will prove to be a short term low that holds for a little while.

However, the current explosion in volatility and persistent downside price action that has repeatedly closed below the lower bands, with sharply increasing volatility, has led to rather predictable price action in the past.  I would encourage you to go back through this post I made in August 2011 during that waterfall decline, because I accurately forecasted price action based upon prior instances of similar action.  And that forecast being spot on just adds further weight to the likely outcomes here, with history as a guide.  So the implication here is that if today's is a bottom of this initial plunge, but the correction does make a lower low, then we may see prices rally back to the region of Monday's high and find resistance there.  Interestingly that area is exactly 61.8% of the retracement of the last 5 days action since the high of point "d" as I have labeled it on recent charts - the 10-8-14 high.

This post shows the trade set-up I mentioned at that time as the initial rebound unfolded.

Here is a follow up post from the action as it unfolded in August 2011 and led to a new low for the correction which ended up being a major buy signal.

The chart above shows a projection similar to the ones linked here, and is based upon a rally to the high of the second candlestick before today's reversal.  In the past when no divergence is present, the market has routinely retested the low before rallying again.  So in this case we may expect a similar outcome.  Each rally here would be a short-term short trade set-up.  And if the bull market has topped, then the next break of support may be significant and lead to much further losses.  But the technical indicators and underlying sentiment will be our guide as we move forward assuming this forecast is roughly accurate again.

The initial rebounds after a sharp decline like this tend to be swift.  I would expect a short-term short sale opportunity to develop by next week.

As a side note, there is perfect hourly time frame bullish divergence on IWM currently and a bearish engulfing pattern on the daily chart just below support.  So it would be logical to go long IWM if one were to believe the bull case here.  You can always treat it like a short term trade and exit part at the first sign of hourly time frame overbought levels.  Then maintain a portion of the trade for a potentially larger advance if the market does put in a lasting low here today.  In these scenarios I go in with the expectation that I may only breakeven most times, but I will be in the market for the times when it does put in a lasting low,

Again, comment or question below if you need further assistance in navigating here based upon your trading time frame, etc.

Pete

Expanding Pattern Now At An Extreme - Short Term Cover Point

If you followed my posts the last couple weeks or took advantage of an option play to profit on the last several days of decline, then my suggestion at this point is that price has now declined to the declining speed line of the expanding pattern boundary and has occurred with a sizable gap.  There is no bullish divergence present at this point to suggest the decline has bottomed, however, I would suggest that this may be a quality point to cover part of a short position or put option, depending on time to expiration, etc.

Click on Chart to Enlarge

So again, I am not saying that today is a price bottom and I am not suggesting going long here.  I am saying that when the crowd is panicking and prices are making an extreme, those are the most contrarian points at which to act opposite the crowd.  In this case that means to cover or exit as they are capitulating.

In this specific case, I believe any rebound will be another shorting opportunity, but I will obviously be better informed as more price and time action unfold.  If a major decline is infolding, I don't expect any rebound to go back to the "d" wave high.  So if a rebound occurs and gives a sell type signal below that level, then I would suggest to short/sell.

For now a sell and hold strategy may be rewarded, but I have a feeling from years of close market observation that the short term downside is likely mostly done.  I could always be wrong.  and that is why I typically stress using a trailing type stop mechanism on part of positions that have major price potential.  I think that would be advisable here, but for options you may not have that luxury due to time decay.

Let me know if you have any questions regarding how to navigate here.


Pete

3 Year High in Total Put/Call Ratio Today

Today the CBOE total put/call ratio spiked to 1.53 which is the highest it has been in over 3 years.  Also the VIX is nearing levels last seen in the very large correction in 2011 where SPY declined 21% in 5 months from top to bottom.

So what is the significance of this reading?  Well for those who follow this blog closely, you know that I always point out the importance of divergences occurring at market turns.  And when we see a new extreme like we are in the put/call ratio, that is telling us that "fear" is high, but the fact that there is no divergence present, it indicates that the correction has NOT made a low.

So from this point, we may be close to a rally attempt after a big downer like this, but in my opinion, the rally will be a shorting opportunity on at least an hourly time frame basis.

Given the larger pattern at play here (possibly an ending diagonal in the Dow 30), prices may decline relatively sharply all the way back to the Oct 2013 low.  That would be another 10% lower in the Dow 30.  So just be aware here that if a bull market top is in place, the whole character of "oversold" will take on a new meaning over the coming weeks.

I will continue to update here at potentially important market turns and try to offer contingency plans at each event.

Pete

Expanding Bias Confirmed in This Decline - Look Out Below?

As of this mornings trade in SPY, it appears that the correction is developing with an expanding bias as suggested in the last post.  The ends of expanding downside patterns can really end with sharp downdrafts.  At this stage I am more or less expecting that.

The break of the August low today is a notable chart occurrence and may lead to some buying and an attempted reversal.  I will post if there are legitimate reversal attempts according to my methods.  At this point hourly time frame momentum and MACD, etc are very oversold, but they are not showing any divergence.  So I would advise against believing that today is a bottom day even if a reversal attempt occurs.  The odds just consistently favor divergence to appear at the significant market turns.

For now if you look at the weekly MACD and stochastics of the SPY and other indexes you can see that the indicator is opened up with a downside configuration.  So this means that the odds are for the larger trend to be down.  From a purely technical standpoint, I would not personally even consider a long trade until there is hourly time frame bullish divergence on the technicals while the weekly is down.  Even better would be for the daily MACD to end up oversold with divergence.

From a multiple time frame stochastics analysis on the weekly chart of SPY, the fast line is just getting to the oversold area.  So we could be alert for this week or next for a daily time frame stochastics divergence to develop while the weekly is near oversold.  We are not there yet since the daily is at a new low in the stochastics for this correction.  So again, waiting for bullish divergence to develop would be advisable here before considering long.

As another guide for the trader here, read this link showing what the last 2 bear markets were like in terms of price and time duration of legs down in a bear market.  The typical bull market correction is about 1-3 months and averages about 10-11% decline.  A bear market leg down is on average larger and longer than that.  So what you want to do is to track the developing price action (and sentiment of course) and constantly compare......"does this look more like a bull market correction, or a bear market decline?"

In my opinion the SET-UP looks complete for a bull market top to be in place, with broad spread weekly time frame divergences, etc.  However, it is early to make comparisons beyond that.

Expanding Pattern Off the Highs Suggests a Further Sharp Stock Decline Coming The Next 1-2 Weeks

Click Chart to Enlarge

This chart is a daily chart of SPY, the S&P 500 tracking ETF.  What I am showing here is that the decline thus far off the high appears to be occurring with an expanding bias and we have seen increasing volatility.  Based upon this, if the next move down continues in expanding fashion, and is 1.272-1.618 times the size of what I have labeled as the "c?" move, then that would project down to the little rectangle box around 185-187 on SPY.  Based upon the time of the recent smaller movements in the pattern, I think it would take in the 4-10 day range for that to occur.

This would fit with the idea of the Russell 2000 completing a double top formation and breaking support and dropping sharply as I discussed a couple times over the last week or so.

Now at this point we are obviously seeing some extreme selling and should be alert for a bottom reversal process.  Yesterday the VIX/VXV ratio closed above 1.0 for the first time during this decline.  This occurrence has preceded the significant market lows over the past few years, often preceding the low by a day or 2.  So while I believe both the SPY and the IWM chart patterns have significant bearish implication and could break the character of the recent corrections, I am alert here for more bottom attempts and will do my best to post here in timely fashion when prices do show high quality bottom reversal attempts.

As a side note, if SPY moves below 190.55 by Oct 31st, then it would retrace the last leg up from Aug-Sept, in less time than it took to form, and this would indicate a likely larger shift in market psychology to the downside.

So as the market develops here, especially if volatility continues to expand, if you have any questions on analysis or trade planning, feel free to start a comment dialogue below and I will try to assist you.  I feel that in high volatility times where rebounds can be very sharp, it is wise to exit short positions on breaks of prior key chart support that may lead to rebounds.  Also, as corrections hit new lows with underlying bullish divergence, my trading experience is that exiting portions of the trade into that type of price weakness will often produce the most favorable exit price.

The specifics obviously need to be planned well, but in terms of the general approach, that is what I would suggest in theory here.

Beware of Another New Low For This Correction

Interestingly as my last post had mentioned, if we saw a new low for the correction and another buy signal, followed by yet another new low and high VIX spike, I think it would bode poorly for stock prices moving forward.

At this point we did see an initial new low followed by a major reversal higher and a follow through type day yesterday.  Now here we are with immediate reversal in prices back towards the lows of the recent correction.  So, again I suggest here that continued "nudges" lower will likely be indications that force is gathering behind a crack in the dam.  And it could break and lead to flood of selling.  Specifically refer back to my last post on the Russell 2000 support level and double top projection.

I again suggest that a short on a break of yesterday's low with a stop above the intervening high could be a profitable play with significant downside expectation.

Pete

Buy Signal In SPY 10-3-14

Everything currently looks just like the significant corrective bottoms in stocks over the last couple years.  The gap up and advance after a buy signal from my bottom spotting algorithm seems like a good start to another move up to new highs for the bull market.

I have discussed the longer term technical set-up as showing multiple time frame bearish divergence and warned that we may be at the end of this bull market.  This current action doesn't really negate that outlook on a longer term status, but it does seem more likely that this current rally could make a new high, at least in some of the major stock averages.

Until the character of corrections (larger size, faster rate of decline, greater time duration) in this bull market, change, I don't feel there is great CONFIRMING evidence that a top has complete.  A failure of last week's low to hold would be a significant sign in my mind for a possible change in character.

Currently, I would suggest that the appropriate strategy for index trading here is to be long currently, but with a stop below last week's low, and to establish short at a close below last week's low for those who look to catch the major downswings as well.

Click on Chart to Enlarge

As has occurred so frequently over the last 2 years at the significant buying opportunities in the indexes, we have seen a typical expansion in the VIX relative to the longer term bollinger bands, now followed by a sharp move back into the bands.  In my opinion from this analytical standpoint another move in the VIX above the current spike would not fit the typical relation of the recent corrections and associated VIX activity.  So again, from a little different angle, last week's low appears important.  And looking out further than that, if there were another spike in the VIX and new buy signal, if it were followed yet again by another higher breakout in the VIX, I believe it could lead to a sharp breakdown in stocks an spike in the VIX.  That is looking out kind of far, but is preparing for contingencies in market action.

One relationship that has occurred at most corrective bottoms in the last couple years is a VIX:VXV ratio closing above 1.0 during the correction.  This did not occur this time around - but that is the only potentially significant disimilarity that I see at this point.

Other measures of intermediate term extremes in selling all seem to have reached the levels that have corresponded to corrective lows over the lat 2 years.  Total put/call ratio, McClellan oscillator, TRIN are notable examples.

I am basically discussing this here to build a case that given the current signals, IF the current bull market is to continue, THEN a corrective low is likely in place already.  That would make any move to lower corrective lows a very notable occurrence, and likely warning of significantly larger price declines in store (in my opinion).

Pete

Today's Bottom Reversal Attempt

Today stocks put in a bottom reversal attempt.  All the key factors are in place based upon my algorithm, so this could be a legitimate time to make a trend continuation buy.  However, the position would need protected with a sell stop below today's low.

This is a shorter term signal in that price is only at a 1 month low.  And these have higher failure rates than similar longer term signals.

Now a subtle factor here is that the Russell 2000, IWM, did break below recent support as suggested.  However, price reversed back to the upside, and it closed substantially higher, where the other indexes were flat.  To me this illustrates the flush out of stops and then trade algorithms kicking into buy mode just below support, which occurred on the Russell but not on the other indexes.  This being the case, it seems to be a hint that the buying is not broad spread legit  market interest, rather it may be simply a reflection of the price/chart structure of the Russell 2000 index.  So for now it looks good.  However, I have seen this type of trade action before at key chart points.  And what I would warn of is that a break of today's low would indicate that all the short term program buying was exhausted and that prices may then fall sharply.  A notable comparison may be the August 2011 break of the June 2011 low.

So at this point it may make sense to be flat rather than short.  Also, a move above today's high could be a typical buy signal.  But a move below today's low could be reversed into a short or used to establish a new short if out of the market.

As a side note, the significant lows over the last year or so have occurred at the 126 day simple moving average.  And today's reversal on SPY occurred there as well.  So again, based upon that measure of trend, this would be a logical stopping point for this decline.  And again at significant market turns, there will be a change of character.  So, if prices decline below today's low with several percent follow through, that may reflect a larger scale market turn.

This is my take on things, anyway, and I will track the market more closely here for the blog as volatility is picking up.

Pete

Downside Projection Based on IWM (Russell 2000) Chart Pattern

Click on Image to Enlarge

This chart is a daily chart of the IWM etf which tracks the Russell 2000 small cap index.  Of note here is a picture perfect double top so far where there was a false breakout and immediate selling.  Now prices are at support where I have highlighted with green arrow a price level that has formed a very tight support level at about 108.00 on IWM.  These are logical stop points based on price history on the chart.  That being the case, there are two things that we can be quite sure of in my opinion.

1. Prices will break below those levels in order to run the stops 
2. Given the magnitude of the pattern, there are likely enough stops and new short orders to create a follow through in price below the support level

How far will it follow through?  Obviously only time will tell.  But based on a typical double top chart projection, I have placed a projection line down from the support level showing a price projection to 95.50 if the double top completes and meets the equal projection from top to neck line, down from the neck line.

My personal bottom reversal algorithm registered a new extreme in downside panic yesterday.  So at this point, we need to see a divergence in real money sentiment to develop concurrent with a price reversal bar in order to consider any long side trade from this point.  

So to be clear here, there is currently a long side set-up on par with other high quality set-ups that have occurred in this bull market.  So on that basis keep alert for long opportunities.  However, given the multiple time frame large scale bearish divergences just completed, the double top in the Russell 2000, and other large scale optimistic extremes registered recently in the bull market, I expect that this correction could unfold differently and more ferociously to the downside.  And bottom reversal signal that does occur certainly needs to be protected with a stop.  I will update when those signals occur.