SPX At Make or Break Point

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There are some significant potential time relationships that are occurring right now in the S&P 500.  Three potential reversal time points all lined up on Thursday.  The primary time being that the rally off the October low is now 0.618 of the time of the May-Oct decline.  The other relations are represented by the green boxes as a possible ABC relationship, and the purple line which is the same time as the August rally off that waterfall decline low projected up from the Dec low.  Given the price at a breakout point here, this may be a set-up for a failed breakout.  Any technical signal can be used here to enter short if a valid sell comes. 

If the trend is to turn down in the markets from this point, the logical price confirmation would be for the coming move to retrace the entire rally since the Dec low in less time that it took to form.  If that happens, I would consider the trend to be/remain down.  If that does not happen, BUT the market does correct more slowly, then we will likely see another sustained move higher to follow that correction.

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The total put/call ratio is relatively low right now, and extremely so, given the range over the last year.  The market shouldn't have but a few days to make a top in a typical downtrending environment.  I will also note that the longer term put/call ratios are in down trend mode.  So while price is neutral, the sentiment is in bear mode.

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There has been a 7-8 week cycle at play over the last year.  This past week would be due for an inflection point. 

Based on the evidence above, my belief is that the market is unlikely to successfully make a breakout of this level right now.  However, if a reversal doesn't shape up in the next few days and the market remain below the Oct high, then the trend indicators will likely be in up mode on the daily time frame.  Those can lead to steady low volatility up trends.

Market at Price and Time Resistance

In November I showed some time projections for bear market rallies and mentioned that since 2000, the average bear market rally has been about 62% in time of the average declining leg.  We have just surpassed that time frame in our current market.

With a slight new high above the Oct high in the S&P 500, and the S&P 500 at 1295 which has been repeated horizontal support and resistance, this will be a defining level for whether the trend is up or still down.  Also the 78.6% retracement of the May-Oct decline is just overhead, and downtrending move will typically not retrace more than that.

 The chart above shows that the weekly stochastics is overbought.  There is bearish divergence on the shorter time frame RSI compared to the Oct high.  If the downtrend is to resume, there should not be more than a brief break of the Oct high.  If an uptrend is developing, then we may see a pullback prior to a break to new highs yet again.

The daily ADX/DMI on the Dow 30 is starting to shape up like an uptrend.  However, the textbook signal of an uptrend is when the ADX turns up above 20, which it is not yet.  However, several more days will put it there.  So again, we are at a defining point in the next few days here.

Market Update

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The daily MACD has turned down on the indexes now as shown in the chart above.  However, so far this move down is much slower than the move up off the late Nov low.  So I think the odds favor the market turning up here, similar to mid April.  The seasonality is positive and there is no confirmation of a new downward pattern yet, so the odds are that the market drifts up over the near term.

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The 10 day advance-decline average did not hit quite the extreme level on this last little rally, for a top of a leg up.  The average crossed back below zero which is usually a decent continuation sign for a downward move after an extreme reading, but it may be a whipsaw here.

The equity put/call ratio was above 0.90 the last 2 days, which is a little odd given the mainly positive bias Friday.  From a contrarian standpoint, it would favor at least a day or 2 bounce from these levels.  Longer term I don't think it is very significant.

Again the 1226 SPX level is a significant harmonic level.  If the market stays under that level (which it did close back under after moving above it Friday) it would favor continued weakness on that front.

Probably the most reasonable expectation is for a somewhat lackluster and slightly positive market into the New Year time frame.  Then likely some selling afterwards would be my guess.

[As a side note, I will be making some significant changes to the blog for 2012.  I will make a more detailed post going over those as I make them.]

S&P Update

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The current trades are going basically as planned right now. The next step I will be looking to do is to move the stop on DXD to a breakeven point. Depending on what tomorrow brings I may opt for doing the same with SPXU and holding it. As I've noted several times in recent months, I expect the initial move down from the highs to be sharp. I wouldn't expect the highs of the last day or two to be exceeded prior to the break of next support. That is 3-4% lower on the S&P which is about another 10% gain down from today's levels on SPXU.

Now tomorrow is the monthly payroll/jobs data. There is a contrary element to these reports. More weakness will likely be ahead if the market gaps up tomorrow. But there is some decent chance of a rebound if the market gaps down.

The chart above shows boxes around the June-July and the current corrections which are on a log scale. One thing I always say is to look for a larger and faster correction than any prior counter trend move. These often start new trends. By this measure, a move below 1045 in the next trading week will create such a situation. Also when considering that volatility (VIX) was 50% lower on the start of this decline than the June-July decline, such a decline would be very significant.

Also, I still am suggesting that the market may move back down to the June high/July low region in the next month or two.

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The action in gold today appears to me to confirm a new leg down in gold, which does not support the idea that there may be another major inflationary leg up, at least not beginning real soon. However, on a breakdown move like this prices should typically not close back above the breakdown point if the decline is to continue. This is all the more important as it is now oversold on the daily oscillators.

Some Fibonacci Ratios to Consider

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The chart directly above is the S&P 500 cash ($SPX). Most of the notes on the chart I have mentioned at some point in prior posts, but I thought I'd bring them all together.

The most important thing I wanted to point out is that the advance from the July lows to today is an almost perfect golden ratio relative to the March to June advance. For those who don't track Fibonacci relationships much or have never seen them "work" this won't mean anything. I have looked at so many charts and seen so many "harmonic" relationships in corrections, that I have no doubt what so ever that these ratios show up in various ways in stock prices. The especially interesting thing here is that the perfect 0.618 relationship of the March-June advance projected up from the July low, almost pinpoints the top of the gap down on 10/6/08. It is at times amazing how the relative sizes of various moves relate to create Fibonacci relationships between key psychological points in the market. Even more amazing is that a basically exact 161.8% (inverse of 0.618) extension of the January closing high to the March closing low coincides exactly at the level of that gap down as well (see chart below).

This really struck home this February when I saw a somewhat similar thing occur. Without going into the details, there were gaps in the decline last November that were at precise locations dividing the decline into Fibonacci based sections. Then the exact middle of that leg down became the apex of a contracting type pattern at 875.75ish on the S&P. I was then able to use the projection of the % decline of that November leg down, down from the apex in conjunction with another specific type of harmonic pattern to project 650-670 as the next likely bottoming range for the S&P. It bottomed at 666 and I posted a blog trade on the day of the low. The point of this is that when these things start to come together, it is possible to go on trading runs like shooting fish in a barrel, which was basically how it went from January through March of this year.

So, this all could be a waste of time and the market could go up forever or just make a muck out of anything I've talked about, but the Fibonacci ratios relative to the position of the gap are a fact regardless of what happens here, because it is all based on past price data. There is also an interesting breakdown of the July-present advance if a top happens here. I have basically put the info on the chart, but won't go into much on that, because I am just speculating on a top here.

In any case, I feel that the market is talking Fibonacci language and I'm listening.

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Expectations and New Bearish Trade Set-Up

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Last week I had said that I would revert back to short-term trading mode if the S&P 500 did not manage to fall below 800. It did not, and that prompted me to suggest placing a stop loss on BGZ to protect some of the gains we had. The stop loss was hit Friday resulting in a 4% gain, so there are no open trades on the blog right now.

The chart above is the S&P 500 as of the end of this past week. I have put several notes and lines on the chart with the most likely scenario that I think will occur. That scenario is a sharp advance next week up to 875 or beyond, followed by a very severe decline beginning after that. The reason I put these projections and expectations on the blog is because it is fundamental to the way I trade and allows trading decisions to be reduced largely to logic.

I like to create "if" -"then" type scenarios. If so and so happens, then I will make a trade......

Also, I have expectations for what "should" happen after the trade is entered, in order to confirm the likely correctness of that particular outlook.

So the logic for the coming week is.......

If the S&P 500 moves above 875 by Thursday with overbought short-term signals, then I will suggest a new trade on an inverse ETF (BGZ in this case).

Now the rest of the analysis may only interest or seem coherent to someone interested in wave theory, but there is a logical component that should be easily grasped in any case.....First, the light blue boxes (with green lines inside) surround the upward phases of market movement since October. Second, the pink lines highlight the weekly highs and lows of the downward phases during that time. Notice that the upward phases have multiple overlapping price moves, like price is moving a lot, but not getting anywhere fast. Now the downward phases don't overlap, and price is able to move in one direction for a sustained period of time.

The basic market logic is that the current trend is in the direction of the fastest and largest price moves. That still is definitely DOWN at this point. So until, we see a large and fast upward move (larger and faster than any other upward moves), then it is wise to assume the main trend is still down.

I have referenced the price pattern above as a possible "triple three" correction, which is a term from Elliot Wave theory. Without getting into details, that is the most complex corrective formation possible. So after this upward phase ends, the larger correction should end, and the market should resume a strong downward trend. Again, if this does not happen, then I will have to consider a change in perspective.

Because the potential still exists for a huge move down, if I recommend BGZ this week, then I will plan on holding it for a longer period to try to catch the big move. I will be using intermediate term models for the exit rather than short-term models. If the market follows the scenario laid out above, then we should be able to get in at a lower price than the 62.26 entry on the last BGZ trade, which will be the best of both worlds -- we already made a 4% profit on the last trade, and we get back in the new trade at a better price than the original.

Pete

Potential Change in Strategy Later This Week

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The chart above is the S&P 500 ($SPX). Nothing has significantly changed from my perspective, but if the S&P 500 does not fall below 800 (another 4% approx.) by the end of this week, I will plan on shifting my blog trading strategy back to short-term only until things make a clean break one way or the other. The reason for this is that I would be a bit befuddled from a technical standpoint if prices do not fall almost immediately. So, an exit recommendation for BGZ tomorrow evening or mid-day Friday is possible.

Yesterday was a big decline, but prices stayed above support, and there was no follow through down today. The light blue box on the chart shows what I have previously noted as the key price levels to watch (800 and 880ish). Also, the red uptrendline from the Nov. to Jan. and Feb. lows is an important line. Prices are riding that line for the last few weeks.

Now as a side note and piece of market education.......

Sentimentrader.com (the main site I use for contrarian type data) has an indicator that shows what volume of calls and puts are being used to open new option positions by "smart" option traders (S&P 100/OEX options). In stocks and options there are those who consistently time the market well (and logically), and those who don't. You should pay attention to what the smart traders are doing, and typically do much the same.

The indicator as of this past weekend is showing that the smart traders are opening put options to a relatively large degree over the last couple weeks. This basically means that they expect the market to fall from here. This indicator shows that they are demanding more put protection than at any time during the entire bear market thus far. This indicator does not move to extreme levels often, but when it does, I pay attention. The last times the indicator approached current levels were right near the May 08 and August 08 market peaks which led to large declines over the next 2 months each time.

Pete

Short-Term Overbought Again

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Short-term breadth, momentum, and put/call ratios, are all at or very close to typically overbought extremes. We are currently at a slightly lower level than the last overbought signal from last Wednesday. I like to go with the longer term trend for short-term trades, which in this case I consider to be down. I also like to see successive overbought signals occurring at clearly lower price levels in order to enter bearish trades. Right now it is not clear that the highs from last week won't be exceeded, so I can't be sure that this signal is at a lower level yet.


The first chart above is the S&P 500. The blue circles and vertical lines indicate the 3 period RSI is over 80 while the 200 and 50 day moving averages are sloping down or flat. Several of those instances coincided with short-term overbought signals on the models I use for trades on the blog. Typically there was an immediate pullback of at least 3 days. Several instances also marked significant tops leading to major declines. Also the notes on the chart show the typical break of support after a bear market rally top, followed by very choppy rallies that barely held the highs of the initial rebound rally after breaking support. The light blue boxes outline the May and Sept. instances. We are set-up almost the exact same way right now. If the result is different this time, that would sound an alarm that maybe the market is changing character.


The next couple days will be key to see if the break above the downtrend line (blue line on yesterday's chart) from last September to this January is able to be decisively cleared or if today's close above that line will be just another whipsaw fakeout (which is my guess due to overbought extremes today).


I read a backtesting study this morning showing the short-term returns after a 1% up day the day before a Payroll Report (like today) with a gap up and higher close on the Payroll Day (like today). The three day returns are consistently negative with an average of -1.0% return. That is not a real big negative average, but the consistency coupled with short-term overbought readings makes for a pretty good bearish set-up in my mind.


Two other interesting pieces of data from today......


Despite a large up day, the volumes of the index ETF's (SPY, DIA, QQQQ) are much lower than yesterday. From past studies I have seen on this type of set-up, I believe this also has short-term bearish implications.




Also, despite the large up day today, the VIX only declined modestly and ended the day well off its morning lows forming a "hammer reversal" candlestick pattern in the process. I noted a similar occurence on the blog on Jan 2. That day marked the last real significant up day before that rally stalled and then gave way to 2 weeks of selling. See the second chart above for the VIX chart.


All in all, the short-term set-up looks pretty good for a bearish ETF trade, but I am going to hold back until we see what Monday morning brings. Any new short-term trade should be viewed completely independently of the current longer term trade on BGZ.