Well that didn’t take long. We found the Red October. And this crystallizes a key aspect of the trading process: Market analysis. Nobody can tell precisely what the market will do next and in what shape or form, BUT keeping a close eye on the signals can help up identify the risk/reward at any given time and as traders our job is to constantly reevaluate the signals. The structures we have been evaluating said the consolidation phase would resolve to the downside and it did. Tuesday’s nights $ES chart showed us that $ES 1944 was a likely target. It was hit. Yesterday morning’s review of the details of the 125MA hit revealed that at 10/12 handle spike lower was possible and we got exactly that to 1934. I may of course be preaching to the choir here, but I want to highlight the critical aspect of all this:
People that just bought the previous 4 days lows and held were just not paying attention or had no trade plan or process. As traders we have to respect the signals and constantly keep a lookout as to what the market views as important. And what’s important can change and will change, but as long as it’s relevant it’s relevant. And yesterday’s move showed that the 125MA $ES check remains relevant for now:
So what are the signals telling us now that we got the flush?
The chart above is one of the signals that for now suggests that the risk/reward has shifted to the long side. That does not mean we can’t go lower from here, but in my mind this is not a good place to short at all. The key evidence:
Firstly note that this long term chart of the high lows that I have been showing this summer has finally cracked. The key observation was that this had been the longest uninterrupted period of no negative readings and the speculation was that this would change as we approach the end of QE. Well it did:
But now we can observe that the readings are already as negative as they were during the end of QE2, but still far from how negative they can get. The similarity in divergence to 1998 and 2007 are notable. 1998 resulted in new highs, 2007 did not, but for now we have no crisis on our hands, hence I have to give weight to the QE2 example.
The percentage of stocks above the 50MA on the $SPX is reaching a key bounce zone:
This was one of the elements missing in yesterday’s chart and here we are. So not good risk reward to be short here, but the chart can still move a bit lower.
The $NYSI also continued to move toward the extreme oversold reading observed in last year’s structure:
The message is in essence the same: We may move a bit lower, but the risk/reward it pointing toward the long side. Also note the structure points to a bounce and then one more low.
The $SPX monthly chart also points to 8MA support just underneath at 1936:
So seemingly this could be an area hit today if we see additional weakness on Draghi. I plan to add calls there if we get there. But I’m also highly conscious of that monthly MACD ready to cross over.
The weekly chart remains ominous as well as it shows a break of trend line support, but remember it’s a weekly chart and the week is not over. A solid bounce can save it again:
With the pre OPEX week low approaching next week I am keeping a close watch as the 1882-1900 $SPX area as a target, but ideally would like to see a bounce toward the trend line for a retest and see oversold conditions alleviated first. A push toward the weekly MA near 1975-1985 would likely do it.
How oversold are we? The $IWM’s RSI says it all:
Its weekly chart shows it at key support and we are now in a 5th consecutive week of decline. That didn’t even happen in 2011, but rather in 2012 and resulted in a multi year bottom. So risk/reward suggests at least a bounce to touch the trend line before resuming lower. Will it move all the way to the lower trend line? Unknowable, but if it did this market would move a lot lower than 1,900:
As it stands the data says we are very oversold and are playing out a repetitive structure that suggests a bounce is coming that I want to be long for. If this is the case next week will then be critical to determine whether a swing low is in place (the still higher probability case) or if we break much lower.
My daily roadmap for now suggests something similar to the outline below which would in essence be a blend of the two scenarios which would build a beautiful heads and shoulders with an 1,800 target on a renewed break of 1,900:
Now that would be fun 😉
Today in my view we either bounce right off of Draghi today or may see the lower price range I suggested first and then bounce. Tomorrow is NFP Friday and we may see some short covering ahead of it. I’m not the only one seeing these internal signals and if I were short I’d take off some off ahead of NFP and who wants to wake up to a 20 handle gap up? I would love to see a move into 1,900 next week for the low before OPEX, but as we all know: You can’t always get what you want.
Yesterday I also started initiating $TY shorts based on the long held view that a sell-off would produce a flight to safety into bonds. It sure was accomplished yesterday and my $TY short is betting that yields will rise. They will eventually as the Fed will raise rates next year. The question was always when to get back into the trade. I had waited and yesterday appeared to be good risk/reward:
Any bounce in equities should see a retreat in bonds. For now everything is held hostage to the ECB action today and we have to await the market’s reaction. My strategy is to add into future and option long positions into the monthly $SPX 8MA level of 1936 should we see it.