Potential SPY Reversal

As SPY fell Friday after 2:00pm, it did so in two distinct thrusts that were retraced about .618%, and closed while engaged in a third thrust downward. So, a potential Bullish Three Drives pattern is developing. See page 220 in The Harmonic Trader. Here is the pattern so far on the SPY 1-minute chart (click to enlarge):

So, a drop to $73.24 on Monday is a potential reversal area. The equivalent level on the SPX is 729. Since the market is so weak, a further extension of the final thrust down might occur beyond 127% to 161.8%. Those SPY/SPX levels would be $72.80 and 724.95.

In the comments on Friday, I said that the market could bounce when the Russell 2000/IWM hit its November low. And the R2K is only an eyelash above its closing low on November 20th, and its intra-day low on the 21st, right now. So that is good additional evidence for a bounce after a further dip.

Also in the comments Friday, I mentioned that the IWM has a bullish inverted hammer candlestick on its daily chart. So, that is another piece of evidence.

Do you see what I’m doing here? I’m using three different approaches to build a case: harmonics, traditional support/resistance, and Japanese candlesticks. I will continue studying the problem from different angles and see if I can strengthen case further.

The next angle is sentiment. As I mentioned in the comments on Friday, people on CNBC were euphoric over “The Amazing -199 Point ‘Rally'”. In fact, you can see Maria Bartiromo praising the market while it was falling at 3:45 into this interview with Robert Prechter on CNBC Friday afternoon (sorry, CNBC took down the video).

That went on all day. As we have been discussing in the comments, there was no panic as the SPX took out a major low. In fact, there was quite a lot of bullish cheerfulness as reflected in such indicators as the put/call ratio. So, I’m thinking if a rally develops next week it won’t get far because so many traders have probably already placed their bullish bets.

Now lets do a gap analysis:

First, lets consider that the Gap of Doom was a “continuation gap” continuing the move down from the February 2nd top. Here is what the textbook says about such gaps on page 219:

Its inference is that prices will go as much farther beyond the gap as they already have gone between the beginning of the move and the gap, as measured directly (and vertically) on the chart.

And indeed, if you look at the Fibonacci retracement I have drawn on the chart, you can see that the Gap of Doom is placed neatly in the middle of the wave down from the top on February 9th to to the close on Friday. In fact, the top of the gap is right at the 61.8% fib (blue line and blue arrow) and the bottom is right at the 50% mark (green line and green arrow).

Prices snapped back hard from Friday morning’s gap down (red “G” on the chart), so it is possible that that was an exhaustion gap which may terminate the wave. Also, during the day Friday, I said in the comments that I was shorting as SPY filled the gap at point “X”. Prices usually reverse when gaps are filled, so I was just fading the gap. However, the fact that SPY was able to fill just about all of the gap is actually bullish because it ate away at most of the resistance there. So, if SPY can climb back up to the “X”, it has a good chance of being able to eventually punch through.

This chart shows some potential rally targets:

The market has two downtrend lines: The 2009 downtrend line (upper blue), and the February downtrend line (black). I have also made an exact parallel to the upper blue line to form a potential downtrend channel.

SPY may want to drop a bit more to tag the lower blue line before moving up. If SPY is not able to recapture the black line, it will likely embark upon an even steeper dive. The purple and yellow lines are potential Fibonacci resistance levels, and the blue “X” marks an ideal spot for shorting. There is triple resistance there from the blue downtrend line, the Gap of Doom, and the turquoise line, which would be a 50% retracement of the drop from February 9th. That’s about 805 for the SPX.

As Phil mentioned, there is a full moon on March 11th, so a rally up to the blue “X” around that time would likely bring out the same frothing-at-the-mouth-bullishness that we saw at the full-moon peak on February 9th. Wouldn’t that be a beautiful shorting setup?

Also on the chart, notice the volume at the November low (black circle), and the volume last week (blue circle). As I have been saying in the comments, volume looks too low to put in another major bottom. However, if volume continues to increase (purple line on volume chart), it would be very dangerous to add short positions.

Thursday’s Trading – 2/26/09

I don’t have much time to write tonight, but I think that Thursday morning we will find out what the big funds think of the “stress test” news that came out after the bell on Wednesday.

So, I will be watching XLF very closely. On the chart in Wednesday’s game plan, I showed XLF with a 100% extension off of its low. On Wednesday, XLF was able to extend up to the next Fibonacci level (127%) at $8.37. That is also the lower bound of its Gap of Doom, and it immediately fell back.

If XLF can power up into the G.O.D, then we have a hint that the big funds might like what the Obama administration is doing with the banks. And if that’s the case, then SPY may be able to complete its head-and-shoulders bottom.

The futures were rallying a few points after hours, but have fallen back as I write this. So maybe the rallying was just some knee-jerk short covering after the “stress test” news came out.

Also, since we are in the traditional month-end-markup period, you would think that the gremlins would be levitating the futures to drum up some phony bullishness for the open. But they are not, so far anyway. So, maybe that is a hint that the big funds are not enamored of the latest banking rescue.

SPY Working on H&S Bottom

Here is a 15-minute SPY chart over the past couple of weeks (click to enlarge):

The height of the attempted Head-and-Shoulders pattern is purple line “A”. If SPY is able to break above the neckline on strong volume, it could run up the price-projection line “B”.

Notice that SPY is having trouble holding the green uptrend line. Also, the Chaikin Oscillator is still negative indicating insufficient money flow into SPY.

Even if SPY can get it together and break-out, the setup implies that it will not be able to fill the Gap of Doom.

Wednesday’s Trading – 2/25/09

It’s very curious that Obama is on a mission to cut the deficit. Weren’t the Keynesians just arguing that we need to dramatically increase deficit spending to stimulate the economy and pass a gigantic stimulus bill? You know the rationale: it doesn’t matter what the government spends money on as long as money is injected into the economy. They could buy cars from GM and drive them into the ocean, and the jobs created at GM would still be a net gain for the economy. And now Obama is going to cut the deficit?

I’ll bet that nothing is cut from the deficit. In the end, money will be shifted from Republican constituencies to Democratic constituencies. Politics will be done as usual, and nothing to truly help the economy will be done as usual.

Game Plan – 2/25/09

Now that Bernanke has shot down the Obama bank-nationalization trial balloon, all is well. The crisis is over. The banking crisis has been solved – yet again. In fact, we should have a big party on March 14th to celebrate the first annual anniversary of the solving of the crisis when Bear Stearns, the black sheep of Wall Street, was put down.

Oddly, after March 14th, the banking crisis just kept coming back, like the Terminator, alternately crashing and rallying the stock market. Funny how that happens. And the black sheep just keep on multiplying somehow.

But I’m sure everything is fine now! I’m sure all the toxic assets were magically wiped away while Bernanke testified before Congress. Hurrah!

The XLF rocketed upward 13% in relief today. Take a look at the moonshot on this hourly chart of the past few days (click to enlarge):

The XLF has completed a full 100% Fibonacci extension off of its low. I drew my fib extension from the low at point “A” to the peak at point “B” to the low at point “C”. So, at point “D”, we have the 100% extension. Of course, the XLF can extend farther, and if it does so tomorrow, it may be the first part of the market to confront its Gap of Doom. Rest assured that the XLF, and the rest of the market, will not sail right through the G.O.D. There will be a fight, and in the short-term, it is an excellent area to short against.

SPY is already overbought on its 60-minute slow stochastic. The last time it reached that level was February 13th – one trading day before the Gap of Doom. Of course, SPY was overbought on longer time-frames at that time, so after a modest pullback, or some consolidation, SPY could push higher.

However, there will almost certainly be a sharp correction to Tuesday’s rally soon becuase the froth is already thickening. Traders bought calls like crazy on Tuesday. Another day like this and the put/call ratio will be as overbought as it was at the peak on February 9th.

While the XLF is closest to its Gap of Doom, the IWM has a smaller gap coming up first. The IWM’s close from the 19th is a potential early stalling point for the market.

You should also have this down-trend line on your SPY chart. Might be a problem on Wednesday:

Here is the inverse head-and-shoulders pattern on the 5-minute chart that I was talking about in the comments on Tuesday:

To determine the price target of this pattern, you measure from the neckline to the head – green line “A” on the chart. Then you measure that same distance upward from the neckline – green line “B”. Notice that SPY turned down right after hitting the target.

The fact that SPY just completed an H&S means that it is now a man without a country. We don’t know what the next pattern will be. However, SPY was sold heavily at the close, and came in second on the selling-on-strength chart. So, with a nuetral news-flow, I would expect SPY to begin the day Wednesday moving down.

I added to my shorts at the bell. However, if SPY falls on light volume, I will consider parting with them because a low-volume decline would make the next pattern a bull flag. If a bull flag were to develop and complete, I could then put my shorts back on at better prices.

Tuesday’s Trading

Now that the QQQQ has taken out its January 20th low, the next stop is the November low. The Q’s still have a gap left over from the open on November 24th. I have the bottom of the gap at 26.67 and the top at 26.84. So, if the market takes another leg down this week, that is a logical zone in which to look for support.

Apple is also nearing two gaps left open from January 21st and 22nd, so those might be important levels where the market could bounce. Gaps will usually produce an initial bounce, but if the gap is filled, think of it as a support level being erased.

Make sure to see JungleGirl’s EWT projections here.

Game Plan – 2/24/09

Looking around the blog-o-sphere over the weekend, it seemed to me that the accepted wisdom was that the market was very oversold and that shorting was dangerous. I had that opinion myself. Another example is Sol at xTrends who is currently losing money on a long ES position. xTrends has been correctly bearish for a long time.

So, a lot of otherwise winning bearish traders were playing for a bounce on Monday. And yet their buying didn’t even make a tiny dent in the market. Even though most traders seemed to be in cash waiting for a bounce to short, or long trying to catch a bounce, the market plunged anyway.

I think we are seeing large funds distributing in a serious way. At first, I couldn’t think of a catalyst that would blow away the bullish technical setup that we had going into Monday morning. But now I think it was Obama’s pledge to cut the budget deficit. That, of course, is code for “raise taxes”, and “raise taxes” is, of course, code for “raise taxes on non-Democratic interest groups.”

That’s right; it’s soak-the-rich time. Obama hasn’t announced anything yet that I know of, but I’m thinking we should plan on such things as capital gains taxes being raised. And if you add that on top of all the other things going wrong in the economy, you could see why big funds would want out of the market. There is literally no light at the end of the tunnel.

So, while the market is indeed very oversold here, I’m willing to be short because this sort of free-fall can get ugly. In fact, the double-top scenario that I wrote about four months ago in Goodbye Bull is inexorably playing out. And it is a very long way down to the completion of that pattern.

So, my plan is to have a small short position to profit from any sudden plunges, and add to shorts on any strength that may materialize. If we embark upon a listless, apathetic drift down, there may not be much strength to short. In that case, shorting on lower time-frames might be the only option. So, for example, instead of waiting for SPY to get overbought on the daily stochastic, you might short it when it gets overbought on the hourly.

It is possible that a new apathetic market will behave differently, so it’s good to start thinking about what it might act like.

Just look at the put/call ratio. The market takes out a major low, and nobody is alarmed? Nobody is buying put-option insurance against a market plunge? The apathy meter is pinned to the edge of the dial.

Here is a 5-minute chart of Exxon on Monday (click to enlarge):

After a fatally optimistic gap-up at the open, XOM fell in a bearish broadening pattern (megaphone) all day. If that pattern remains in force Tuesday, things will not go well for the market. If I’m not mistaken, Exxon is the stock with the largest impact upon the SPX.

No More Rallies

Rallies are so 2008. Forget about rallies. There will be no more rallies. The jack will no longer pop out of the box and flop around like a flaming moron. The spring will not get wound tight enough anymore. Why not? Because the child is tired of playing with the toy. He will not expend the energy necessary to push the jack back down into the box. He is either depressed and in need of medication, or off playing with other toys such as gold.

Steven M. Sears plaintively cried out for an answer to the Vix conundrum in Barron’s:

“Even though the VIX is at an extremely elevated level, it is still far below last year’s intraday high of 89.53, even though the stock market is falling through last year’s low. It isn’t clear that anyone has a really good answer why, and this just makes people more nervous.”

If you have been foreclosed upon and kicked out of your house, do you still need homeowner’s insurance? No. If you have sold all your stocks and gone into treasuries or gold, do you need to buy put options on stocks? No. If you are a value investor with a years-long time horizon, do you buy puts on your stocks? No. If you are grimly holding onto stocks that are practically worthless, shaking your fist at the market and shouting: “I’ll see you in hell bear market!” do you need to buy puts to protect your stocks from becoming more worthless? No, you don’t have any money to buy puts.

A few days ago in the comments, I said that I thought we were heading into a long apathy phase of this bear market. And I’m thinking that investor apathy toward stocks translates into relatively lower levels for the Vix.

Of course, I’m exaggerating when I say there will be no more rallies. But you see what I’m getting at right? Last year’s March-to-May rally actually got up above the 200-day moving average. Remember that? They just don’t make rallies like that any more.

The McClellan Terminator

Take a look at this chart of the McClellan Oscillator (click to enlarge):

During the rally that peaked on January 6th, the MacOS hit an all-time high – point “A” on the chart. Think about that for a second. An all-time high level of bullishness when the economy was in a death spiral. Think about how wrong that was. How insanely, incredibly foolish those bulls were.

Now they are being punished. What do you think would be a just punishment? I propose that these bulls be punished with an all-time low on the MacOS. As far as I can tell from my data, it looks like the October 10th low is the record so far (“E”). And today we closed a bit above (“D”).

So, one more down day, and justice may be served upon the Larry Kudlow’s and Dennis Kneale’s of the world.

On the chart, I have drawn a Fibonacci price extension. I connected the peak at “A” to the low at “B” to the peak at “C” (light blue line). The software then draws the Fibonacci projections using those points. The point (ha,ha) of this is to get an idea of how far down the current wave will extend. In many cases, the wave from “C” to “D” will be equal to the wave from “A” to “B”.

The purple line marked “100%” would be a “harmonic” extension of the original wave down, and is a potential target.

The red and green dashed lines are the overbought and oversold levels for the MacOS. We have been oversold for five days now. During the plunge down to the October 10th low, we stayed oversold for six days. So, another down day is certainly possible.

Tuesday could be a capitulation day. A big plunge down, soaring volume and then a snap back. Where might the market bounce? I suspect that it is at the level where a lot of the big value fund mangers will be willing to catch another falling knife. What do they have in mind? 700? 650? 600?

I don’t know, but I should have something further to say on the subject later when I am done studying all of my charts.