The S&P 500 must have taken notice of the multitude of
headlines coming at market participants and proceeded on a path
of pure chaos. Since October 4th, the S&P 500 Index (SPX)
managed to trade in a range that spanned from 1,074 to as high as
1,171 in 4 days. To put the past 4 days price action into
perspective, the S&P 500 Index rallied 97 points or 9% in
less than 96 hours.
Since late July, market participants have been dealing with a
whipsaw that has been wrought with headline risk coming from
Europe and huge swings in the price action of the volatility
index. A few short days ago I was calling for a bounce higher in
the SPX as every time frame was oversold. After the jobs number
came out Friday morning domestic equities rallied sharply higher
and in the short-term prices were excessively overbought
prompting some profit taking.
Around lunch time the news wires broke that Spain and Italy
had their sovereign debt downgraded by Fitch Ratings. The
downgrade put U.S. banks under pressure quickly and the price
action started to rollover. By the end of the day price action
was starting to work higher but a sharp selloff played out in the
final 30 minutes of the session putting the major indices back
into the red at the closing bell. So the real question that lies
ahead is where do we go from here?
There is no easy answer to that question as the headline risk
coming out of Europe over the weekend could have a dramatic
impact on prices on Monday. Just as a reminder, U.S. bond markets
will be closed on Monday for Columbus Day, but equities markets
will be open as usual. At this point in time my short term bias
is to the downside.
It would be healthy to see the S&P 500 roll over here and
find a key support level where buyers step in and support prices.
A higher low would be constructive and could lead to a more
prolonged intermediate term rally which could last into the
holiday season. However, before we can see any sort of rally we
need to see a bottom form. While I do believe we have initiated
that process, until I see a higher low carved out on the daily
chart I will consider the current price structure to remain
In order to break to new lows, the SPX would have to push
through several layers of support. I am of the opinion that we
are unlikely to see the recent lows broken, but the chart below
illustrates the key support levels going forward. A test of the
1,040 - 1,050 price range remains possible, but the price action
the past week makes it seem less likely. Within the context of a
hyper volatile period of time, just about any possible outcome
remains feasible. The daily chart of the SPX below illustrates
key support levels for the index:
In addition to the weak price action into the close on Friday,
several other clues are pointing to potentially lower prices in
the near future. Members of my service know that I focus daily on
several underlying ETF's which help me get a grasp of the overall
market conditions. On Friday, the financials (
), the Dow Jones Transportation Index (
), and the Russell 2000 Index (
) all showed relative weakness against the S&P 500. The chart
below illustrates the relative performance on Friday:
The financials and the Dow Jones Transportation Index are
excellent sectors to monitor when trying to determine the future
price action of the S&P 500. Most of the trading session on
Friday the financials (
) were exhibiting relative weakness versus the S&P 500 Index.
Later in the session, the Dow Jones Transportation Index (
) started to roll over as well and once both ETF's were under
pressure it was not long before the S&P 500 Index flipped the
switch to the downside.
The financials (
), the Russell 2000 (
), and the Dow Jones Transports (
) all put in large reversal candlesticks on the daily chart by
the close of business on Friday. This is an ominous signal that
lower prices for domestic equities may be forthcoming. The fact
that key sectors are showing signs of weakness is a negative omen
for the S&P 500 and the early part of next week. However,
there is a bright side to this scenario.
If support levels can hold up prices next week and we see a
higher low on the daily chart form, the bottoming process could
be underway which could lead to a strong rally into year end.
Obviously a probe to new lows is possible, but I believe that we
are in the beginning stages of forming a bottom and a base for a
rally to take shape.
If support levels hold up prices, a bottoming formation will
likely get carved out on the daily chart of the SPX. The chart
below illustrates two potential outcomes that could cause prices
to rally sharply. In one case, a higher low is formed and we see
prices take off to the upside. The other scenario involves an
intraday selloff down to the 1,040 - 1,050 price level that gets
snapped back up and a huge reversal candlestick would be formed.
These scenarios are common during bottoming processes. The daily
chart of the S&P 500 Index is shown below with the two
The other scenarios would involve prices blowing through
support and possibly knifing down to test the S&P 500 1,000 -
1,008 support area. While I find this scenario to be less likely
at this time, anything could happen in this trading
The key in the short run is the utilization of defined risk
through the use of stop orders. In addition, a trading plan with
stop orders and profit taking levels planned ahead will help
remove emotion in a volatile tape. The price action is wild, but
from my perch the likely scenarios all involve some short term
selling pressure. If my analysis is right, this could be a huge
turning point for price action the rest of the year.
The next few weeks are going to provide us with clues about
the rest of 2011. The question traders should really be asking is
whether support will hold, or will we break below the recent
lows? Right now, the upside looks limited, but in this trading
environment the best thought out plans can turn out to be useless
if price action does not cooperate. Be nimble and define your
risk, as volatility is not likely to subside anytime soon.
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This material should not be considered investment advice. J.W.
Jones is not a registered investment advisor. Under no
circumstances should any content from this article or the
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recommendation to buy or sell any type of security or commodity
contract. This material is not a solicitation for a trading
approach to financial markets. Any investment decisions must in
all cases be made by the reader or by his or her registered
investment advisor. This information is for educational purposes