Bull markets don’t die of old age. The Fed kills them. And with the Fed admitting last week that inflation is no longer transitory, the thought that the Fed is considering homicide has been infecting the markets from top to bottom. The damage is serious, and we deal with a deeply wounded market.
All time frames (Monthly, Weekly, and Daily) have ceased one-time framing higher for the first time this year. Again this week, options market makers are pricing in considerable volatility. The expected move is double the normal range in each direction from Friday’s close (120 points on the cash index). For the cash index, the WEM high is 4665, and the low is 4411. As one concern, weekly options pricing allows for a potential move to the October low before the market makers start losing any money. It is a great time to sell premium as an options trader.
However, now that the market has everyone’s attention, it may be ready for a bounce. I gave an uber-aggressive long “trade” signal late Friday at 4604 on the S&P 500 (apologies for the 4614 misprint). I am holding a call debit spread this morning, good through the 21st, and we will see if it becomes profitable. Using a spread to tamp down your Vega risk is critical, as a straight call profit can get muted if the volatility abates.
This aggressive swing trade is not supported by a Navigator buy signal, which has yet to materialize. This trade is more of a technical day/swing hybrid and oversold play that I will not hold for long. I may sell into any strength in the next few days. But it is useful to review the technical context.
The market sentiment is close to a short-term, negative extreme which is bullish. For example, the VIX and the Put/Call ratio are at the highest level for the year. The CNN Fear/Greed index is at an extreme as well. In other words, fear is back, which is positive for a bounce.
Price is intersecting with the weekly mean, the 50, 89, and 100-day lines, the weekly channel uptrend line, and a 50% retracement of the October to November rally. These are technical levels where institutions typically add to positions.
Additional bullish reads include the laggards (like the Dow (DIA) and Russell 2000 (IWM) bouncing Friday while the monsters of tech (NASDAQ 100 – QQQ) were finishing the initial phases of their declines. Neither the Dow nor the broad NYSE put in new lows, diverging from the other indices. So far, the DIA and IWM are holding their 200-day lines. Junk bonds are not confirming Friday’s lows either, and we had fewer decliners on the A/D line. There is more, but you get the picture.
This confluence gathers around the 4550 level, which should be the key level to watch for now. If 4550 does not hold, it is a quick trip to the next confluence of support at 4500. Short term, I expect a bounce up to 4625 or so, then another roll down to test last week’s low at 4492. All of this down leg should culminate in a final low or retest around the 15th when the Fed wraps up its latest meeting and announcements, and the 80-day cycle trough is due. The fact that cycles bottom around quarterly earnings and Fed meetings is no accident.
You can watch for my technical setup signals, but the better wisdom is to enjoy the holiday season and wait for the Navigator Algorithm to reset on the daily timeframe. This is a dangerous market with a lot of volatility. Last week, we had 2% and 3% daily swings, which is stunning with five or 50 to one leverage on a futures contract. There are more of those swings in front of us.
This is not the typical correction we have seen over the last year. This decline is much more serious and could signal the onset of a cyclical bear market. However, bull markets rarely transmute to bear markets immediately. The market usually establishes a trading range first, and I could see such a range forming from the October low to the recent highs (roughly a 10% range). Otherwise, if this is merely a deep bull correction, we will see some spike lows (remember those?) and fireworks before the uptrend resumes.
Money managers and hedge funds still have record long positions and margins. Unwinding all of that, should these professionals head for the exits, will make last week look like a blip on the radar screen. As well, Libor Rates inverting and the crash in oil prices warn of a potential recession ahead. With Consumer Confidence in the proverbial toilet, a recession is definitely on the table. It all depends on the virus fear mongers, the Fed, and the fiscal stimulus coming out of Congress.
It does not get much better than this as far as volatility goes. However, no matter how it looks on your screen, these are huge price bars, even on a five-minute chart. Consider reducing position size (e.g., use micros rather than minis on your futures trades) with the volatility at hand.
What the market is doing right now is bouncing the laggards that led the market down while the large-cap tech stocks finish correcting. So your best trades could be the Dow and Russell Futures today, rather than the S&P 500 and NASDAQ 100 – both of which bear the brunt of the large-cap tech stocks catching up to the correction.
We will come into the open with overnight inventory net long – so expect some profit-taking first. Use Friday’s candle range as your balancing area. You are looking at a playground roughly from 4500 to 4600.
If we head north, watch your downtrend line which could stop any return to 4600. The 5-day line (currently at 4564) is the flex version of the downtrend line and has been provided considerable resistance since the decline started. Closing above this flex line (and trendline) will be the first step to bringing back the bulls.
Going south, the intermediate, weekly channel uptrend line can also stop any return to 4500. The 100-day line is the flex version of the weekly channel bottom/uptrend line. Closing below those lines bolsters the bear case, likely to establish a trading range from the October low.
Use a break above the overnight high at 4572 or below the overnight low at 4531 as your first directional clues. Breaks of the trendlines also help you determine direction but watch for fakeouts. As always, monitor for continuation, which is best accomplished using a market and volume profile chart. When you see volume and time at price confirming direction, you have the “continuation” we look to confirm.
The bottom line is to consider long trades at the low end of the balancing range and profits at the high end. Be very careful taking positions in the middle, which is where we are slated to open at this writing.
Short trades are off the table for now unless or until we start closing candles below Friday’s low at 4492 on the hourly chart. Even then, it would be a quick trip to 4450. Otherwise, the market is very oversold here, and you should consider covering any short positions on weakness. The lows of the last three trading sessions congregate around 4500, so it is an identifiable line in the sand.
Also, keep in mind that we tend to put in lows on Monday and turn it around on Tuesdays. This is a notably strong seasonal period for stocks. However, the Santa Claus rally may not ensue until after the Fed meeting on the 15th.
Be very, very careful here. Don’t box yourself into a corner and watch position size in this volatility.