A Healthy Market Pause Looming

Last week here I wrote “I took a look at every bullish weekly MACD signal cross since March 2009. In each of the 10 instances, the market continued to make higher highs the following week 100% of the time. Furthermore, in 9 of 10 instances the market also closed higher to end the week. The one instance that failed (July 2013), the market closed 1 point down, so essentially flat. No system is full proof, but that should give any one attempting to short the market pause.”

As the previous instances suggested, the market did make a new high keeping the 100% bullish weekly MACD signal valid. The second indicator however is now 9 for 11 as we closed lower on the week. However, note that just as the first failed higher weekly close (July 2013) when SPX was down a minuscule amount, this last time it too was only down 0.27%.

Implications for next week:

Unfortunately there isn’t as clear a path for next week, but based on several factors it does appear that a period of consolidation through sideways action or a small pull-back is more likely than a further rally. Stocks making 20-day highs has begun to fall back showing less buying interest at these levels. This doesn’t necessarily mean the current rally from the breakout at the start of February is over, but it does signal that it might take lower prices to bring back more buyers. Screen Shot 2015-02-28 at 5.59.39 PM

Furthermore, and this is purely anecdotal, there appears to be less stocks that look appealing for an imminent breakout. Many of the momentum stocks that I follow have recently provided amazing opportunities for short term gains (especially with options), but their breakouts are being given back to test areas of support. If anything I view that is healthy and bullish as rallies are being held back for longer consolidation periods. Having said that, more patience is likely needed before a further rally that offers good risk/reward long set-ups.

SPY open interest for clues to next week:

Below I have posted two different views of the SPY open interest because the wider range shows a much different picture than one viewed more narrowly. The first includes the 215 strike on SPY. There is almost 160,000 open calls at that strike substantially outweighing any other strike. Typically when I have seen this in the past, price never even gets close to that high strike. The last time we saw this was during the third week of December 2014. During that week, which began on December 15’th, the market dropped the first part of the week making a short term bottom for the remainder of the year. Toward the end of the week the market gapped up (in which it printed that magical ghost print at 212.97) and then closed the week at 207, below the very high open interest calls that existed at both 210 and 215. Perhaps one could even make the case that the ghost print had something to do with the high strikes. Regardless, the point being made is I would be reluctant to expect SPY to touch or even get close to 215, which is currently 2% higher than Friday’s close. To learn more about how to read open interest see here and hereSPY.A

The second view below is more narrow and offers areas of support through the puts that align well with technical support. There is high put open interest at both 209 and 210. That would be the area the market will likely find support on weakness. Typically a bounce would ensue at that level; however note that a second touch below the 210 level would likely lead to lower prices at least targeting support at 208.50 and possibly the 20-day moving average at 207.86. Note that dropping below 210 could possibly lead to delta hedging by market makers and thus lead to a quicker and more intense drop than usual when in a longer term uptrend. More about delta hedging can be found herespy

In sum, the rally from the breakout at the start of February is likely to continue higher, but probably after a small-pullback/consolidation period. I would view any rally next week suspiciously and instead look for areas of resistance to short stocks in a downtrend and/or areas of support to buy stocks in an uptrend.

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