Bounce or Bottom? Next Week’s Game Plan

Last week here I discussed my bias being up and that if we were to get a dip below 205 it was a gift and to buy it. That turned out to be very sound advice even with all the volatility. About a month ago I warned of an impending small correction, which as you can see has begun to take place. The question is, was that it (less than 4%) or will the market see lower prices in the next few weeks? My current bias is the lows are not in; however, my primary bias* is that next week the lows will hold and the market will move at least a bit higher.

*As a rule of thumb please keep in mind that when I have a primary bias I am very open to being wrong and always have a plan of in place for other outcomes.

Oversold/Overbought: We finally made some real progress toward a washout in breadth for the first time in 2015.

SPX stocks at 20-day highs: This one is the more sensitive of the measures that I am showing below so getting oversold by itself typically can only signal a bounce not necessarily a washout. Having said that, when seeing extremes in this measure that last more than a day or two (as you can see in Oct of ’14) in conjuction with other breadth extremes it helps mark bottom.Screen Shot 2015-07-11 at 2.40.49 PM

SPX stocks at 20-day lows: This one is better at marking secure bottoms, typically after a couple readings over 50%. We have reached that once thus far during the current correction, but for a more confident swing long set-up, I would want to see this move higher.Screen Shot 2015-07-11 at 2.40.04 PM

SPX stocks above their 50-day MA: Another measure that has made progress toward a washout by getting near 30%, but once again, a better swing set-up would be getting closer to 20%. Screen Shot 2015-07-11 at 2.39.07 PM

TRIN: I typically don’t display this, but last week it became significant when it reached a reading over 3, which often precedes near term lower prices and a bottom. This measure compares advancing and declining stock issues and trading volume as an indicator of overall market sentiment. (For more on TRIN, see hereScreen Shot 2015-07-11 at 2.57.01 PM

Given that we have not seen oversold readings like that all year, the bounce was almost inevitable. That being said, I think one more good flush to really wipe out breadth would be a much better set-up for having a very strong and lasting rally.

SPY open interest and important levels: Taken at face value the open interest below is considered bullish with strong support at 205/206. It would be wild if the market dipped there again and held, but once again if it does buying the dip has good risk/reward.

Bearish scenario: If SPY does fall toward 205 (whether at the start of the week or toward the end) and cannot hold above it and especially if it breaches the low from last week of 204.11 then odds greatly increase we get the flush that I think sets-up the next big rally. Below 204, the next level of support is 202.50’ish and then 200’ish. Each level I believe are buying opportunities (at least for a bounce).

Bullish scenario: My main bias is that we will likely fill the gap from Monday June 29th which at least takes the market a bit above 209.50. From there I would suggest a wait and see approach, but as of now note that the best pin on SPY is 210 and price may gravitate there sometime during the week (note: the open interest often changes during the week and is important to keep track of).


In Sum: If we get to the 205 level, the risk/reward favors buying the dip again. If the market can remain above 207.5 then odds greatly increase we fill the gap from June 29th and potentially go higher. However, if you benefit from the long side, my inclination would be to not overstay your welcome because the evidence at hand does not yet support the lows being in.

Good luck next week. If you are looking for much more analysis and guidance to trading the recent volatility (including trading options in high beta momentum stocks) consider a subscription. Here is what one subscriber tweeted to me at the end of last week: Screen Shot 2015-07-10 at 5.14.07 PM