Will the Bulls Charge Their Way to New Highs?

Screen Shot 2015-08-29 at 2.43.51 PMLast week here I stressed that oversold can stay oversold and that I believed the market had not bottomed. I laid out the bullish and bearish arguments and it was clear that the bearish ones had more going for them. I also drew some comparisons to the 2014 October correction as an exercise that steep and rapid drops can get steeper. There was no way to predict how last week would turn out, but it definitely was tradable.

A lesson in patience:

Before I go on to next week, I want to illustrate how we played it last week and the importance of patience (which btw is one of the most difficult things traders struggle with, including myself). Due to the extreme sell-off on Monday our main goal was to catch a large bounce. We got stopped out a couple times early in the week for minor losses when testing the waters; however, we didn’t get heavy long till Wednesday. Below you can see the tweet I sent out very near the bottom of Wednesday’s range right after I alerted that I was purchasing calls on the QQQ’s and some of the momentum stocks. Those purchases led to huge returns in just a few hours and were multiplied by Thursday morning. 
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Screen Shot 2015-08-28 at 10.55.24 AMI also mentioned my thoughts that the market would head higher near the bottom via my public twitter. Screen Shot 2015-08-28 at 10.58.51 AM

I realize I’m self promoting (hey it’s my blog post), but there is also a couple of lessons there. 1) Patience pays! It’s very hard to sit back and do nothing (especially for me since I have subscribers) but by not blowing ourselves up or losing our minds the first couple days of the week we had plenty to put to work when there was a good risk to reward opportunity. 2) Although I really try to have a semi-detailed game plan for the week, when things go array it changes often and stresses the importance of being open minded and able to adapt. Onto next week.

Oversold/Overbought: I mostly use these for turning points. Last week was a prime example in that the market was very oversold which is why we found it more prudent to stalk long positions. The market is still oversold on two of these measures. All this suggests is that this bounce could still have legs without necessarily being a V-bottom.

SPX stocks at 20 day highs: This is still very low and considered oversold.Screen Shot 2015-08-29 at 7.46.46 AM

SPX stocks at 20-day lows: Clearly the most sensitive to market bounces, this is no longer oversold and is back to being at very low levels.Screen Shot 2015-08-29 at 7.47.01 AM

SPX stocks above their 50-day MA: Still oversold. Note that below you will see this in a comparison to the 2011 correction where it stayed oversold for weeks.

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A little bit of history:

Below I show what happened during the 2011 correction. I am in no way suggesting this is a model of things to come; I am merely demonstrating a different kind of bottoming process than the market has experienced in the last several years. We all know what a V-bottom looks like so this is a good refresher in case this correction turns out not to be a V-bottom. It’s important to keep in mind that previous V-bottoms have come from a rising trend as opposed to six months of going no-where. Perhaps that means the ‘V’ will be even more ferocious than in October 2014; no one knows. The main take-away is it’s important to keep an open mind to all possibilities and a reminder of how things played out in 2011 can help us do so.

Also, if this is not a V-bottom and if the lows are not in, 2011 can help demonstrate things to look for upon another retest of the lows to determine if a bottom is close.

Below you can see that after the first bottom SPX rose 9.3% in four trading days. Keep in mind the correction in 2011 was larger in percentage terms (however not in several breadth measures which were worse during this correction) so last weeks bounce of 6.5% in three trading days doesn’t necessarily equate to a V-bottom.

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In the chart below of 2011 you can see that it took almost 2 months (57 calendar days and 40 trading days) before the second low was made. Again, this demonstrates that even if the market continues higher or makes a higher low in the next couple of weeks, it doesn’t necessarily equate to last Monday being a bottom. Finally, on both charts you can see that upon the second low the RSI, MACD, Stocks above their 50-day MA, and VIX were all making lower highs whereas volume had decreased.Screen Shot 2015-08-29 at 11.07.59 AMJust for a little comparison, below is the V-bottom from the October 2014 correction. It never reached as oversold as this latest correction, nor did it come from waining breadth for months, but it’s always a possibility. Screen Shot 2015-08-29 at 2.17.12 PM

SPY open interest and levels: Below I display two different open interest graphs because the picture is different based on how wide or narrow I frame it. Both are more put heavy which is often a sign that the week will be more bullish; however, given the recent volatility I wouldn’t put a ton of weight into that conclusion.

The first graph shows that SPY 195 has a lot of put support. That also aligns well with the gap from Wednesday to Thursday.  It would be a good place to try a long if the market were to fall below Friday’s low and retest that area. spy

The second graph, which takes a wider frame, shows 190 being much stronger put support. Hence, if SPY cannot remain above the 194/195 area that would be the next place to look for support with regard to the open interest. Note that the gap fill from the October correction (which has already been filled) is also near the 190 area. SPY.A

There isn’t much call resistance on the upside; however levels I would deem as important resistance are roughly SPY 202’ish and the 204/205’ish area.

Main take-away and quick trade ideas:

Whether we go higher or not next week does not confirm that a bottom is in. If the market gaps higher Monday keep an eye on breadth (advance/decline, up-down volume, TICK etc) as well as the VIX. For the rally to likely continue, the former should confirm strength while the latter should begin to descend. On a gap down Monday or a drop from resistance during the week, look for support at Friday’s low, 194/195 and then 190’ish.

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