The Week in Crayons

Despite ending the week somewhat off their new highs, the markets for the most part continued the slow and relentless rally that began about a month ago. As has been the case during that time, sellers have been few and far between and price action once again occurred on muted volume with relatively little volatility. Not much has changed since last week from a technical perspective and most of the analysis I mentioned in last Friday’s post still stands.

Looking at a chart of the e-mini futures contract for the S&P 500, we can see that we are still in the same narrow rising channel that has contained our rally after breaking out at the start of the year. Price is for the most part in the same range it was in last week except for a failed attempt above 1320 which occurred during the middle of the week off the back of strong eps reports(most notably AAPL). We are now very close to last year’s highs which should serve as a strong magnet for price action as the bulls will eventually try to push price to new highs mirroring the action that has already occurred in the nasdaq composite index.

However, we remain oversold and are beginning to see signs of waning momentum. Notice that we printed a yellow candle on our SG22 momo trend bars on Friday’s close, the first such bar in over a month. This is a hint that upward momentum is slowing down and traders should begin to exercise caution in regards to our current swing up. The first key level to watch if this weakness persists is the 1300 area. This was support last week, and a break below it would also likely take price out of our rising channel. After that, the rising 20 day moving average would likely become the next key area of support which would also coincide with the mid 1280′s which supported price nicely after breaking past our last major pivot high formed in late October. Trader’s should be wary that price dropping into these levels shouldn’t necessarily be seen as a sign to short this market as sellers have been virtually non-existant so far this year and a retracement at this point may end up taking the form of a benign sideways drift instead of a deep price pullback. If price were to remain in our channel and continue squeezing higher, look for the 1340 area to become a major test as we begin to probe last year’s highs.

While this type of slow rise can be frustrating to traders that feel they have not capitalized enough on it can be frustrating, continue to remain patient and wait for the proper setups to appear as we work off our oversold nature very close to some stiff resistance on the longer term charts.

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The Week in Crayons

The markets continued their slow march up this week with little to no real pull backs as the bulls relentlessly stepped in to support the markets any time there was a hint of a drop. We have now drifted in one direction(up) with relatively light volume and volatility for about a month on most of the major indices which is in stark contrast to the highly volatile back and forth movement we experienced for most of the latter portion of 2011. While we can’t truly know until we experience a substantial retracement on the current move, it appears that the market has had a change of character recently and is more likely to be bullish to neutral instead of the neutral to bearish undertone that characterized the back end of last year’s trading. In fact, the start to 2012 is somewhat reminiscent of the start we had in 2011 which also began with a slow and steady march up that seemed to defy gravity.

Looking at a near term chart of the e-mini futures contract for the S&P 500, we can see this low volatility uptrend clearly. Notice how the last several week’s worth of price action is confined to a single narrow range channel. As mentioned earlier, this is in stark contrast to the volatile oscillation that occurred prior to this move. We are now clearly above several key areas of resistance including all of the major moving averages and are poised to challenge last year’s highs. However, Stochastics has had an oversold reading for the entirety of the breakout and while we can continue this slow squeeze all the way to the highs, risk reward does not favor chasing momentum here unless your time frame is less than one to two days for a trade.

Of course, action has been completely bullish for several weeks now, and someone looking to short this should realize that the potential for us to squeeze to last year’s highs is very real. In fact, the nasdaq composite has already formed new highs this week and could be a harbinger of things to come from its relatively weaker peers. In addition to the possibility of a continued squeeze higher, another thorn in the short seller’s case right now is the potential change in character in the markets which could lead to a benign correction that drifts either sideways or slightly down and fails to offer proper rewards commensurate with the risk taken at this point.

As we can see on an older chart of the e-mini futures contract for the S&P 500, this exact scenario occurred during the end of 2010/beginning of 2011. Notice the long narrow channel which contained price action neatly for practically three months. Also note that we were oversold for basically the entire time as well.

While this scenario doesn’t have to play out exactly the same(and likely won’t), it should offer traders a hint of what can possibly occur over the next couple of months and serve as a good warning for those that are looking to short this type of action prematurely. On the other side of the coin, looking at the steep drops that occurred at the end of that run should also serve as a warning for anyone looking to chase extended price action into areas of potential distribution.

We are now a few weeks into the new year and while the character of the market appears to have changed, astute traders should keep an eye on price action and wait for the market to conform to their expectations/scenarios, instead of allowing the market to force them into poor trading decisions.

If you have any questions or comments, feel free to contact me on twitter @stockdarts or in our great chat room if you are a stockguy22 member. If you aren’t a member, what are you waiting for?
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