the chop zone redux

We had another week of erratic action in the markets as we continue to chop in the broad range of consolidation we have been trapped in since late February. While the week started on a positive note on Tuesday, we finished the week in a tailspin as we plunged through several levels of support on all of the key market indexes. As I have mentioned recently, we are currently in a “chop zone”, and traders are better served keeping the action to a minimum until conditions improve, or using strategies that take advantage of the range bound action we are experiencing. One of the keys to successful trading is recognizing what the overall market structure is at a given time and adjusting to it. Right now is one of those times where swing traders will likely have a tough time while day traders can feast on the large intraday swings. Always keep an eye on the overall market structure, and make sure your trades match the current environment.

The markets erratic behavior this week is best illustrated by taking a look at a chart of the S&P 500 etf (SPY) and noting the fact that we broke out and closed above our recent channel on Tuesday only to free fall throughout the week and ultimately break down and close below it on Friday.

While this sharp turn-around was obviously very bearish, we are now at some solid support levels just above $130, and are likely due for a bounce into next week. Also note that we had a pretty volatile week, and are likely due for some range contraction as the markets try to absorb the precipitous drop we just had over the last few days. However, keep in mind that the market always punishes complacency, and traders should remain nimble and wait for action confirming that we are ready to bounce before entering any trades.

In fact, looking at this week's action on a 15 minute chart of SPY, we can see that we have yet to form any sort of substantial base from which to rebound, and continue to trade below several key declining moving averages.

Traders looking to play a bounce next week should keep an eye on the intraday time frame and watch for some sort price stabilization along with the reclamation of some of our key averages before attempting to trade against such a strong trend. This is another key concept beginning traders tend to miss. Even though most swing trades are initiated from levels on a daily chart, using intraday analysis to fine tune your entries and exits will improve your performance by adding extra confirmation signals that will keep you from entering trades too early or exiting too late even when you're analysis of the larger time frame is correct.

Looking at yet another time frame, we can see that the overall trend in SPY on the weekly chart is still up, and the negative action we've experienced over the last few weeks has not done any real technical damage to it.

While this week's candle takes us below the rising 20 period sma, we are still in the midst of building a base close to our multimonth highs, and are likely to continue to consolidate somewhere between $126 and $137 as market participants try to figure out the future direction of the markets as we head into what looks to be a Q.E.-less summer. Notice that the last broad range consolidation we experienced lasted about 5 months before we emerged from it. While it appeared that we had ended our recent consolidation in late April as we broke out of an inverted head and shoulders pattern on the daily chart, that breakout has obviously failed, and we have now been in our trading range for about 4 months and likely have a some more time to go before a new direction can emerge. Over the next few weeks, traders should watch the weekly chart in order to get a better grip of what the big picture is and to make sure they don't get overly caught up in what the shorter time frames are telling us. Don't forget, that the best trading environment is when all time frames are aligned. This is certainly not the case right now, and traders should continue to avoid the “chop zone” until all time frames can give us a clearer picture of where the market is ready to go.

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Posted in Charting & Analysis, Commentary, Featured Articles, General Trading