The Week in Crayons

After half a year of broad range consolidation on slowly expanding volatility, this week’s brutal distribution took most of our main indexes well below our 2011 range while sending volatility levels higher than they have been since the “flash crash” we had last year. From a technical analysis perspective, healthy consolidation should take place in a quiet manner with decreasing volatility, while expanding volatility usually signals an impending reversal. The swan dive we saw in the S&P 500 index this week shows us what happens when volatility cannot quiet down as traders continue to disagree on the proper price levels for a market. Below is a chart of the average true range of the SPDRs S&P 500 trust series etf (SPY). Notice the growing volatility as we chopped around throughout the first half of 2011.

We are now at pretty high levels of volatility, and while it is not completely out of the question that they continue higher, the likely scenario in the coming weeks is that of diminishing volatility as we begin to back fill and retest the levels we have blown through over the last week.
Looking at a chart of SPY, we can see that we almost reached the measured move from the head and shoulders pattern we formed throughout this year in two days. We eventually found some support around the $117 area which funny enough also happens to be the price level we were at just before last year’s flash crash. Much of the fuel for those two days of brutal selling was likely from burned buy the dippers that emerged on Wednesday’s hammer candle that ended up being a vicious bull trap.

Watch for choppy action as we begin to find equilibrium around these levels, with Wednesday’s price action serving as a pretty stiff level of resistance as trader’s that are still involved from that day waiting for those levels in order to get out of dodge. Friday’s lows are likely to be retested in the coming weeks as well, as the bears are likely to see if they can force the market lower now that they have gained control of the intermediate time frame.
Looking at the long term time frame, the bulls are still in control, but their grip is tenuous at best right now. @captkirk888 , one of the great traders in our stockguy22.com virtual trading floor shared this longer term chart of SPX with us. It is interesting to note that each time we have dipped below the 20 period moving average on the monthly chart, we have for all intents and purposes been in a bear market.

This week’s close puts us right on the average, and it appears that the bulls will have their work cut out in keeping us above it in the coming weeks if we are to stop from slipping into the bear market scenario. Also, note the Slow Stochastics readings. They are beginning to turn under 80 which has also been a fairly good indicator of the long term health of the S&P 500.

While the picture is looking quite gloomy for the bulls right now, one small glimmer of hope resides in the Nasdaq Composite. In looking at the PowerShares QQQtrust (QQQ), we can see that the Nasdaq is actually still in its yearly consolidation range and was able to find support at its base on Friday showing great relative strength over its peers.

Of course, QQQ is still at risk from many of the harbingers of reversal that already took down its peers as it is seeing massive volatility growth as it attempts to consolidate and is now well under its 200 day moving average on heavy volume. The question over the coming weeks as the markets begin to quiet down and realign is whether QQQ will follow its peers down as we head lower, or whether it will become the new leader that pulls the rest of the markets up as it recaptures it higher price levels. This is a question that is likely not to be answered anytime soon, and as I have repeatedly stated, traders should continue to trade lightly if at all during this tough environment and patiently wait for better times.

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Posted in Charting & Analysis, Charts, Commentary, General Trading, Stocks