A poor finish this week erased most of the bounce the bulls were able to manage from last week’s lows and has brought the markets back to the brink of another breakdown as we sit just above those critical levels that held us. While the weak action is certainly not positive, it should have been expected as it is quite unreasonable to think that we were going to “V” bounce right back to the top of our yearly range after such a drastic fall from the top. The lows held for now, and we are basically in no man’s land as the markets begin to assimilate themselves to their new price neighborhood. Several classic fear indicators such as the VIX, bonds and gold have soared this week and indicate that the potential for lower prices is still quite strong, so traders looking to trade to the long side should play it cautiously for now and wait to see if we can hold these lows through the next couple of weeks. Those looking to short this market either just missed their trade or are now booking profits and waiting for better risk reward setups to appear.
Looking at a chart of the SPDRs S&P 500 trust etf (SPY), we can see that we are either in the midst of forming a wide range bear flag, or have just broken down from a narrower rising flag and getting ready to break to new lows. Notice the rising volume on the drop as opposed to the rather light volume as we drifted higher.
The $112 price area now becomes a critical level of support, and if we lose this level, we are likely to retest $110 and probably form new lows in short order. Those looking for higher prices need to see us hold these levels and close the gap we formed on Thursday’s action. One small silver lining for the bulls is Friday’s seemingly negative action. While at first glance it appears to be a bearish candle like a gravestone doji, trader’s should keep in mind that context is very important to candlestick analysis. In this particular case, a gravestone doji or shooting star is formed at the end of an uptrend and hints that the bulls are losing control of the current market. However, in a downtrend such as the one we are currently experiencing in the intermediate time frame, this inverted candle is actually a hint that bulls are starting to push action higher even if they weren’t able to hold it. Of course, without confirmation it means nothing, but those hoping for a bounce should keep an eye on the coming price action to see if we do indeed get some support here. The healthiest behavior for the markets right now would be to continue to back fill these levels as volatility decreases. Even if the bulls cannot probe much higher from here, it would be a decent victory if they can stall out the current flag and turn it into a base.
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