After spending nearly two months trying to stabilize from the free fall we had in early August, the markets finally broke out from the rising channel that has contained our price action during that time. Unfortunately for many market participants, it was to the downside. The swift move down was felt by most equity classes as the U.S. Dollar raged to the upside on the heels of this week’s FOMC meeting. Keep an eye on dollar strength as it will continue to put pressure on the markets now that the “free money” trade is apparently off the table.
The sharp mid week reversal is evident if we look at a chart of the SPDRs S&P 500 etf (SPY). I wrote last week that the real battle for the bulls would be in holding the now rising 20 day moving average if we pulled back off the top of our range.
Well, so much for that. We blew right past those levels on Wednesday’s plunge and eventually found support at a very important level of support at $112. While this level has held as support on several occasions now, our lows just above $110 now become a magnet that will likely need to be retested at some point in the near future. This week’s action was undoubtedly negative, and any bounce back to the 20 sma(which is now turning back south) should be looked at with suspiscion.
Looking at the bigger picture as we examine a weekly chart of SPY, we can see that we are beginning to fail at our 200 period moving average as we attempt to hold on to the $112 area. Notice that this area not coincidentally is also the site of our eventual breakout from last years multimonth consolidation following the flash crash in early May. If we fail here, the lows of that range become a critical level of support that the bulls must hold. Note that the measured move from the bear flag we appear to be completing here would indicate a drop right to those same levels.
While many have disputed whether or not our recent consolidation was in fact a bear flag, it had many of the characteristics of one and has certainly had the psychological makeup of one. It is important for technical traders to step back and understand what participants are doing instead of getting hung up on the exact criteria that define a pattern. While many declared that the head and shoulders pattern we completed earlier this year was too “obvious” and too well publicized to work, it obviously ended up being a valid pattern that saw its target move completed in a matter of days. While this may or not be a bear flag, and we may or may not ultimately fail from here, traders should be aware that there is a strong potential for a move southward to the key lows we formed last summer and should remain on the sidelines or with significant cash levels until we stabilize. If we are able to hold at these levels, the $122 area now becomes a significant price ceiling that the bulls need to overcome.
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