While the markets opened down on Friday looking tired and ready to roll over after a week of positive gains, they gained traction midday and eventually rallied to close just below the days high’s. Friday’s price action was part of a larger pattern of afternoon strength that has become prevalent during the early stages of the 2012. While this is typically bullish in nature as it shows that sellers are having difficulty in gaining control of the markets from the buyers, traders should also take into account that sellers are consistently attempting to push the market down but are eventually becoming overwhelmed as buyers continue to step in during intra-day pullbacks. Another key factor to consider is that this price action is occuring at relatively strong levels of resistance.
This behavior is evident as we look at a chart of the e-mini futures contract for the S&P 500. Notice the string of candles with long lower wicks over the last couple of weeks. Most of these are some form of doji candle and reflect indecision as the markets attempt to find a fair price. While there are a few hammer candles sprinkled into the mix and the overall pattern looks fairly bullish, context should always be taken into consideration when examining candles for clues on future price behavior. While a hammer candle often signals a potential for a bullish reversal, this must occur after a prior downtrend in order to be viewed as a valid signal. When hammer candles occur after a long uptrend, they instead hint at future weakness as sellers are beginning to appear even if they have yet to truly gain control of a market. While this is not necessarily a bearish signal, it certainly is a warning that bullish momentum is beginning to wane.
Another point to consider is the strongly oversold Stochastics reading we are printing on the S&P futures. We have been oversold for a few weeks now and are certainly due for some sort of pullback as price attempts to find equilibrium at new levels. However, traders should not take these signs of temporary weakness as flat out bearish signals as overall price action this year has been strongly bullish. There has been a consistent bid throughout the last two weeks and price is now clearly above the critical 200 day moving average. We have also just cleared the pivot high formed in late October and are in the process of forming a critical higher pivot high indicating that we are now techically in an uptrend.
One level to watch if we pull back is 1260. This was the scene of our breakout at the start of the year and held as support when we tested the gap created from that breakout. This will likely also coincide with the rising 20 day moving average which should provide additional price support as well. Past that, the next key level would be around the 200 day moving average in the neighborhood of 1242 or so. Depending on the timing, this could also coincide with the bottom trendline of the symmetrical triangle we formed over the last quarter of 2011 which would also likely support falling price action. If those two levels do not hold, 1200 would be a likely area of conflict and would present a critical test regarding the state of the markets.
Looking at the overall picture, traders should recognize that while the potential for a squeeze higher is possible, the odds are not in favor of buying now when you consider that we are at levels of fairly strong resistance while the market is showing signs of becoming tired after a nice 3-4 week rally. Now is the time to identify key levels of support on stocks and patiently wait for them as the markets begin to work off their oversold nature whether it be through a retracement or a slow sideways drift.
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