The Week in Crayons

After breaking support late last week and threatening for a more substantial pullback, the markets pulled an about face early this week reversing course and rallying quickly back to erase much of last week’s losses. This abrupt move higher likely indicates trapped shorts that misjudged last week’s breakdown getting squeezed out of their positions as they compound the buying of those that are late to the party and chasing upward momentum. The sharp move higher has brought us back to the levels of resistance that ultimately led to the price rejection we encountered last week and although we now find ourselves below our previous range as we enter an area of likely distribution there are some positive signs of bullishness that hint at a possible move higher and back into our previous range.

Looking at a chart of the S&P 500 e-mini futures contract, we can see the obvious resistance we face now as we find ourselves just underneath the “floor” of the descending channel we formed from March to early May. Just above this area lies the horizontal levels of support/resistance from which we ultimately broke down from in early May around the 1350 area. it is likely that price action will stall into these areas as we digest the the strong move we had this week as we formed a “v” shaped bottom after what now appears like a “fake” breakdown. However, there are some clues that the market is ready to challenge these areas of likely distribution possibly even squeezing right through them.

Notice that although price action formed a new pivot low this week as we tested just below the rising 200 period moving average that Stochastics actually formed a higher low exhibiting bullish divergence. This suggests that momentum is actually picking up, even if it isn’t evident in the price bars at the moment. We are now firmly above our key 20 period moving average after holding and closing above it on two consecutive days to close the week. This is a widely observed landmark for many traders and obviously we’ll be moving higher if price action can maintain above it into next week. However, because price moved so quickly this week, the likely makeup of those involved right now is probably a mix of a few early buyers looking to take profits as many shorts and momentum chasers provide the fuel for the move higher. Because of this, the prudent course of action as we head into next week is to wait for a clearer signal that many of these volatile participants are bowing out of the current move.

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