The Week in Crayons

After almost two weeks of drifting sideways with no real movement, the markets closed the week by pushing higher and finally challenging the year’s highs we printed back in April on most of the major market indexes. Despite the corrective nature of the action over the last few months, there has been a strong bid supporting us as we have relentlessly marched higher after bottoming out in early June. Considering that we have made it all the way back to the point from which we initially dropped, the case can certainly be made that we have either finished or are about to finish our correction and are ready to begin a new phase in the market cycle. However, until we see a sustained follow through past resistance or a firm rejection or failed breakout from these levels we stand at a crossroads in the markets right now. While the most common scenario after a correction is a resumption of the previous trend, the chances that we top out at these levels again or continue a more complex correction are still in the cards. While the urge to jump in and chase price as it breaks higher is natural, traders that have not participated in the recent move higher should exercise patience and watch price behavior as we negotiate our highs to see if we are indeed entering a new trading environment.

We have already seen a change in market character over the last couple of weeks which can be seen as we take a look at a chart of SPY, the etf that tracks the S&P 500 index. Notice the preponderance of gaps and wide candles as price oscillated wildly up and down the channel we’ve been in since the price drop we experienced in May. During that time, we can see that each impulse up was corrected by an ensuing drop in price as supply would overcome demand as it came into an area of distribution. Compare that behavior to what we have seen recently as the move up was corrected through time instead of price as demand kept up with supply and would not allow price to drop at all.

This is showing us that market participants consider our current levels to be at a fair value and are willing to buy here instead of hoping for a better deal. However, despite the bullish nature of our recent price action, we still stand at resistance with an overbought reading on Stochastics after a rally on low summer volume, so the safer stance right now is to watch how price responds to these levels and wait for a high probability setup instead of chasing momentum and hoping for a follow through. One of the keys to watch in the coming weeks is the action in other broad market index etfs such as QQQ, DIA and IWM to see if they can follow the lead of SPY and break to new highs for the year. As a common proxy for risk appetite, IWM in particular must play catch up after lagging its peers throughout our recent correction.

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