The Week in Crayons

I mentioned a couple of weeks ago that we were at an inflection point in the markets as we concluded the consolidation phase we were mired in for most of the summer and looked to begin a new phase of price action in the near future. Well, the near future just happened as we blasted off to conclude this week likely initiating a new bull market phase now that we have broken free of the strong levels of supply that held us up earlier this year. Of course, nothing in the markets is written in stone, but the odds are certainly stacked in the bull’s favor right now and traders should focus on bullish setups over the next few weeks as the markets forge higher and establish a new price neighborhood.

Looking at a chart of the SPDRs S&P 500 etf (SPY) we can see the stark difference in price action recently compared to what we saw throughout the middle portion of 2012. Notice how most of the recent behavior preceding the breakout we had on Thursday has been characterized by narrow candles within a relatively tight range as opposed to the wide candles that meandered in a messy fashion over the broad range we traded in after breaking down in May. This tight contraction in price culminated this week in a string of doji candles as buyers and sellers fought to a standstill as they wrestled for control of the markets. As it often happens when volatility dies down as markedly as it did in this case, the floodgates eventually open as one side overwhelms the other. In this case, the bulls won the battle which resulted in the explosive move higher we saw to close the week.

Regular readers of this blog have been aware of this change in behavior for several weeks now and were hopefully prepared for this week’s breakout with some small anticipatory plays. If we truly are at the start of a meaningful move higher, than those that were caught off guard by the surge higher will have plenty of opportunities to get involved in the coming weeks as we begin to establish a higher ground in the markets. Unlike the last several months of of choppy action that favored range bound trades/fades, look for breakouts and trend continuation moves to start working much better if we continue to rally from here. The neckline from the head and shoulders pattern we formed earlier this year has been an excellent tell for 2012 and has clearly demarcated the different phases of action we have seen so far. It should now serve as strong support if we are to continue higher from here. Other key areas of support to watch would include our rising 20 day moving average as well as the price areas around $142 and $140. If we lose these levels than the bullish case would likely be nullified and would warrant a reevaluation of price behavior.

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