The Week in Crayons

Despite spending most of the week drifting lower in the markets, we remain somewhat close to our recent highs as the sellers continue to have a difficult time pushing the action southwards. Overall, our recent action has the look of buyers taking profits rather than the distribution that comes in during a topping process. As has occurred repeatedly in the last several weeks, we are consolidating in time as price drifts mostly sideways making little headway into the prior move higher. The key to using technical analysis when evaluating the markets is to understand the underlying psychology that it represents, not in blindly following lines and indicators in a vacuum. In this case, we can infer that traders and investors are not allowing price to drop substantially because there is strong demand to stay fully participated in the current environment. This is a strong hint that we are currently in a buyers market, and we should look for those types of opportunities until we see a divergence from this pattern of behavior.

Looking at a chart of the SPDRs S&P 500 etf (SPY) we can easily see the recent behavior by looking at the narrow bands of consolidation that both precede and follow expansive moves higher. We have been exhibiting this type of behavior since August in a marked contrast to the sloppy alternating moves higher and lower we saw through June and July. This behavior is a classic hallmark of a bull market, and traders that have mistrusted these signs, particularly over the last few weeks have missed out on a very nice rally. However, not all is lost as the market is still in a bullish stance at the moment as seen by the proper alignment of its rising moving averages and will probably offer some nice opportunities in the near future.

However, things are never fully certain in the markets, and a couple of warning signs have surfaced recently that hint at some underlying weakness beginning to emerge. The first warning sign popped up last Friday as price reversed at new highs and finishing lower creating a shooting star candle that is currently marring the daily chart with its ugly presence. This candle has since been followed by a flag pattern which is bullish, but has also been broadening which is a mildly bearish volatility pattern signaling a growing dispute between buyers and sellers. Lastly, looking at the Stochastics Indicator, we can see that momentum has been decreasing as price has risen creating a bearish divergence. However, considering the strength of our recent price action, these signals can be interpreted as hints that we likely need more time to digest the huge moves we’ve had in September rather than the signs of an imminent top. We have had a pretty strong move to new highs this month, and it would not be surprising if it took a bit longer to digest these gains as the markets wait for participants to fully trust this rally.

We are currently still well above our rising 20 period moving average and are likely due for a test into it at some point in the next week or two which could also coincide with a retest of our last breakout around the $144 price area. This should hold as support with additional support just below that area around the $142 price level. The shooting star candle we formed last week becomes immediate resistance now and will be a critical obstacle for bulls to overcome before we can resume this rally. If we can spend a week or two digesting our gains in this range it will go a long ways towards resetting the many charts that are now extended and offer new trading opportunities as we set up for our next move.

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