The Week in Crayons

I heard/read a few traders this week allude to “bear market trading” during discussions of swing trades in the current environment, and while we certainly have had some weak action over the last month or so, it is WAY too early for traders to conclude that the current rally is dead. For all of the negativity we’ve seen concerning the recent market, the fact is that we are still either above or somewhat close to the highs we printed earlier this year even after the recent sell off. While the current move lower has had some warnings of further weakness, it has also been an orderly consolidation of a strong previous move and overall we still do not have any glaring signs from a technical perspective that point to an impending top. Next week will likely be a critical test as we finally come into an important area of support and the price action at these levels should give us a good indication of what is in store for the markets as we head into the final quarter of 2012.

Looking at a chart of the SPDRs S&P 500 etf (SPY), we can see several forms of support converging roughly around the price area of $142. The nearest term support comes at the bottom of the near term channel we’ve been declining/consolidating in throughout September. We are now at the bottom of that channel which coincidentally is very near the key 50 day moving average. Not coincidentally, this channel forms a somewhat wide bull flag pattern on the weekly charts showing us that in the larger perspective, the recent action is still relatively healthy. Aside from that, we are also now testing the breakout above the highs we printed during the early portion of this year in April, a level that served as very stiff resistance at the time and which should now theoretically serve as strong support.

The initial failure we had at this level earlier this year took place in the form of a head and shoulders pattern that eventually resulted in a swift sell off and prolonged climb back up as we spent several months trying to get back to those highs. The neckline of that head and shoulders as I’ve mentioned in the past has served as an excellent barometer for the behavior of the markets this year and has clearly demarcated what I consider to be the major phases of action so far in 2012. We are now heading into oversold territory and I would expect some sort of bounce from this area into next week and likely a move up to or 20 day moving average which is now beginning to turn south.

We have very clear levels of support and resistance right now with our floor being the previously mentioned area of likely demand at $142 and what is now going to be stiff resistance at our highs just above $148, not to mention our recent failure at $147. A failure to hold above the $142 area would be a gigantic red flag and a strong reason to step back and reevaluate the current environment. In that scenario, likely support would be found at $141 and perhaps even as low as $138 around the 200 day moving average. There is a slew of earnings reports coming out next week as we head into our last quarter of 2012, keep an eye on the reactions to those reports as they could serve as a catalyst for the markets one way or the other.

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