The Week in Crayons

Most of this week was spent in a lackluster drift sideways as price attempted to find equilibrium after the strong move higher over the last couple of weeks. Wednesday was the one exception to this pattern of behavior with its very strong trend higher, albeit coming off of a fairly decent gap down during the overnight session. Overall, we finished slightly higher than the close from the previous week and are still in about the same spot from a technical perspective that we were in as of last Friday. The one exception to the technical landscape is yet again Wednesday’s candle as it showed true demand emerging and is giving us a hint that perhaps this current bounce/rally may be able to persist for a little while longer. However, we are still under significant levels of supply and are in the middle of a substantial range, which means that the correct choice for most traders will be one of limited action as we continue to evaluate the current environment.

Looking at a chart of the SPDRs S&P 500 etf (SPY) we can see that we are right smack in the middle of our most recent price extremes around $148 and $135. When you combine this reality with the fact that the near term trend is up, the intermediate term trend is down and the long term trend is up, you get a muddy situation that is hard to trade with any real conviction on either side. There are plenty of cases to be made for both long and shorts at the moment, and while neither is really a high probability trade, both sides do warrant attention until we get a clearer picture of the next move in price.

The case for shorts in a nutshell is that we have had a drastic move lower as we stare at the edge of a fiscal cliff in a terrible economic climate and our recent bounce is no more than a dead man’s bounce that only served the purpose of allowing the bears to take their profits while preparing to reload. We are now reaching overbought status on Stochastics as we approach a somewhat significant level of resistance with even more levels of supply immediately overhead. After failing at our highs for the year, we have fallen drastically lower on heavy volume in what may be shaping up to be a topping pattern. Also, we recently breached and explored beneath the critical 200 day moving average and a retest of this common benchmark is a strong possibility as well.

On the bullish side, the case can be made that we are still in a strong multi-year bull rally and are likely in the process of wrapping up a consolidation phase after pushing to new highs just a few months ago. We have bounced off of a high volume drop which has the markings of a near term capitulation bottom and are in the process of reclaiming the price neighborhood we fell out of earlier this month. From a technical perspective, nothing truly damaging has occurred on the recent pull back and as long as we continue to hold above our 200 day moving average the likelihood of a move higher is fair. We are also seeing demand reemerge as we begin to rally just as we start the holiday season, a time that is typically strong for the markets.

In the end, we can go either way right now and the greatest likelihood is that we end up with a little bit of both as we continue to back fill our recent range. One of the key levels to watch in the near term is the $142 area which has become a point of contention between the bulls and the bears recently and is likely to be a level we revolve around over the next few weeks. Just above that is our next level of resistance around $144 which would coincide with a descending trend line that marked our earlier descent from our last push to new highs. A break above this would likely lead to a push up to $146 and possibly even to our yearly highs. To the downside, keep an eye on Wednesday’s lows just below $139 as that should now serve as good support after the strong showing from the bulls at that level. If we were to lose that level, a trip back down to fill the gap just above $136 would be very likely. Keep an eye on price behavior as it deals with these levels in the coming weeks as these reactions are likely to paint a clearer picture of our current landscape and provide us with actionable setups.

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