Thursday, July 7, 2011

Finding the Key to the Market

In any given market there is an over-arching concept or chart that can sway it one way or the other. For example, in a market driven by FX, the breakdown or breakout of a particular currency will have a direct, lockstep effect on stock and commodity prices.

Earlier this week I spoke about what I called the "FX-factor", or the affect of the Euro/US dollar coupling on the US stock market. The charts I posted showed clearly that the dollar would bounce and the Euro would fall, and that's exactly what happened. However, the market didn't react as it normally would. The USD and the SPY essentially rallied together.

There are an infinite number of reasons why this may have been the case. In my opinion, the combination of low volume and a market consumed with fundamentals like European debt and US jobs data let the major stock indices float as if in a vacuum.

The question now is what sort of catalyst will cause the markets to finally correct to a sustainable price in the short term. The S&P 500 is very close to a double top on the daily chart, but that's still another 30 points away. It's possible that we get there, but it's increasingly unlikely without first pulling back to consolidate.

SPX still far away from 1370 double top
While I was watching this chart today, I was reminded of early June when we were wondering where the market would bottom. If you followed me on Twitter then, you'll remember that we were looking for either a hit of the 200 daily MA or the pivot low just below it. Due to the precipitous fall we were experiencing at the time, I chose to wait for the pivot low as it had a higher risk/reward ratio of playing out in my favour.

SPX bounces sharply before hitting key pivot

Of course you'll also remember the SPX just barely hit the 200MA and never hit the bottom pivot before sharply reversing to the upside. The Nasdaq was a different story; it broke its 200MA and went all the way to the pivot below it. After hitting this level, the SPX, Dow, etc. all bounced sharply to the upside and the rest is history.

Nasdaq gets huge bounce from key pivot

With this in mind consider that we're in a similar situation right now. The SPX has just broken a major pivot level and seems to be on its way further up to the double top at 1370. The Nasdaq on the other hand is very close to its double top from early May and it will only take a slight push up for it to reach this level. Following the logic that the Nasdaq led the markets up, it stands to reason that it could lead the retrace back down. This could suggest that the SPX retraces before hitting 1370.

Nasdaq double top is extremely close
Right now, this is all just a theory based on an observation. We'll have to wait and see how the market reacts to this level either tomorrow or the next day before concluding that it's the key to the market. I may take an additional short should the Nasdaq hit the double top target, but if we close above it I'll most likely cover the entire position and wait on the sidelines for the next trading signal.

Check back here for updates on this topic and follow me on twitter for my latest thoughts on the market.

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