Thursday, August 18, 2011

Deja-vu all over again for markets

Today the S&P 500 closed sharply lower, falling nearly 4.5% on the day. This fall was dramatic, but not entirely unexpected. Yesterday I posted about the possibility of a fall as we were trading within a macro bear wedge on the daily SPX chart.

The potentially bullish consolidation we saw over the last two days is now off the table. I recognized the distinct possibility for this consolidation to fail but I'll admit that I didn't foresee a return to the kind of trading we saw during the plunge last week. However, reviewing the charts late last night I noticed a pattern repeating itself.

In late July, the SPX put in a top and began to consolidate within a large green candle. It appeared to me, and others, that the market was due for a short term push up before ultimately falling. Of course, this was not the case as global indices would fall precipitously shortly after, negating the bullish consolidation.

July 21-26 consolidation fails just before precipitous fall

This week, we saw a very similar situation unfold. We had sideways, potentially bullish consolidation within a larger bearish pattern and expected a small push up before ultimately pushing back down. Instead, we saw the micro bullish pattern fail, triggering the macro bearish pattern as well as massive selling.

A similar failed bullish pattern to July's huge decline

None of this is surprising, especially when the market is as fragile as it has been over the past few weeks. But what it tells us is that we can continue to expect short term patterns to fail as long as extreme volatility remains.

The August 9th bottom is still intact and, as long as we don't close below it, it has to be respected. I will be referencing the fib levels in the chart above for support and resistance as we trade up or down.

Going forward, I will be closely monitoring the progress of the longer term bearish wedge on the SPX chart. Should it play out to completion, we could expect a break of the Aug 9 bottom and a plunge much lower in the coming weeks. However, I don't expect this to happen all at once, nor do I expect it to happen without dramatic bounces along the way. This is why it's so important to trade prudently and carefully as being on the wrong side of a trade in this kind of environment can lead to especially big losses.

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