Online Trading Academy’s core strategy is centered on the proper reading of price action. We interpret what the market is telling us to do and act accordingly. If the security we are trading is in an uptrend, then we are buyers. And when the trend changes, we become sellers. There are techniques we can use to identify the turning points of the markets to buy the bottom and sell the top. But it is always easier to be patient and wait for the trend to develop and simply join that trend in progress.
Many novice traders and even notable fund managers have been caught shorting this market too soon. Many were trying to time the top and were shocked to see the markets’ ability to continue upward. I had not seen any signs of the markets top and was still a mild bull. I warned of shorting too soon a few weeks ago in my August Market Update article.
Part 1 (17 September 2013)
The S&P 500 index and other indexes are starting to show weakness. As I write this article, the weekly chart of the S&P 500 is forming the right shoulder of a head and shoulders formation. This last occurred in 2011 and led to a sharp decline in the markets. Even the pausing prior to the pattern is eerily similar now to how it looked a couple of years ago.
We should be reminded that if we make lower highs followed by a lower low, it could be a precursor to a bear market as we saw the same formation in 2007-2008.
The key to whether this formation and a bearish trend will happen is the supply level on the daily chart. Price is currently touching that supply and if it holds and sends prices lower, a trader should expect a bearish winter if we break to new lows to complete the pattern.
The weekly charts of the equity indexes are still in a bullish trend. They have not confirmed the reversal and may not. Be patient with longer term trading and investing and make sure you protect your capital with stops. Without overhead supply zones in the S&P, the Dow, or the Russell 2000 index on weekly charts, trying to time the top is more of a guessing game. Consistently successful traders do not gamble with their capital and neither should you.
Part 2 (12 November 2013)
I received several emails regarding my 17 September article (Part 1 of this post). I wanted to address those questions and look at the markets and where they may be heading. I wrote Part 1 on September 17. Since that time the markets did endure a small correction that failed to make new lows and has now made new highs.
One signal that a student offered as a bearish reversal sign was the potential head and shoulders pattern on the Dow futures. Looking at the chart below, you can see that there were two patterns that worked out well. The peak of 2007-2008 was a head and shoulders. The current pattern is NOT a head and shoulders. The right shoulder is too high and we have now made a higher low and higher high negating the pattern.
Looking at the Dow may be the wrong thing to do anyway. Going back to a technique I highlighted in my article, “Watching the Markets.” I have attached a chart that shows the ETFs that track the major market indexes. Measuring them from the low on October 9th, you can see that the leader in the uptrend is the NASDAQ.
The leader should determine when the laggards can fall. As you can see, the NASDAQ is finding some weakness recently. The Russell 2000 has already started to fall.
The QQQ’s are sitting in the middle of a weak supply zone from 2000. That is why prices have started to stumble. This is a weak zone and the fact that we haven’t dropped yet leads me to believe that price could go higher until it reaches the stronger zone above.
There is also some weakness in the sector rotation. Consumer discretionary stocks usually outperform the staples during bullish markets. When the staples start to outperform the discretionary stocks, there may be a market trend change coming.
So while the bears are still quiet, they are hiding just around the corner. Be cautious with your long positions and pay attention to the trend for direction.