Market Once Again at the Brink

Stocks turned lower again after Friday’s one day short squeeze. Note that the bottom B-Band turned sharply lower over the past two days, as did the 50-week average.

We are likely to get more short squeezes along the way down, but it is clear that this market remains in a long term downtrend.

SPY has support at $126.25. If this level gives way, and it looks more and more like a strong probability, then a retest of $120 would be the most likely target.

Bulls Looking to Regain Control

Short sellers were able to take the SPY below its near term uptrend last Monday. Following prices consolidated in a sideways move that lasted for 3 days. It looked as if the market was headed for a quick washout move back to this year’s lows. On Friday, however, this consolidation range broke to the upside instead of breaking down and Monday’s breakdown is now looking more like a failed move than it is an eerie omen of lower prices to come.

Friday’s move puts heavy emphasis on the fact that it is important to trade what you see and be prepared for anything while not anticipating anything.

Getting short was the right thing to do following the breakdown, but now that we appear to have a failed breakdown it is equally important to not fight the market by tightening up stops on short positions.

It’s probably early to start getting overly bullish on the market as the indices still have a lot of healing to do, but signs as of Friday are encouraging for the building of a bullish case as we move into the Fall.

Path of Least Resistance Lower

The SPY broke down early this week and has since been consolidating below resistance. The near term and long term trend are both down and so is the path of least resistance.

The only fly in the ointment is the fact that stocks like FNM, FRE, and AIG are getting hammered so badly that the odds of the Fed stepping in to rescue them are increasing by the day. A Fed rescue will probably not save the market, but it could certainly lead to a gap up that hurts short positions.

Breakdown Watch In Effect

Near term trends for the QQQQ and IWM have been up over recent weeks while the same near term trend for the SPY has been trading sideways, or neutral. Attempts to move higher have all been rebuffed and it now looks increasingly likely we will see a breakdown this week switching the near term trend back to down.

When and if the SPY’s near term trend turns lower it will offer improved risk:reward as it will compliment the long term downtrend. Think of it like a car that gets a tune up and is once again firing on all cylinders.

Today’s scans revealed a great deal of set ups weighing heavily on the short side. Unless the Fed steps in and attempts to rescue Fannie Mae again, or some other vital news emerges, we are likely looking at lower prices this week.

Watch For The Fade

On Friday the SPY rose slightly out of a pullback pattern, but on shrinking volume.

Scans don’t give us a large indication what to expect on Monday. However, watch for a potential price spike this week that gets quickly faded. A gap up on Monday would offer a good shorting opportunity.

Financials

While it seems most traders consider the weakness over the past two days to be merely just a light pullback in a near term uptrend, we see ominous clouds on the horizon.

US law is a funny thing. If you are just an average Joe you are held to a very strict standard and the rule of law is considered quite rigid. For example, commit a minor traffic violation and few are let off with a warning. Instead, heavy fines are meted out, points get put on the record and insurance rates rise.

Things work differently in the financial world though. If you are a member of society we like to refer to as big money, laws are more flexible and as often as not, violations are merely winked at.

In fact, there are instances where breaking the rule of law is openly not enforced.

After the financials were down too much for the government's sensibilities a couple of months back they announced emergency measures wherein they planned to actually enforce the rule of law already on the books and forced traders to cover their illegal naked shorts.

Today they lifted these emergency measures and low and behold, the financials were once again taken apart.

The logic in this measure is hard to find, but nonetheless the financials threaten to take apart the latest market rally, as does a potential ongoing bounce in oil.

Keep an Eye On Transports

The SPY pulled back to its breakout point today and found a few buyers at the close. Nevertheless, our scans today found very few reasonable long set ups. Generally when we find so few long set ups the market is projecting another negative upcoming session.

On Friday the SPY broke its trading range so we could arguably say the near term trend has moved from a sideways trend to an uptrend. Yet, with today’s lack of follow through we hesitate to make the switch in our Risk Assessment Meter. If buyers come back in tomorrow then it would be more reasonable to adjust the meter and call an uptrend. The proof is in the pudding though and as of today’s close the evidence is just not in.

Oil has been the tail wagging the dog and USO, while still in a steep downtrend, is in an area where buyers may indeed show up. The transports appear to be projecting a turn around in the oil trend as false breakouts in the sector are legion. From failed moves come fast moves so the failed breakouts in the transports may be sending us a clue as to what to expect from the market this week.

Time will tell.

Let's Be Careful Out There

The near term trend closed out the week with a bullish bias. Nevertheless, there are reasons to exercise continued caution here. The SPY closed right at its 50-day average and near term sentiment is reaching the overly bullish area.

These reasons for caution do not mean that the market is going to reverse here but they do mean that the market still needs to prove itself. Friday’s volume gives us no clues as to what to expect next week either.

Bullish Set Up Emerging

The market remains range bound but is showing some bullish signs on a daily basis.

The SPY is back at the 200-week average, where it has continued to find resistance. That said, if it can break out above this level then the scenario we pointed out last week which has the market launching a multi week rally would then seem to be the most likely probability.

In addition to the 200-week average, the SPY is faced with its 50-day average just overhead. Today’s volume was weak today so we are looking for a bit of backing and filling in this area. There’s no denying, however, that the set up looks very bullish here. At a minimum we expect a breakout. Whether the breakout is for real or fails is a whole other question entirely.

Market Tries to Digest Meaning of Fed

The SPY moved back up to the area where it has been finding resistance over the past two weeks; the 200-week average mentioned in our last update. It has been trading in a bullish continuation pattern on its daily charts, but keep in mind that the broader market remains in a long term downtrend, so bullish patterns like this are a lot less trustworthy as the longer term path of least resistance is down.

The Fed left rates unchanged today and the market responded with mild enthusiasm. But again, keep in mind that it usually takes a few days before the market fully digests the Fed statement and as often as not gains made on Fed day get faded within the next day or two of trading.

Right now this market is still indecisive and it needs to prove itself one way or the other before it can be traded aggressively. Proof will come either in the form of a breakout from the trading range or a breakdown. We would tend to get more aggressive with a breakdown than we would a breakout as once again, the long term path of least resistance remains down.

Decision Time

The market has been trading indecisively over the past couple of weeks making it very difficult to pick a side to trade.

After breaking through support at $125 the SPY has bounced, but leadership has been non existent and we are not seeing large groups of stocks rally out of firm bases.

Scaling back to the weekly view it is clear that the SPY has been struggling below its 200-week average, now trading in the $129 area. Each rally attempt to this average has been turned back.

Nevertheless, indecision reigns supreme. While the long term downtrend is in tact the SPY looks poised to do one of two things here.

We could potentially see a rally over the next 6-8 weeks that takes the price back up to the falling downtrend, similar to the bear market rally which occurred last March through May. If a rally fails to develop then we are likely to see the SPY fail once again at its 200-week average and then turn back to test its multi year uptrend now situated in the $118 area.

As noted, we are not yet seeing stocks break out of firm bases, which puts the multi week bear rally scenario on thin ice. If such a rally is going to develop, we will need to see stocks behaving much better than they have been over the past few weeks. It could still happen, but we wouldn’t be making any long side trades until the market proves itself here.

As it now stands, we are finding many more short set ups than we are long.

Either way, it’s best to continue to be cautious at this stage. Until the market breaks this 2-3 week trading range either to the upside or the downside risk will remain high.