S&P 500 May Be Headed Lower According To This Chart

Dr. Thomas Carr

August 2, 2016 12:41pm

It is notoriously difficult to pinpoint the exact tops and bottoms of major market trends. Many who try and who trade on their reckoning more often than not find themselves on the losing side of the trade. The reason for this is simple: the most reliable factor driving market prices higher or lower is momentum. Momentum is the “gorilla in the room” for every fan of Efficient Market Theory.

With this in mind, we can build toward developing a system that more accurately predicts major market turns. We should avoid thinking the market will reverse whenever there are new highs or lows, and the momentum behind the move is strong. New highs or lows on strong momentum tends to lead to more new highs or new lows. Instead, we should be looking for market reversals to happen when, after those new highs or lows, we see a marked decrease in momentum, and the failure of the market to print new highs or lows.

Such is the case for the S&P 500 now. Over the past 12 trading days, following a new all-time high off a very steep post-Brexit rally, we have seen momentum completely dry up. Spot price has traded in a range the narrowness of which we have not seen since the 1980’s. The RSI(5) indicator has fallen from a peak over 83 to right around 30 on today’s pullback. This is the type of condition that can lead to a market top forming.

As you will see from the chart below (of SPY, the ETF proxy for the S&P500), a number of key technical oscillators have registered bearish divergence — indicating a weakening of momentum — as the S&P 500’s upward progress stalled in recent trading. We also see declining volume throughout the consolidation period, as well as a bearish crossover in the MACD indicator.

Keep in mind that we have the all-important July jobs numbers out this Friday. We may see hopeful bulls put a floor under today’s move in anticipation that the numbers are close to expectations. No one wants to see another weak jobs report, and numbers that are too strong would trigger worries that the Fed will raise rates this summer. But numbers near expectations would help the bulls case. But it doesn’t hurt to be prudent here. Given the chart above, and the possibility of a bearish jobs report, it seems wise to begin to hedge open long positions with either call-writes, index puts, or with a batch of inverse ETF’s.

Happy trading, TC