I must admit I was wrong in my previous analysis that the S&P 500 Index (CBOE: SPX) would have a sharp breakout. It did break out an upper channel resistance area but it failed to continue that move. Instead, it sold off sharply and by the end of the day on Wednesday a failed breakout was obvious. The chart below illustrates the failed breakout and the rest of the week.
Most readers likely believe that I went long when the breakout was imminent before Tuesday’s close. However, over the years I rarely chase breakouts unless I see multiple days of price stabilization above breakout levels. Generally a consolidation zone above a key breakout level is bullish. However, in recent months it seems that standard technical patterns have not been working well. In fact, chasing breakouts over the past few years could have produced some ugly losses depending on the underlying and the timing of the breakout.
Armed with recent price action and concern for the S&P 500 giving back gains, I did not get long the S&P 500 for members of my service at OptionsTradingSignals.com. On Wednesday morning, I was leaning long because price action overnight was confirming the breakout. However, when preparing my morning post for members I noted the apathy in various markets.
I am constantly monitoring price action in the Financial Select SPDR ETF (NYSE: XLF) and Wednesday morning was no exception. The ugly price action in XLF kept me from getting involved in a long S&P 500 trade for members. By late in the day Wednesday, XLF had proven to be accurate and prevented losses for myself and for members of my service. The chart of XLF at the close on Wednesday looked like this:
My point here is to illustrate to readers how important it is to monitor various aspects of the marketplace. I generally focus on the S&P 500, the CBOE Volatility Index (CBOE: VIX), the financial XLF, iShares Russell 2000 (NYSE: IWM), and the Dow Jones Transportation Average ETF (NYSE: IYT). A trader can learn a lot about the broad marketplace by monitoring the price action in these underlying assets. Often times the Russell 2000 or the XLF will throw off clues about which direction price action favors.
At first glance, we could see the S&P 500 bounce higher in coming days as it is coming into a key pivot low that dates back to April 18th. I am expecting some buying support to step in around that price level as it also corresponds with the lower bound of the recent descending channel the S&P 500 has been trading in.
While we may see further downside, the April 18th pivot low should offer a solid risk definition area for traders. If prices push lower, a short trade using a stop somewhere around or above the key 1,295 price level would make sense. Those looking to take the S&P 500 long could place a stop order below the key 1,295 price level to define risk.
Regardless of where one believes the S&P 500 is headed, using a key support/resistance level to place trades with limited risk makes a lot of sense currently. I will be patient and wait for the market to throw off clues as to which direction it favors before accepting additional risk. The primary focus for traders during periods of wild price action should be to concentrate on reducing risk and allowing others to do the heavy lifting. The daily chart of the S&P 500 Index below illustrates the key pivot level:
Obviously the S&P 500 is coming into a key support zone, but another factor which cannot be ignored at this point in time is the U.S. Dollar Index. On Friday, the U.S. Dollar pushed significantly lower and most of the key commodities such as gold, silver, and oil all closed the day near day highs. The U.S. Dollar Index looks vulnerable currently as its recent rally seems to be short lived and it appears to be poised to retest the recent lows. The daily chart of the PowerShares U.S. Dollar Index Bullish (NYSE: UUP) is shown below:
The first two-three trading days of this week should provide us with clues in terms of price action in the S&P 500 and the dollar. If the dollar continues to weaken it should help support the S&P 500 and the commodity complex. For right now I’m going to sit on the sidelines and wait for the price action to setup before taking on additional risk. The key level to watch is the 1,295 level on the S&P 500 and recent lows on the U.S. Dollar Index.
With QE II winding down and price action starting off the month relatively ugly, June could shape up to be a very interesting month for investors and traders alike. Until later this week I would keep positions smaller than normal and use stop orders to protect capital. Anything could happen, but this is the closest we have been to rolling over in the S&P 500 for months. I do not have my helmet on yet, but in a couple of weeks depending on price action I might have to wipe the dust off of it.
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