On Tuesday the S&P 500 and the heavily traded SPDR S&P 500 ETF (SPY) dropped around 1.5% on increased volume and closed the day at levels last seen in early August.
The question on everyone’s mind now: Where will the index will find support — and thus, where will the year-end rally begin?
Active traders and investors have a well-defined downside target area near the early August lows, which increasingly also coincides with the rising 200-day moving average.
While the bears usually growl the loudest on any down days, over the past six months or so I have witnessed a growing crowd looking to “bottom-pick.” After more than five-and-a-half years of a rampant bull market in the broader U.S. stock market, traders have become conditioned to buy every single dip.
The risk that arises therein is that of trying to catch a falling knife when the market for once doesn’t immediately bounce back and continues falling. For that reason (and for purposes of risk management), it helps to wait for so-called follow-through buying days once oversold readings on the SPY ETF have been reached before dipping a toe.
As the tape got redder and redder Tuesday afternoon, my Twitter stream saw an increasing number of traders discuss the various “oversold” readings from the S&P 500’s momentum indicators, thus leading those traders to buy into a plethora of equally “oversold” single-name stocks.
Witnessing this in real-time, I decided to tweet the following: “In down-markets people forget how highly correlated stocks become. Trade the indices and don’t try to ‘hide’ in some ‘safe stock’.”
While stocks as an asset class are notoriously highly correlated, this correlation tends to dramatically increase during times of volatility, particularly in down markets. As such, I often find it easier and more sensible in times of heightened volatility to trade the broader indices rather than individual stocks, at least until better support/resistance areas have established themselves.
SPY ETF Charts
Looking at the multiyear logarithmic weekly chart of the SPY, note that while the index continues to hold its 2009 uptrend line, the rise since early 2013 has come on waning upside momentum where the relative strength index (RSI) on the bottom part of the chart has developed a series of lower highs. Ultimately this should lead to a break of this support line, even its only for a brief moment.
On the daily chart, while the SPY saw a sharp bounce last Thursday/Friday, Monday’s bounce found good resistance around the 50% retracement area of the selloff from the Sept. 19 top down to the Oct. 2 lows, which also coincided with the 50-day simple moving average (yellow line). The quick reversal of last Thursday’s/Friday’s rally is bearish and speaks to further downside.
While last Thursday’s lows on the SPY ETF near $192.35 could offer some support, much better support comes in at the confluence area around $190-$190.50, which is made up of the early August lows and the rising 200-day simple moving average (red line), which has not been visited since December 2012. Quick traders may try for further downside to this level, while more tactical active investors and traders could look for bullish reversal moves taking place there.
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Download Serge’s trading plan in the Essence of Swing Trading e-book here. As of this writing, he did not hold a position in any of the aforementioned securities.
