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Market Still in Downtrend Despite Rally

Big move is a plus for the bulls, but we’re not out of the woods yet


Serge Berger is the head trader and investment strategist for The Steady Trader. Sign up for his free weekly newsletter.

And you thought it would be a quiet August? The global sovereign debt crisis and economic slowdown is causing unwelcome volatility for those wanting to take some well-deserved time off at the beach, but that’s the world we live in.   

The S&P 500 rallied a solid 3.43% on the day yesterday, and closed just a smidge above 1,160. Yesterday morning, I discussed that a close above 1,260 would increase the chances that we will at least head back to 1,200 again in the near future.

It is important to note, however, that with the crazy market volatility of the past two weeks, we have in essence traced out a new trading range between 1,100 and 1,200. While yesterday’s rally was constructive on most fronts, we remain just about smack dab in the middle of this range. It is not until we can hold above 1,200 that a move toward the eventual 1,240-1,260 area can be forecast with more clarity.

A simple-yet-effective way of looking at a chart’s weakness/strength is to see where the 50-day simple moving average (yellow line) is in relation to its 200-day simple moving average (red line). If the 50-day is below the 200-day, the chart is in a downtrend, and that is the case with the S&P 500 and just about all equity charts in the U.S. and European markets at the moment.

SPX Daily

While theU.S.stock market is not yet in a bear market, according to traditional measures, it sure trades like it is. Volatile moves (specifically sharp rallies lasting several days) like the one we saw yesterday are classic characteristics of bear markets. Expect this to continue for some time.

Looking at a close-up S&P 500 chart (10-day, 30-minute chart), it is of great importance to note that yesterday’s trading session ended with the index very close to the bottom of the open gap down (gray box) from Thursday, Aug.18. Coincidence? Hardly. Gap levels, either the open or close of the gap, have built-in magnets that attract stocks and indices toward them. So in the case of the S&P 500, the next logical “magnet” would be near 1,190, which is the top of the gap from Aug. 18. The size of the gap is 30 points — very large and difficult to “fill” in one day.   

SPX Gap Chart

Speaking of gaps, the five-day, 30-minute chart of the industrial sector represented by the Industrial Select Sector SPDR (NYSE:XLI) could also soon be facing the challenge to fill the gap from Aug. 18. The same goes for many other stocks, sectors and other key groups of stocks. 

XLI Chart 

Yesterday’s rally was solid and certainly a check in the plus column for the bulls. Now we must measure the move each day and a daily close (if and when) above 1,200 could more easily give way to the 1,240-1,260 area, where we eventually should find more resistance.

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