Get Ready to Sell, Sell, Sell the SPY ETF

The SPY flags major bearish signs as we wait for confirmation of a cyclical bull market top

Let’s face it: The benchmark S&P 500 Index had an incredible run since its lows in early 2009. Doubters and perma-bears have routinely been beaten into the ground as stocks rose in unabated fashion, rewarding those that respect price action as opposed to trying to make rational sense of the macro picture.

beat the bellHowever, all cyclical bull markets come to an end at some point — making a meaningful mean-reversion move lower — and recent price action in the SPDR S&P 500 ETF (SPY) suggests we might finally be close to such a moment.

Over the years, I have learned the hard way that greed, fear and staunch opinions have no place in the business of active investing. In general, trying to fight a trending market is expensive — at the very least, it leads to losing money, and at worst, it leads to losing your mind.

The trick is to a) take any macroeconomic news with a big grain of salt, and b) understand that the stock market and the economy are not the same. Closely following the trend in the market is key, as it allows us to spot any changes in the trend well before the crowd comes to realize it.

SPY ETF Stock Charts

Looking at the below multiyear weekly chart of the SPY ETF, note that ever since October 2011, the index has been forming a narrowing wedge, which reached its tightest levels (i.e., lowest volatility) in June. Of course, this type of formation ultimately leads to a bigger move in one direction or another.

Not so coincidentally, upside momentum — as measured by the Stochastic oscillator — topped in late May, and with the SPY ETF selling off last week, is now well on its way lower.

Also, the relative strength index (RSI) topped in November 2013 and made a lower high in early July, just as the SPY made a fresh all-time high.

These types of negative divergences between price and momentum on the weekly chart are notable, and bearish for the medium term of six to nine months.

SPY ETF chart weekly
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From a tactical technical perspective, to declare a top in the market, what we need to see in coming days/weeks is either a lower high, a double top or breakout fake-out (a quick bearish reversal in price).

Once we have this confirmation in place, the better strategy for the coming weeks and months looks will be selling and/or shorting the SPY ETF — and stocks in general — into the rallies. This is the reverse strategy of “buying the dips,” which has worked so well for the bulls since early 2009.

On the daily chart, note that last week the SPY quickly and cleanly snapped its 50-day simple moving average (yellow line) and yesterday found support at its 100-day simple moving average (blue line). Also note the cluster of increased volume in recent days. Because of the relentless bull market since 2009, the 50-, 100- and 200-day simple moving averages have routinely served as good reference areas. Even at times when the 100-day MA was violated, the SPY often quickly bounced back above it or found support at the 200-day MA (red line), at least since 2012.

Important to understand is that correlation among stocks tends to be very high in cyclical bear markets, which includes sharp oversold bounces.

SPY ETF chart daily
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For the SPY ETF, near-term support likely lies somewhere between $190 and $192, from where a tradeable oversold bounce could occur. This bounce will then need to be measured and if/when we get the aforementioned confirmation of a top, then more tactical short positions in the SPY make sense.

How far could the SPY fall before a cyclical bear market has run its course?

A traditional measure would be about a 20% selloff from peak to trough, which would take the SPY ETF down to about $158 to $160, or back to where the index broke past its 2007 highs in the spring of 2013.

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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.

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