Trade of the Day: Prepare for the Next Leg Lower With the S&P 500 Spy ETF

U.S. large-cap stocks as measured by the popular SPDR S&P 500 ETF (NYSEARCA:SPY) have rallied more than 20% over the past couple of weeks. A sharp bear market rally took hold on the extreme near-term oversold conditions.

spy etf
Source: Shutterstock

With economic and corporate data likely to overwhelm the headlines in coming weeks, the SPY ETF stands a good chance of embarking on another leg lower sooner rather than later.

Bear markets tend to have three distinct stages:

  1. Panic stage: an initial sharp drop or crash brings about great uncertainty for investors.
  2. Bear market rally: once the market exhausts most of the initial sellers, a sharp counter-trend bounce occurs.
  3. Resumption of downtrend: As economic and corporate data and outlooks hit the news, a slower and choppier move lower tends to kick in for risk assets such as the stock market.

The initial sharp drop in February and the first half of March in my eye qualifies as the panic stage. The ensuing sharp rally we have seen over the past two weeks is likely the first sharp bear market rally. All of this gets us much closer to the third part of the bear market, which is a more persistent but less volatile trend lower.

SPY ETF Stock Charts

spy etf weekly chart
Source: TradingView

On the multi-year chart of the S&P 500 we see that the dramatic overshooting rally from Q4 2019 into mid-February 2020 resulted in a sharp mean-reversion move below the long term trends. The bounce-back of recent weeks so far has brought SPY back to a confluence area of resistance made up of the underbelly of the long-term up-trend, the red 200-week simple moving average, as well as horizontal technical resistance.

Through the lens of technical analysis on the longer term charts, this is about as ‘perfect as it gets’ for a setup to re-short the S&P 500 SPY ETF.

Source: TradingView

On the daily chart we see that the the sharp rally off the March 23 lows on April 7 had just about reached the 50% retracement line of the entire sell-off from the February highs. Intraday on April 7 then quickly rejected this area and began to reverse lower.

While this does not have to have been the absolute highs of the bear market rally, in my eye the reward-to-risk is now setting up well for a bearish trade in SPY, betting on a resumption of the downtrend at least to an extent.

Trading SPY

Active investors and traders could look to short the SPY ETF in the $265 – $270 area with a next downside target at $250. Any strong bullish reversal and a daily close above $280 would be a clear stop loss signal.

My absolute favorite way to play this bearish trade in the SPY ETF is with a simple but very specific options strategy. Join my webinar on April 8 to learn this strategy.

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