SPX and USB: Equities May Be Plotting a Head-Fake Whipsaw

On Friday, I mentioned that I believe the market is finally close to breaking out of the month-long trading range, and after studying the charts further this weekend, I increasingly believe that break will happen over the next few sessions.

I've done things a little differently today, because the chop zone of the past month has left open at least four fully-valid near-term wave patterns -- and trying to talk about four different options would simply confuse most readers.  So instead of doing that, I've simplified the S&P 500 (SPX) chart down to the key price pivot zones, and the next targets if those zones are broken.

I suspect the market is setting up for a whipsaw head-fake break from this range, so watch carefully for the first directional range break to reverse near the pivots.  I'll discuss this in more detail after the chart.

While calling direction from the middle of the range in a choppy market like this is virtually impossible, if I had to pick a direction here, I'd say we rally first to run the bear stops, then reverse.

Let's talk about where these price pivots come from, why those pivot levels could mark reversal zones, and thus why (ironically) bulls probably want to see SPX head directly lower, while bears probably want to see it head directly higher. 

Disclaimer: If you're easily confused and/or have a short attention span, you might want to skip the next four paragraphs.  I've noted where to pick up again.

If SPX heads directly higher, there are two wave counts that remain in play -- and both have intermediate bearish potential and hint at a reversal to follow.  The basic issue for bulls is that an immediate rally would suggest that the three-wave structures of the past month have been part of a triangle.  That triangle has two possible forms:

1.  The most bearish is the potential ending diagonal rally (discussed last week), which is invalidated north of 1887.  Ending diagonals (as the name implies) are terminal patterns.
2.  The second option (a standard triangle) is more near-term bullish, but bearish on an intermediate basis.  Triangles most often occur as the penultimate wave in a pattern.  The thrust out of Elliott Wave triangles is generally strong and fast -- and then reverses nearly as quickly.

So (as noted last week) I think bears want to see prices head directly higher from here, and then watch for whipsaws starting at either 1885-87 or 1900-1910.  Both price zones have the potential to mark intermediate turn zones.  There are, of course, also more bullish options that would remain in play on a breakout, and those come to the fore if SPX can sustain trade north of 1910 +/-. 

As I discussed a week ago, the problem for bears is that the three-wave rally into the all-time high strongly suggests that the final high isn't in yet.  So, in the event of an immediate break lower, the first option for bulls is for an ending diagonal C-wave down.  That pattern is invalidated below 1832.82 (hence the 1833 pivot), which, probably not coincidentally, lines up nicely with the 50 day moving average at 1834.

NOTE:  Fed governors start reading again here.

If SPX sustains trade south of 1832.82, then a host of bearish potentials open up.  So, even though bulls have the three-wave rally into the highs in their back pockets, I would not want to be long south of 1832.  The potential for drawdown beneath 1832 is significant.  As an extreme example: the 2011 mini-crash came on the back of a three-wave rally into the 2011 high -- and while the market ultimately recovered and exceeded that high, there was much more money to be made on the short side for several months.

Conversely, in the event of an immediate rally, do keep in mind that this is a bull market; which means bears should choose their entries and exits selectively and cautiously, and not stubbornly fight the tape.  The wave iii of v count discussed at length during March is still alive and well.

Recently, I've had a few readers request updates on bonds, and there's really very little to add since my last bond update of February 20.  Near-term, the 30-year bond (USB) may still be working on wave B/(2).  Ultimately, I still expect prices to test 138, though bullish bond bets are off below the key overlap.

A chart that bears watching is the ratio of high yield corporate bonds to Treasury bonds (HYG:TLT), which has broken its up-sloping channel for the first time in nearly two years.  The bond charts may be warning that there's trouble on the horizon for equities, but as yet there have been no definitive red alerts here, only hints and allegations.

In conclusion, while SPX is still within the trading range, I'm anticipating it will break from this range in short order.  I further suspect that the first break will be upwards, but would stay very cautious for a head-fake and whipsaw shortly thereafter.  The market, of course, reserves the right to do something else entirely -- so the key levels should help point the way.  Trade safe.

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SPX, NYA, and QE Updates: Distribution or Consolidation?

I'm a firm believer that the recent bull market has been driven largely by money-printing from world's central banks, and specifically by the Fed's quantitative easing programs.  I've given verbose arguments in this regard many times, but the short summary of the argument is that the printing press creates liquidity, and liquidity drives the market.

Let's look at a chart of the S&P 500 (SPX), since a picture is currently worth 18,967 words (remember back in the 80's, when you could buy a picture for a thousand words?  Yet another example of inflation.)  The chart below highlights some of the central bank programs which seem to have been intimately linked to the five-year bull market.

I originally published this chart back in November 2012, as part of (what was then) my long-term bull argument for equities.  The question now is: What happens in the coming days, as the Fed tapers the QE program?  Based on prior history, we can assume that as Fed money-pumping slows, so will the market.  But I think we also have to look a step further and ask:  If/when the shrinking liquidity pool hits the tipping point and the market reacts negatively, what will the Fed then do in response?  I mention this because a lot of bears are looking forward to the end of QE, and the presumed resumption of a "natural" market -- but the Fed can, of course, always reverse policy again if it doesn't like the results.

When we look at current charts, we can see SPX has been in a trading range (or "chop zone") since February.  The challenge is that near-term chop zones can turn the charts into the equivalent of a Rorschach ink blot test:  Bulls see bullish patterns, bears see bearish patterns, dogs see patterns that look like bacon, Cookie Monster sees cookies, etc.

This is one reason I would strongly caution against reading too much into the classic technical patterns that seem to materialize within a trading range -- and especially caution against trying to ride them to their classically-expected price targets.  Trading ranges do funny things, and the main success I've ever had with them comes in identifying them early enough, then selling the high end of the range and buying the low end.  That works until it doesn't, at which point your profits should trump the money you lose when the pattern finally breaks and you're stopped out.

Due to the near-term chop zone and the myopia it induces, I want to look at a broader view of SPX.  I'm not going to republish the 30-minute SPX chart in this update because there's been no material change therein, so please refer to prior updates if you missed it.

Not shown on the chart above:  The 50 day moving average on SPX currently crosses 1834.  In the event of a breakdown, that zone is worth watching simply because other traders pay attention to it -- and in a bull market, that means there are often standing buy orders near the 50 DMA.

A couple other charts not shown in today's update that bear honorable mention:

1.  Nasdaq's volume declining has spiked to the highest levels since October 2012.  It's not unusual for volume declining spikes to indicate an approaching bottom.
2.  The Dow Transports (TRAN) invalidated the bullish triangle count.  The first meaningful resistance zone in TRAN is now 7480 +/-.


Next I want to look at the NYSE Composite (NYA) because, of all the chop zone charts, this one may have the cleanest wave structure.  The red trend lines are where nimble traders might play, but we still have to respect the larger range.

In conclusion, SPX and NYA are both near the lower end of the trading range.  Due to the larger trend, this is probably bears' last shot to break these markets down, so any strong bounces from here would likely lead to new highs.  In the event of a sustained breakdown of the 1834 zone, then SPX's pattern could be seen as a double-top, which suggests a textbook target south of 1800.  Trade safe.

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SPX Update, and Avoiding Tricks of the Trader Brain

"It's not what you look at that matters, it's what you see."  -- Henry David Thoreau

While I realize Thoreau was not referencing trading, have truer words ever been spoken in regards to charting the market?  Ever trader on the planet has access to the exact same charts and much of the same information -- and yet if everyone "saw" the exact same things, then there would be no market at all; we would have only buyers on one day, and only sellers on another.

We don't have everyone on the same side of the trade, though, because we all see the market differently.  One aspect of successful trading is the ability to see things that the majority do not.

Another key is to see what's really there.  While that sounds simple enough, "seeing what's really there" is easier said than done -- partially due to our biology.  It might come as a surprise to learn that our brains aren't actually designed to see what's really there.  This is because our brains lack the capacity to process all the information that comes in through our senses, so one of the functions of our prefrontal cortex is to act as a filter against that constant flood of stimuli.  Without that filter, we would suffer from sensory overload.

Here's where things get interesting:  Scientists have recently discovered that there are neurons in our prefrontal cortex whose sole and specific purpose is to suppress information that we aren't interested in.

Read that again, and then consider the implications for a trader.  We all know that "bullish or bearish" biases can be account killers -- and part of the reason appears to be that our brains are hardwired to actively suppress information that counters our biases.  While science has only discovered these special "information suppressing" neurons within the past few years, I think many of us intuitively realized our brains work this way long before science made it official.

It really is amazing how much information we miss on any given day.  Moving from the scientific to the anecdotal:  When I was 9 years old, my father gave me an impromptu demonstration of this fact  He and I were walking out of a shopping mall in Pennsylvania, when we noticed a beautiful rainbow.  The rainbow wasn't directly in front of us, but was something we spotted with our peripheral vision as we exited.  Rainbows this gorgeous were not commonplace in the Lehigh Valley, so my father took this opportunity to teach me a life lesson.

Instead of heading straight to the car as we'd planned, he directed me to sit on a bench near the mall exit and told me, "Watch people's eyes as they leave the mall.  Count how many people notice the rainbow." 

In the time I sat there, 36 people walked out of the mall, and, as far as I could tell, everyone who noticed the rainbow reacted in some way, even if just to turn their heads and look at it.  Finally my father asked me the results of my tally:  Out of the 36 people who exited, a total of only four had even looked in the direction of the rainbow.

"You see," my father said, "most people are so wrapped up in themselves that they end up completely missing life.  As you grow older, it will become harder not to be that way.  Never lose your sense of wonder."

Keeping an open mind to all possibilities is one way to help instruct our brains not to ignore information.  As I've said before:  Your toughest opponent in trading, and the hardest one to overcome, is yourself.

Last update expected the market would correct lower over the near-term, and Monday's opening pop was sold to new lows immediately.  Two wave counts were shown, and both remain viable, with the additional note that if the ending diagonal is unfolding, there are now enough waves in place for new highs.  The bullish pivot level, and invalidation level for the diagonal, is 1895.  This level invalidates the diagonal because wave (v) of the diagonal cannot be longer than wave (iii) of the diagonal.  Interestingly, this now aligns perfectly with the 1895 pivot zone identified on March 5, long before the potential diagonal formed.

On March 21, I mentioned:

This pattern is starting to look a bit like a triangle, so be cautious of sideways whipsaw action developing.

We can now clearly see the potential of an ascending triangle on the above SPX chart -- and we can find triangle-shaped patterns in many other markets as well.  The Dow Jones Transportation Average (TRAN) shows this pattern as well as any:

In conclusion, last update I opined that the wave structure suggested SPX would ultimately see new all-time highs.  There are enough waves in place now for a complete correction, so it is possible for those new highs to happen directly.  The first key level for bulls to reclaim is 1884, while the second is 1895.  The first meaningful zone for bears to claim is now 1849, but the low end of the trading range (near 1839) is more important.  Trade safe.

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SPX and BKX: Equities Market Reveals Its Intentions

Friday saw a bearish reversal day, as prices opened higher and made a new high, then reversed to close lower.  Normally a day like that has some follow-through on the sell side.  The new high in the S&P 500 (SPX) has created a potential problem for bears on the longer time frames, though, as it strongly hints at an incomplete upwards wave structure.  There are a couple ways we can get there, which I'll outline below.

I've noted the 1883-84 zone as resistance more than a few times in the recent past, and the market demonstrated that it needs a bit more coiling before breaking through.  The form this coiling takes will tell us a lot about how strong the rally will be once resistance is reclaimed.  The chart below outlines two options in detail:

1.  In black and blue is the option of an expanded flat.  The minimum expectation for an expanded flat is a decline south of the black A wave low at 1839.  If the market bottoms there, that would likely mark the bottom of wave ii of v and lead to a strong rally toward the high 1900's in iii of v.  The intermediate structure allows for wave C to be one degree higher and lead to a much deeper correction, but we don't want to get too far ahead of the market, so we'll cross that bridge if and when we come to it.

2.  In green is an ending diagonal.  The ending diagonal is near-term bullish, but much more bearish on an intermediate basis.  This means that, ironically, bears want to see the market rally sooner rather than later.

Both of those counts anticipate the market will do some backing and filling here before rallying much higher.  However, in the event of an immediate rally that overtakes 1908, then it's probable the market is already in the midst of wave iii of v.

For the long-term picture, SPX has remained undecided and continues to keep its options open.  The question has been unchanged for nearly a month:  is the fifth wave completing, or will it extend?  SPX has refused to give a definitive answer so far.

Speaking of long-term charts, on Friday, the Philadelphia Bank Index (BKX) captured its long-term target of 73-74.  This target dates back to nearly a year ago, and its capture represents the potential of a nearly-complete long-term correction in BKX.  Keep in mind that this is simply a potential to be aware of at this stage -- this market hasn't broken any key downside levels (obviously, since the target was just captured), or given any signs of doing so yet.  In fact, the 10-minute chart suggests it's unlikely the final high is in for this market.  Nevertheless, it's worth watching -- and if you were long BKX since 59-60 (or lower), then the target has been captured.

In conclusion, bulls have now created a wave structure which strongly suggests that there will be new all-time-highs in the market's future.  What happens in the next few sessions will help detail how soon and how much higher.  Trade safe.

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Understanding Cycles and the Importance of Trading Systems; Plus USDJPY and SPX

Trading can be difficult, and all of us make mistakes at times.  Some mistakes are small, and easy to forget.  Other mistakes are more costly -- and the more costly a mistake, the more difficult it is to live with afterwards.

The irony here is that, quite often, our biggest mistakes are not really "new" mistakes at all; they're mistakes we've made countless times before.  Few big mistakes suddenly materialize out of nowhere (though they often seem to) -- in reality, they are almost always the result of patterns or habits that we've acted out for many years on a smaller scale.  Since the small versions of our mistakes never cost us much in the past (and thus never caused us much pain), we overlooked them, or ignored them, or never even noticed them to begin with.

Big mistakes offer a unique opportunity to learn and grow, because they can usually be traced back to a core error within our thinking that has previously manifested countless times in little ways.

One of the worst things that can happen to a trader, especially a new trader, is to be rewarded for a mistake.  I have to assume this has happened to all of us, in various ways -- some examples of mistakes that can end up as "winners":

1.  We may take a very high-risk entry that ends up paying a profit.
2.  We over-leverage at exactly the right time and win -- when a move the other direction would have wiped us out.
3.  We buy or sell based on "conviction" and not based on the objective evidence of our chosen trading system -- and end up in a winning trade anyway.
4.  We commit a huge percentage of our capital and end up huge winners, when we could just as easily have lost everything.
5.  We exit a trade based on anxiety and not on objective evidence, and it ends up being the best move afterwards.

These are just a few examples of the mistakes every trader has almost certainly made at some point in his or her career.  The "lucky" ones lose right away, and learn from it -- but the unlucky traders are rewarded and profit handsomely.  Having been rewarded for bad trading behavior, these unlucky traders will not recognize their behavior as erroneous.  Eventually, these traders will be wiped out -- probably in a more painful fashion than if they'd simply lost right at the beginning and had the opportunity to learn and correct their behavior.

Just because something worked before doesn't mean it will work again.  How solid is your personal approach?  What are your rules for entering and exiting a trade?  How do you manage risk and position sizes?  What is the minimum risk/reward ratio you'll accept?  What would cause you to exit a trade early -- or late?  What are the rules that govern exit behavior?  What amount of your trading behavior is arbitrary?  These are just a few of the questions with which traders must continually challenge themselves.

Some years ago, I had a trader friend who was a diehard perma-bear, and it just so happened that he got very lucky in the NASDAQ crash of 2000.  When NASDAQ crashed, he had literally just started trading, and he put his entire account (roughly $25,000) into various NASDAQ puts, immediately before the tech bubble burst.  He kept rolling his puts over as the crash continued, and he ultimately emerged from the crash as a multimillionaire.

Unfortunately for him, he got very lucky on his first trades.  His trading "system" (which basically consisted of "buy puts") seemed to be a huge success.  And indeed, that's a great trading system to have during a crash!  But what do you do when the crash ends and you have no other strategies to employ?  At that point, you really have two options:

1.  Take your profits and walk away.
2.  Learn to employ additional systems.

But my friend chose neither of those options (no pun intended) and simply continued with the put-buying system that had made him a millionaire.  After all, why would he change strategies at that point?  He had been handsomely rewarded for his behavior, so what on earth could possibly motivate him to even consider another strategy?  Tragically, by 2004, he had given all his profits back, plus his original capital.  He went from multimillionaire to flat broke.

There's a reason for the saying, "Easy come, easy go."  If we don't "earn" the money in the traditional sense of hard work and discipline, then we rarely have any idea of how to keep it. 

In the end, "strategies" like the one my friend employed are no different than gambling; and true gambling usually generates similar results:  Sudden great fortune almost always ends in catastrophe.  In fact, the National Endowment for Financial Education estimates that 70 percent of people who unexpectedly come into large sums of money end up broke within seven years.

One factor in this is human nature: the more we have, the more we tend to consume.  I'm not going to delve into that aspect here, though; instead we're going to look at how this ties into the nature of the stock market.

Every bit of observable evidence suggests that virtually everything in the universe experiences cycles.  Consider this statement in terms of the seasons; or the life cycles of all living things; or the "life cycle" of an inanimate object (such as a mountain, or a star, or a galaxy).  In fact, I challenge you to find something that does not experience cycles of some kind.  I personally cannot think of anything in the observable universe that does not undergo a build-up toward a zenith of existence, followed by a decline away from that zenith.

For example:  Humans are born weak and defenseless, but build toward physical zenith as they mature.  At some point, humans reach a peak level of health and strength (the "prime of our lives" as they call it) -- and then we start down the other side of that hill, gradually losing strength and ultimately ceasing to exist (yes, the human condition stinks).  Virtually all living things follow a similar arc.  Even stars have a "prime of their lives," but later reach an age where their energy output decreases and they begin to grow colder -- eventually either burning out or exploding (on the plus side, very few humans explode at the end of their life cycles).

Cycles are so prevalent that certain human concepts exist only to quantify the cycles we observe:  Winter, spring, summer, fall; day, night -- not only are these examples of cycles, but those words wouldn't even exist if we lived in a static, cycle-free world.  If not for the cyclical nature of our climate, we'd have just one name for our only season:  "Sprallter."  "Gonna be another lukewarm Sprallter this year!" people would randomly remark to strangers on the street, "Yep!  Always is!"  

Things such as seasons, and day and night, are obvious examples of cycles that experience a build-up, a zenith, and a decline.  A simpler (and more thermodynamic) way to express this might be to say that everything in the universe is either gaining energy or losing energy -- some things faster than others, but virtually nothing in the universe is static.

It appears that, for the most part, we personally cannot control the massive cycles that govern our existence.  How does this apply to trading and investing?

Let's consider a gambling analogy:  If we sit down at a slot machine, put all our money into it, and simply push the "spin" button endlessly, then we do not control our destinies even slightly: the slot machine does.  Our financial fate becomes tied to the "fate" of the slot machine, and we become completely subject to the laws of chance.  Free will essentially vanishes.  Our fortunes will rise and fall purely based on the cycles of that slot machine.

Some investors and traders approach the stock market in a similar fashion, endlessly pushing the "spin" button, as my unfortunate friend did.  That type of approach gives an illusion of control, but ultimately, it has none.  Entering trades largely at random doesn't control the market any more than pressing the spin button controls a slot machine. 

So how do we separate our financial fates as individuals from the fate of the market?  How do we give ourselves a true advantage over blind chance?

We accomplish this by developing trading systems.  Having a trading system is, in essence, an expression of free will:  it allows us to link our fates to the market when we see an advantage, and disconnect when we don't.  Without a system, we might as well just buy an index ETF and ride the market out wherever it goes.  Obviously, very few people who are reading this (type of) column would have an interest in a buy-and-hold approach.  Likely the very reason any of us sought a system in the first place is because we had an instinctive desire to pull away from the herd, and thus to separate ourselves (and our families) from the destiny of the collective.

I don't have space in this article for a comprehensive discussion of trading system specifics -- that's often the topic of entire books.  My goal was more to address why there's a need for such systems.  In closing that thought, it's also critical to remember that after one develops a trading system, then one must further develop the discipline to stick to it.

Moving on to the charts, let's look at usd/jpy first.  On Wednesday, usd/jpy captured my target of 102.600 (from March 17, reiterated March 19) and as promised, once that level was captured, I switched from near-term bullish to "neutral-leaning bearish."  The bear count can still withstand a bit more upside in dollar/yen, but things become ambiguous with sustained trade north of 102.800ish.

This market is a good example of where a trading system can allow one substantial profits.  Unlike SPX, I've felt the wave count recently was pretty clear in dollar/yen, and this market has performed as expected since I outlined the key zones on March 12.  If you've traded the preferred count and key zones in usd/jpy with discipline for the past 9 days, then you're sitting on more than 200 pips of closed profit, and another (roughly) 30 pips in open profit (for those of us bold enough to close longs at the 102.6 target and reverse short in front of the freight train).  For the risk averse, stops on shorts can be moved to roughly break-even with little remorse.  There's always the next trade, and no reason to give back profits if dollar/yen starts entering ambiguous territory.

SPX has shown resiliency since 1839, and on Wednesday, bulls grabbed the ball right at the key trend line outlined earlier that day.  This pattern is starting to look a bit like a triangle, so be cautious of sideways whipsaw action developing.  Thursday's session was an inside day (all trade remained within Wednesday's range), but that can be interpreted in different ways.  On some occasions, an inside day at the end of an uptrend indicates buyer exhaustion; other times, it simply marks a consolidation.  In all cases, it does indicate some level of indecision in the market -- so it's difficult to draw a conclusion from a pattern that suggests the market itself hasn't drawn one.

In conclusion, we've seen a fair amount of volatility recently -- but, in the case of equities, that volatility has simply created a trading range, and trading ranges are notorious devoid of information.  The key levels have become more critical to the next sustained move.  Have a great weekend, and trade safe.

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Recent Market History Gives Warning for Today's FOMC Day

Today is FOMC day, which is typically a great day for traders who enjoy volatile whipsaw markets and feelings of righteous indignation.  Recent market history suggests it may also be something more.

In Monday's update, I discussed that I felt the market had reached an inflection zone, and it had the potential to put together a decent rally.  The S&P 500 (SPX) has since rallied to within 10 points of the all-time-high, which is an important resistance level.  And now things get interesting again, especially since this week we have March options expiration (OpEx), in conjunction with the FOMC meeting.  During 2013, there were three FOMC meetings that fell during OpEx weeks, and all three led to major turns (plus or minus only one trading day).  I've highlighted this on the long-term SPX chart which follows.

The long-term SPX chart shows that there are two potential intermediate counts in play, and a clear victor still hasn't emerged yet.  If bulls can sustain trade above the up-sloping red trend line (on the chart below), then the market will likely take aim at the 2000's.  For the moment, though, the all-time highs and said red trend line must be respected as resistance.

It's also interesting to note the prior decline found support after a perfect test of the dashed red median line, and is now testing the blue trend line.

On the 30-minute SPX chart, I've outlined the bull/bear key overlaps, and the bearish pivot zone.  I've also revisited the near-terms wave structure slightly in order to explore how the decline could be counted impulsively -- this is largely an academic exercise with this type of ambiguous structure, as opposed to being predictive (as it sometimes is).  The rally off the low is three waves so far.

Finally, let's update the USDJPY Forex chart.  I'm still inclined to lean near-term bullish on this pair until my target of 102.600 +/- is reached on the upside (at which point I would become neutral leaning bearish), or until dollar/yen sustains trade beneath 100.750 (at which point I would become bearish).

The first meaningful level is 101.200:  A quick whipsaw would be okay, but sustained trade south of 101.200 would suggest a retest (or break) of 100.750 (shown as the gray alternate count) -- and the same rules then apply to the 100.750 level, but on a larger scale.  As with many charts, the first key level (101.200) provides warning that a trip to the next level is likely.

In conclusion, I was bearish early in March and remained so until Friday's close, at which point I shifted to near-term bullish.  I would currently label myself as neutral for the following reasons:

1.  The intermediate wave structure has a bearish bias until the noted levels are reclaimed; this conflicts with the intermediate trend, which is still bullish.
2.  Price is clearly in a bullish near-term trend for the moment.
3.  Both trends face resistance at the noted key levels -- meaning those price zones potentially have the power to stall or reverse the trend.  If the market instead sustains trade above those key levels, then odds are good the trend will accelerate.

It will be interesting to see if the FOMC meeting today, in conjunction with options expiration week, generates a major reversal as it has on the past three occasions.  Trade safe.

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