Great Trades

Great stock trades based on fundamentals and technical analysis.

Saturday, July 04, 2009


Confluence of Resistance and VIX Bounce Turn the Market Back

As we said last week, "Now, the market is near a key resistance area, and how it reacts to that resistance will likely determine the direction of the next big move."

The market's rejection at that "Confluence of Resistance" 927 area indicated that the next big move would be down, especially given the failure during this historically positive week, along with the rare VIX action.

On Monday morning, the S&P 500 quickly rose to the 927 resistance area, but was unable to break through it, closing right at 927, for the highest close of the week. The "double violation of the lower Bollinger Band" I mentioned last week turned into a triple violation with Monday's third consecutive VIX close below its lower Bollinger band. As we mentioned last week, even a single close of the VIX below the lower Bollinger Band has been a pretty reliable sell signal.

Tuesday had a sharp drop when the 927 area didn't hold, falling 15 points to the 912 area, providing nice, quick profits to those who shorted Monday's strength as we suggested. The VIX bounced back nearly 10% from its intraday low, but fell back into the end of the day as the market rebounded.

Our automated gap trader indicated the market was likely to bounce back on Wednesday, at least early on. Despite quarter end and pre-holiday favorable timing, the failure of the market to break out through the "Confluence of Resistance" area on Wednesday (the May high around 930 also added to this resistance zone), along with some other technical sell signals, was a strong hint that the market was headed for a big down day on Thursday.

The VIX broke to an even lower low on Wednesday, again piercing the lower Bollinger Band (for the 5th straight day) before bouncing back as the market rally faded. The VIX action clearly indicated a VIX bounce was due, which would mean market weakness.

With the failure at resistance, we very nearly posted another warning of a big down day to come on Thursday, but the unknown reaction to the employment report on the normally bullish day before the holiday gave us pause, and we already had made it clear the reaction to the resistance area would determine the next direction. We were also busy preparing our systems for Thursday's selloff -- It's easier to do blog posts on the weekends when the futures markets are closed.

The disappointing employment report sealed the market's fate for Thursday, as it had its worst day before the July 4th holiday ever. The VIX bounced back over 15% from Thursday's low to Friday's high. Our automated trading system had its biggest one-day gain ever (on an absolute dollar basis, but not % basis, as there were bigger % gainers when the account was smaller -- e.g., on June 22 when the big down day came as expected and the system also had big gains from other commodities).

As we said last week, "This confluence of resistance means it's important for the market to power through through that 927 area next week in order to have the month-end/quarter-end/holiday rally one would expect. If it fails to break though that area and rolls over instead, a break of this week's low would confirm a head and shoulders topping pattern and would also feature a bearish 13/34 EMA cross (red and blue lines)." The market rolled over, but it did not yet break last week's low to confirm the head and shoulders breakdown, and the 13/34 EMA lines haven't crossed yet.

With the very high TRIN reading of over 3.5 at the close on Thursday, the market is likely to rebound some on Monday, at least for part of the day. The VIX bouncing back down off the 20-day moving average (mid-line of Bollinger Bands) and the SPX near its lower Bollinger Band add more reasons to expect a bounce early next week. However, strength early next week may provide a good selling opportunity, as "there are indications that a market shift is taking place..." A break of the June lows will confirm the Head & Shoulders topping pattern and likely mean more weakness is coming.

Another indication that a market shift is taking place is the 9-to-1 up days vs. down days:

As this chart shows, in the rally from March 9 until early May, there were far more 9-to-1 up days than down days. In the last few weeks, that has reversed, with Thursday being the third 9-to-1 down day in 3 weeks.

All in all, it was another great week for our automated trading system, which still has yet to have a down week during this development and testing phase. It was its biggest week ever on an absolute dollar basis, and the gains are getting more diversified, as we've added programs for silver, copper, oil, and natural gas. We continue to tweak the system as needed and adapt it to market conditions.

We'll continue to update this blog periodically, but again, our current focus is on expanding and extensively testing our automated futures trading system. We've had several inquiries into our plans -- as long as the extensive testing in different market conditions continues to show strong results, we plan on starting a hedge fund based on the system. Interested parties can always contact us through the Email GreatTrades link at the bottom of this blog.

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Disclaimer: Great Trades may have a position in all or some of the stocks discussed in this blog, but is not paid by any company to promote their stock. Great Trades contains opinions, none of which constitute a recommendation that any particular security, transaction, or investment strategy is suitable for any specific person. Great Trades does not provide personalized investment advice.

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