After falling 9 of the last 11 sessions, it's safe to say that the S&P's were probably due for a bit of a bounce. Volume continued to dry up over the past week (partly due to the July 4th holiday), which was certainly a bit concerning for the bears. Usually, though, volume is a bit of a better indicator on the upside, in my opinion, since a rallying market needs buyers to move higher while a falling market simply needs an absence of buyers to continue its spiral. And as the macro numbers continued to come out in a disappointing fashion, an S&P move to the 980 level seemed almost inevitable. Truth be told, I got a little caught up in the doom and gloom as well, even going as far as to put a bit of a short S&P 500 position on near the close yesterday (only about a 7% position). Needless to say, today wasn't so friendly to that position. But while losing trades are inevitable (though certainly not the goal), this is one of those instances where looking to the technicals would have at least given me some context before getting short. While it would not have changed my fundamental outlook (still bearish on equities for the remainder of the year), it definitely would have helped me to enter the position more opportunistically. Below is an illustration of one of these technical indicators, which is one of the most reliable I have found.
Initially outlined in Constance Brown's book Technical Analysis for the Trading Professional, the Relative Strength Index (RSI) can be used in certain circumstances to develop upside and downside price objectives. Generally speaking, I've found these signals to be quite reliable and am always on the look out for their development (Yes, I missed the boat on the one outlined below). Simply put, in this analysis we are looking for differences in the price trend and the RSI. As a market moves to a new high (low), it's logical that the RSI should move to a new high (low) as well. It's when this lockstep movement deviates from what is expected that we should take notice. Take a look at the daily chart of the S&P 500 below.
What should jump out at you (and me for that matter) is the fact that the higher highs in the RSI denoted by the dashed green line coincided with lower highs in the S&P 500. This isn't a situation that should logically occur. But how does this help us other than to say that the market is acting in an unusual manner? The technique described by Ms. Brown is to take the difference in the closing prices associated with the highs in the RSI and subtract them from the closing price associated with the low RSI during the period. In this case, the high close on May 12 was 1,171.67 and 1,117.51 on June 18. The May 20 close that coincided with the low in the RSI was 1,071.59. Using Ms. Brown's methodology, a downside target (think the place where the current downtrend is likely to reverse) of 1,017.43 can be calculated. It should be noted that this target is not a projection of closing price, but rather price movement that can be seen intra-day as well as at the close.
So how did this signal fair? On July 1, the S&P 500 hit an intra-day low of 1,010.91, a mere 6.52 points lower than the price projection. That's the kind of stuff that gets me excited. And it's also the kind of thing that frustrates me all the more when I miss seeing it. None the less, it's yet another example of the types of things that we should all be at least aware of before putting a position on. To successfully navigate the markets today, we've got to do our homework, both fundamentally as well as technically. Unfortunately, I didn't do a good job of following this advice yesterday. Hopefully, though, this will help illustrate a technique that you can use to help better time your trades in the future.
In closing, I know I spent a lot of time today on technicals, so I'll be sure to get into my fundamental outlook in some depth beginning with tomorrow's post. The short version of my outlook is one that is largely bearish for nearly all markets. Globally, there are a host imbalances that simply have to be corrected before we can all move forward economically. Domestically, we face a confluence of generational shifts, financial rehabilitation, and shifting government policies that will provide headwinds for quite a while. As such, I believe that opportunistic trading strategy must be employed for the foreseeable future. But the details of all these issues are for another post. In the meantime, I'll be reevaluating my net short position to see whether or not I should add to it, wait, or simply run for the hills.
- JMO
*** All the opinions expressed in this blog are solely those of the author and do not necessarily reflect those of any other individual or organization. ***
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