Here’s what to look for in the action today…
General Trends
As I went through my chart review this past weekend, the first thing I thought of was, “Is it possible last Wednesday’s 1.8% drop in the S&P 500 was just a one-day correction – designed to shake out weak bulls, and get overly aggressive bears to make big downside bets just before the market blasts higher one more time?”
After all, most of the technical momentum indicators never reached extremely overbought conditions. We never got a breakdown in traditional leading sectors like high-yield bonds and semiconductor stocks. And technical conditions quickly reached oversold conditions on Wednesday’s decline – which is why I advised my Delta Report subscribers NOT to add short positions into the decline.
The proverbial rubber band was stretched too far to the downside. We were likely to get a solid bounce higher.
That’s what happened on Thursday and Friday. The S&P 500 rallied all the way back up to the 2382 level – which was its previous support. Now, it’s resistance.
So, now we’re at an inflection point. A strong push higher from here and the bulls take back control. But, if resistance holds, then look out below. Stocks will be headed lower over the next few weeks.
It could go either way. But my money is betting on the downside. Here’s why…
Stocks
The S&P 500 closed Friday just below its 9-day exponential moving average (EMA) at 2383. And the daily chart has the look of a bear flag pattern. Take a look…
Wednesday’s big decline had the look and feel of an “impulsive” move – meaning there was plenty of volume and plenty of selling pressure behind the decline. But, since the decline started with most technical indicators in “neutral” condition, they quickly reached oversold levels and set up for a solid one- or two-day bounce.
That’s exactly what we got.
In two days, the S&P recovered almost 50% of Wednesday’s decline. It jumped back above the 50-day MA line. Now it’s challenging the resistance of the 9-day EMA.
If you’re leaning bearish, then this is an ideal spot at which to take a short trade. You’d be shorting stocks at resistance, and you could keep a tight stop loss on the trade.
For example, if the S&P were to rally above 2395, then it would clearly break above the 9-day EMA and the momentum would shift back to bullish. You could cover the trade for a small loss of about 12 points on the S&P. That’s a loss of about 0.50%.
On the other hand, if resistance holds and the market presses lower from here, then look for the S&P 500 to decline below Wednesday’s low of 2353. In fact, if the bear flag pattern plays out, then the price target is somewhere around 2340.
That would be a 43-point gain on a short S&P 500 trade, or nearly 2%.
So, the risk/reward setup right now favors the bears by a 4:1 margin.
Of course, there is a fly in the ointment…
The Volatility Index (VIX)
The VIX generated a buy signal on Friday by closing back inside its Bollinger Bands.
But the decline in the VIX was so large – a decline of almost 18% – that we have to wonder if most of the possible upside from the “buy” signal has already happened.
VIX option prices, which – prior to last Wednesday’s market decline – were indicating a higher price for the VIX going into mid-May and early June, are still pointing to a higher VIX over the next few weeks.
Though, when the VIX was trading above 15 on Wednesday, VIX options were pricing in a lower VIX. That’s one of the reasons I told my Delta Report subscribers not to add short exposure during Wednesday’s decline. The VIX option prices did not support a further selloff in stocks.
After Friday’s market action, and with the VIX back down near 12, the options are once again pointing to a higher VIX over the next few weeks. And a higher VIX usually correlates to a lower stock market.
So, I think traders need to remain cautious. Aggressive traders can use the recent bounce as an opportunity to establish new short trades.
The upside for stocks looks limited from here.
I’ll update Delta Report readers on these trends throughout the day on Jeff Clark Direct.
Best regards and good trading,
Jeff Clark
Mailbag
P.S. Thanks to all my readers for your thoughts, insight, and great trading stories. Please keep that feedback coming right here.
Here’s what came in recently…
Loved your baseball analogy on Friday. I played with the Phillies for 8 years and finished with the Brewers. Keep it coming! How is your family involved in the game? I have two sons playing college ball and one of them looking forward to the draft on June 12-14. He is hoping to get his shot. Thanks for your wisdom. Love your advice and insight!
– Pat
I just wanted to give you a quick shout out, and say thanks! Great job on the TWTR, AG, and URBN recommendations. I have learned so much from you over the past couple of years, and always look forward to reading your commentary every morning and throughout the day. I am very excited and looking forward to the roll out of your trading earnings algorithm, it sounds very interesting!
– Ryan R.