The Volatility Index (VIX) generated a sell signal when it closed back inside its Bollinger Bands last Wednesday. And that sell signal is happening at a time when the S&P is tracing out a dangerous chart pattern.

Take a look…

This chart shows a bearish rising wedge pattern (the blue lines). This pattern often resolves to the downside in a quick, severe move.

On Friday, the S&P 500 closed right on the support line of the rising wedge. There’s room inside the wedge for the S&P to rally one more time and test the resistance line of the pattern. So, it won’t surprise me too much if we see some strength in the market early this week.

But, I think the odds favor a breakdown.

Notice how none of the technical indicators at the bottom of the chart are even close to oversold territory. They’ve just started to roll over and break down. So, there isn’t much energy available to fuel a bounce attempt. It seems to me the path of least resistance for the market is lower.

If the index breaks down from this rising wedge pattern, then the first downside target is the late July low at about 2790 or so. That lines up with the 50-day moving average line – which makes it an obvious support level.

But, if the selling pressure really kicks into gear, the S&P could drop all the way back down to the June low near 2700. That would wipe out all of July’s gains and cause a lot of pain for folks who chased stocks higher into overbought conditions over the past two weeks.

Of course, that sort of a decline is a lot to ask for. But we are entering a seasonally weak period for the stock market. The action from mid-August through late September tends to be bearish. And with the VIX generating a new sell signal, traders should be on the lookout for a larger downside move.

Best regards and good trading,

Jeff Clark

Reader Mailbag

Today in the mailbag, a reader points out a technical difficulty…

This Market Minute, Jeff is displaying a chart of the VIX while talking about the S&P. I’d like to see the chart of the S&P he’s referring to.

– Deborah

Thanks for pointing out the error, Deborah. The correct chart, of the bearish rising wedge pattern on the S&P, is now on the site and noted for the record.

Readers… how are you trading the S&P this week? Are we headed to new highs?

Let us know your plan here.