Thursday, February 9, 2012

SP 500: The Big Picture

Regardless of whether you trade or invest, and regardless if you trade or invest the S+P 500 directly it is important to understand where and how the benchmark is trading. The markets are moving more and more in unison with the major indices whether it's through indexing or etf's I can't say for sure. But whatever the case may be, it's the reality, so without a gauge of the overall picture you can still find yourself underwater buying good companies simply because the overall indices are in a Short Term, IT, or even Long Term bear market. I use the SP 500 simply because it has the most exposure to all of the sectors of the equity markets. The Nasdaq is also a great barometer of the risk-on trade.

To the charts, it's important to set aside the news and the noise and look back at the bigger picture as a whole and form your own conclusions, in my opinion the more you do this the better off you will be. I will share my own opinions which may or may not fall in line with the majority.

The top chart shows a daily chart of the SP 500 cash market since the March 2009 lows, as you can see clearly marked on the chart each of the 3 waves up that have completed and the 4rth wave up that we are currently in. I've also outlined the sell off reactions we've seen. First notice how the sell off reactions have increased in size even though percentage wise a drop of 38% was completed in each of the last two sell offs before the market bottomed. So even though the percentage move may have replicated, the bears are finally starting to see value in selling this market at these higher prices. You can also see the power of repetition as the rally wave ups have closely matched in size and strength, as outlined. Our current rally wave has an upside projection of 1425-1435 as. Of course if you recall from the last post, the next immediate upside target comes in line around 1385 or so. Each target should be met with a reaction size with at least profit taking.

Now let's take a look at a slightly longer time frame to look at an even bigger picture, the middle chart above is the monthly chart of the SP 500 cash. It shows the bull market run of 2002-2007. A nice 5 year bull market run that ran just over double in value from it's lows and created a bull market rally of 807.46 pts. Now we can match the size of that bull market to come up with an upside target for the very long term of approximately 1475 or so. So between the 1425 - 1475 level the market will indeed be telling whether this can be a sustainable bull market, or just a bear market rally on the Very Long Term time frame.

Anything can happen in these markets right now with the underlying fundamentals, I must stress I am not making any predictions for the longer term, my time frame has always been the short term, but I always try to stay on top of the bigger trends. I'm also just stating the probabilities for the bull and bear case, the 1425-1475 level going forward is THE line in sand in my opinion, if sellers don't come out there they won't come out for a long time to come, as the equities will make new all time highs. If they do decide to show up, and the overall markets put in another lower high, I would expect a drop with a maximum downside target in the mid to low 500's in the SP. Again as noted on the chart, that is a maximum downside target, there's many support levels below it would have to break through to get there, which I will point out when/if the time comes. Again only speaking/thinking in terms of possibilities right now.

The third and final chart above shows a daily chart of the SPY, the blue lines outlined show the breakaway gaps when the market was last trading at those price levels, that going forward will prove to be resistance if/when we get there. These lines are smack in the middle of the 1425-1475 SPX levels mentioned in the top two charts, to give even more confluence and fine tune possible entry/exit strategies.

Now what is a breakaway gap? Well a gap in general is an imbalance, when the market closes and opens the next day up or down from the previous day's close, the imbalance is the day's gap. The daily gaps tend to get filled or tested that same trading day, if not sometime in the future. So breakaway gaps are price gaps/imbalances that fail to get tested. They later become magnets and/or support and resistance depending on whether the gap is above of below. The breakaway gaps are in the early stages of the financial crisis in late 2007 before things really got nasty. So you know interest at these levels will accelerate if/when we return to revisit for some unfinished business.

So basically this post can be taken is a reference of what we've done and what to expect in the future, you can use this as you wish for whatever time frame you look at, or not at all. It can be a word of caution, as we approach very important levels soon, loading the boat on the long side regardless if the economic data is getting better, may not be the best idea. If long from well below, it could be a signal to lighten up a bit and see how it reacts going forward. If bearish and think the world will end soon, then it can be areas to start scalling into short positions. It does seem with 0% interest rates forever, that a bear market swing back down to the 500's in the SP may be quite a stretch, and you could very well be right and I happen to agree. However recall in 2009, who would have thought we would ever see these current price levels so soon. That seemed as impossible as maybe revisiting 500 SPX is now, we'll just have to wait and see. The markets and supply/demand will be the ultimate judge.

Stay safe!