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We just finished three hours of short-covering. The market managed to tuck up into the monthly open around 4408, near the 21-day line and slightly above yesterday’s RTH low. Unsurprisingly, this is now resistance and will take some time to conquer if we are headed back north again.

The remainder of the day will tell us whether the market can find acceptance or needs to roll back down and retest the lows. The “ABC” nature of the short-covering rally makes it look corrective to the downtrend underway rather than the first rally in a new leg up.

Let’s see how the rest of the day goes. If you followed the Pre-Market Outlook, you should have more than enough gains to take the rest of the day off.

A.F. Thornton

Programming issues have been plaguing me since Sunday. I will get everything from yesterday back up on the website later today. Meanwhile, we exited most of our positions last week at the peak, excepting for Energy (XLE). I had set a wider than usual stop to give it plenty of room. One would think XLE would have reacted favorably to Middle East turmoil. We hit our stop about an hour before the close yesterday nonetheless. And perhaps that is one of our “WWSHD” signals (when what should happen doesn’t).

Overnight, the major indices continued lower to tag their 50-day lines. That would have been the end of it in the past few markdowns. However, in June and July, the markdowns did not finish until Monday or Tuesday after monthly options expiration. The monthly expiration is tomorrow (Friday). And we will be gapping lower this morning from the lower third of the overnight range. Overnight inventory is net short.

And the previous corrections started a few days later than this one. Of course, this markdown could be different now that we are in that seasonally weak period of the markets – August through October. Notably, as well, we have now dropped below the August monthly open at 4408, so the monthly candle has turned red, putting a potential bear monthly candle on the board.

Also, we have been in a small pullback bull channel on the weekly chart which normally ends with a large pullback of 10% to 15%. At the very least, the market typically will go sideways for a while. The only question is what the size of the trading range would be. As an example, could we tag the July 19th low around 4200 to form the bottom of the range?

Today, then, is as simple as framing our bias between the overnight low at 4347.45 (the market looked like it was exhausting into that level last night) and the overnight halfback at 4374.50. Above the halfback, I start feeling a tinge of positive bias. Below the overnight low, there are a couple of prominent VPOCS at 4339.75 and 4316.50, but it could also mean a trip all the way down to the 200-day lines, though not likely in one session.

Overnight inventory is certainly net short enough and we are close enough to the ONL to assume that there is potential for a short-covering rally. As always, buy the high of the first one-minute bar or a cross back up through the open should the opening drive be lower.

In either situation, it would be better if the ONL does not get taken out in early trade. Monitor for continuation and target the overnight halfback first. The outcome and tone of any short-covering rally will always give you tons of information that will help you discern the potential outcomes for the rest of the session.

On any fade and then failure, preferably one that cannot even reach the overnight halfback, the cross back down through the opening price is a short trigger.

On an opening drive lower that takes out the ONL, target the first VPOC at 4339.75 and monitor for continuation. Good confirmation that such a move has the legs would be a failure of the NYSE tick to get positive at all during the first half-hour of trade.

Both Gap Rules and Spike Rules apply this morning.

A.F. Thornton

As I had suspected, yesterday was somewhat of an anomaly, making me highly suspicious that the Fed intervened in the market to cushion the Afghanistan news.

So it appears that the 40-day cycle markdown has resumed. But with the CBOE Put/Call ratio at the highest level we have seen all year, I do expect a short-covering rally at some point today, perhaps even into the close.

I would target the 21-day EMA on the daily chart as the first reference point and target for the cycle low. From there, you can double the decline if the 21 does not hold and then target the 50-day line.

A.F. Thornton

Note that the CBOE Put/Call ratio has hit the highest level since January this morning. With that many shorts, the risk of a rally later today is higher than significant declines.

Above are the four most common outcomes of an opening gap down, as we experienced this morning. Of the four, the behavior is closest to the lower right-hand corner. We wedged into a reversal about 11:00 am EST. We have experienced a nice rally up to test the gap, where we find ourselves at this writing. The bottom of the gap (where the market opened) is also yesterday’s low and the old trendline we broke this morning. All of this congregates around 4450, a half-roundie that could provide resistance.

Whether this is true buying the dip or short-covering is not entirely clear, but it is certainly not the disaster it could have been this morning. You should be happy with some nice gains if you followed the morning plan. We breached 4441, setting up a short trade to 4430. The market wedged into that level, setting up a long trade that you should still be holding, but getting ready to exit on the current rising wedge now forming into the gap around 4450. After I exit this trade, I am done for the day.

I suspect there might have been some intervention in the markets this morning due to the global picture. We can never know for sure. Also, the global chaos is likely to hold the Fed tapering and interest rate hikes in abeyance. Kind of like bad news is good news. In any event, the sellers were unable to press their case below the morning low, and the buyers are still in control for now. We will see what the afternoon brings.

The put/call ratio is elevated and that may stymie further declines today. But until proven otherwise, we are still in the initial stages of the nominal 40-day cycle correction.

A.F. Thornton