View from the Top Down

In This Series, We Examine the Stock Market From a Big-Picture, Swing-Trading Perspective

As it did in the last writing, the analysis starts this week with the failed bear breakdown back on 6/18. Granted, it was a quadruple witching Friday, leaving a few doubts about the validity of the anticipated decline. But what has followed has been a virtual melt-up in the NASDAQ 100 and S&P 500 indexes, which are now throwing exhaustion and “Trend Reversal Imminent” signals on the Navigator Algo as you will see when you click on and enlarge the S&P 500 index chart above.

If you were quick to the punch, this was a classic, “When What Should Happen Doesn’t” buy signal. Shorting the rally at the former high failed twice for me in the following week. As well, the Navigator Algorithm itself threw a weak buy signal on 6/24.

Nevertheless, the Founders Group chose to ignore the potential swing buy signals instead favoring short-term day trading rather than a longer-term position. Most of any long positions we have taken from the daily 5-EMA have been home runs – though many of the buys were in Globex. When I am back in the States, such signals won’t be as easy to execute as they have been in the European time zone.

Our reluctance to take swing positions was simple. This high into an intermediate trend, you can get caught in a liquidation break that can wipe out several weeks of gains before the close of a given day, when most swing traders (not sitting at their computers) could lose all the benefits of their trading gains. Worse, the break could start in Globex, giving you no ability to preserve your gains before the open. Stops are helpful, except there are no stops on call options.

The weak structure underpinning the rally so far continues to support a large liquidation break ahead. Immediately below us are unfilled gaps and untested points of control. As presented in the Chart below and viewed from a year-to-date perspective, there is a virtual “air pocket” between 4100 and 3900 on the volume profile. We have discussed these low-volume nodes before. When the market enters these zones, it moves very quickly until it finds another high-volume node to hold it.

Also under consideration is the stealth correction occurring under the surface in the value or cyclical names. Accompanied by a rally in treasuries, the lower interest rates have boosted tech and growth stocks at the expense of Financials (XLF) and (XLE) Energy. (You could try some long calls on the latter two sectors on the theory they will play catch-up). Absent that, the negative breadth, strength, and momentum divergences on the S&P 500 Index itself cast some doubt on whether this rally is sustainable before a good-sized break.

Those divergences would need to right themselves this week to keep this uptrend going, but sentiment extremes and the 18-month cycle also still loom as negatives. Unfortunately, they give us very little guidance on timing the peak.

One other carry forward continues to be the butterfly topping (harmonic pattern) in the NASDAQ 100 (QQQ) shown above. This pattern would support the intermediate peak we are expecting at or near point “D,” particularly when the NASDAQ 100 is the lead player in this rally. That gives us a bit more headroom, but not much.

My ideal scenario is a peak, intermediate correction, and then a continuation of the bull into the end of the year, or at least a transition to a trading range. Bull channels, especially tight ones, tend to morph into trading ranges, and that would not surprise me before summer is over.

My swing-trading outlook remains neutral to slightly bearish. I do not see anything cataclysmic on the horizon, just a market that is short-term overdone and in need of an intermediate decline of about 10% to 15% to reset. If you examine the Volume Profile Chart above, that would take us to the high volume node around 3850 (also the 200-day moving average) at the extreme. The June low might hold us in place as well, perhaps avoiding the air pocket that causes me some concern.

The main thing to remember at this stage is that the declines will come swiftly and may carve deeper than the time it takes for you to get back to your computer to push a button. They could happen overnight in Globex before you wake up. This is not a concern when you use stops. However, you cannot set a stop on an option, so keep that in mind.

My mid-year outlook video will be out by Friday.

A.F. Thornton