We have initial evidences of a potential pause of the "V Bottom" rally off the October low:
- Daily time frame: Outside Day (Dark Cloud Cover) & Exhaustion gap.
- Weekly time frame: Shooting Star.
- VIX jumps 10.44%.
On Friday SPX gapped higher but quickly reversed engulfing Thursday's candlestick. This price action (Exhaustion gap) usually occurs at a trend reversal of an extended move.
Obviously this potential trend reversal pattern needs to be confirmed next week. Furthermore the 10 dma which today stands at 2058 and coincides with an accelerated trend line from the November 4 lod must be breached.
If this is the case the critical levels to the downside are:
- Rising 20 dma = 2043.
- The last breakout former resistance now support at 2019.26 (September high).
If the September high does not hold then a shallow correction should bottom in the highlighted target box, which has a range: 1944 (Runaway Gap) - 1978 (0.382 Retracement)
In the weekly time frame we have a Shooting Star (Potential reversal candlestick), which will be confirmed if next week the gap at 2063.50 is closed. If this is the case the critical levels are:
- Rising 5 wma = 2044 (It coincides +/- with the 20dma).
- September high = 2019.26.
If the September high is breached a mean reversion to the 20 wma which stands at 1985 would be doable.
Regarding VIX on Friday, which was supposed to be a quite day, it gapped up and jumped 10.44 %, probably a signal of unrest.
Here we have a descending channel, which is not a clear reversal pattern but the Bollinger Bands are tight hence a large move could be in the cards.
If we take into account that momentum and breadth indicators are in overbought territory the pending confirmation of a reversal is feasible:
- Daily Momentum: We have an overbought RSI (14), which has begun to roll down, and an overbought Stochastic, which must breach the 80 line if the scenario of meaningful pullback is correct. At the same time the MACD has to confirm the reversal pattern with a bearish signal cross.
- The % of SPX stocks above the 50 dma reached almost 89% last Monday. This breadth indicator measures the degree of participation. It clearly shows a bullish bias but readings close to 90% are considered extremes. More often than not these readings precede a market top.
- The RSI (14) of the NYSE Summation Index has been hovering in overbought territory since the beginning of November. There is no signal cross yet but the MACD histogram is approaching the zero line (Negative divergence). Bear in mind that if the Summation Index triggers a sell signal (By crossing its 10 dma) usually a bearish bias carries on for an extended period of time, until the RSI (14) enters oversold territory.
- The weekly Stochastic of the NYSE Summation Index signal cross usually precede the Summation Index buy/sell signal cross. At the close of last Friday it kissed the sell signal. So next week it will be very important since it could mark a change in the market behaviour.
- The McClellan Oscillator is displaying a blatant negative divergence. If next week it crosses the zero line it will most likely set the "reverse gear" that will initiate the sell signals.
Once/if momentum and breadth signals turn bearish, as I have mentioned above, bears will have to breach the trend line support in force since the November 4 lod which coincides with the 10 dma and the 20 dma. If this is the case a shallow correction would retest the last break out level of the September high (Target 1), while a standard minimum correction should aim at the support zone (Target 2).
Regarding the daily Dark Cloud Cover reversal pattern, in my opinion as we can see in the 5 min chart, it correspond to a potential truncated Ending Diagonal that should have concluded a Triple Zig Zag from the October low. If this is the case we need to see an impulsive decline. Barring a gap down next Monday an assumed wave (ii) may back test the trend line of the wedge and resume a potential impulsive sequence to the downside.
An impulsive sequence would set the ball rolling into a trend reversal.
I am already long TZA. Next Monday I will seek a long entry also in SPXU and maybe I will sell Dec SPY 207 calls.