The S&P 500, Fed, Dollar, and a troubling DJIA pattern
The Federal Reserve is holding a two-day meeting Tuesday and Wednesday of this week. Market participants are expecting the Federal Reserve to prop up financial markets yet again with some grand new plan. The fact is the Federal Reserve is running out of bullets.
Interest rates cannot move much lower in terms of the Federal Funds rate, additional quantitative easing seems redundant since Treasury yields are close to all-time lows, and finally a twisting of maturities will do little to alter the current economic conditions.
The Federal Reserve is just repeating practices which have proven over a long term do little to create jobs or get the economy moving in the right direction. A stock market rally does not help a person looking for a job!
It is possible that even if the Federal Reserve proposes additional stimulus the market could sell off. I have been trading less in this environment and have been focusing on looking for trade setups that could work regardless of price action. For now I am sitting predominantly in cash waiting to see how price action reacts to the news flow this week.
S&P 500
If I had to guess, I continue to believe that the S&P 500 (SPX) (SPY) will get back to test the key 1,250 – 1,280 price level. While this resistance level is apparent, Mr. Market will be able to tear up traders if price jams into that resistance zone. Mr. Market loves nothing more than to shake people out of positions. If price works higher I would expect the 1,250 – 1,280 price range to offer just enough risk / reward to get investors and traders involved in a choppy trading environment. The key upside levels on the S&P 500 are shown below on the daily chart of the S&P 500 Index below:
SPX Daily Chart
The flip side of that argument would see the S&P 500 jamming into recent resistance around the 1,230 price level. If prices rolled over and momentum picked up, a test of the recent August lows would likely transpire and could produce a breakdown and a lower low.
When looking at recent price action, the S&P 500 Index has put in a series of higher lows which is a bullish signal; however the S&P 500 has a long road ahead to break out above the 2011 highs. If the S&P 500 carves out a lower high on the S&P 500 Index at 1,230, 1,250, or even 1,280 and subsequently takes out the August lows then the secular bear will be back. The weekly chart of the S&P 500 Index shown below illustrates key support levels:
SPX Weekly Chart
For now I am just going to sit in cash and wait for Mr. Market to provide me with some better clues. The trading range is pretty wide going from around 1,100 to 1,280. What I will be watching for is a strong move supported with volume that pushes price out of this range. As of the today, price action was trading around the middle of this range but it is possible that in coming days we could see a breakout in either direction.
Dow Jones Industrial Average
I'll briefly point it out that I have not heard much mention of this DJIA (DIA) pattern in the mainstream financial media.
Over the weekend I was looking at some longer term charts and I accidentally stumbled across this head and shoulders pattern on a weekly chart of the Dow Jones Industrial Average. I rarely pay much attention to the Dow as I monitor the S&P 500 closely. However, I could not ignore what I was seeing. I also noted that a similar pattern also exists on the S&P 500.
I am generally not the kind of trader who tries to predict where price action will arrive in the distant future. However, I am not going to ignore clear chart patterns that I recognize regardless of the time frame I am looking at.
For those not familiar with a head and shoulders pattern, it is a very ominous signal. Head and shoulders patterns are generally topping formations that if triggered result in violent selloffs. On this chart the pattern is obvious and if the pattern were triggered the forthcoming price action would be decisively negative for domestic equities.
The long term monthly chart of the Dow is shown below:
DJIA Monthly Chart
If the pattern is triggered on an undercut of the March 2009 lows, the head and shoulders formation would produce selling pressure that would target the 3,800 – 4,000 level on the Dow. Yes, you read that right! I want readers to recognize that this pattern is not a given and it could play out over a long period of time. The pattern would suggest that a test of the 2009 lows is possible, but I will leave the likelihood of that test up to Mr. Market.
I view this pattern as a potential warning signal for long term equity positions. Consequently, it is far too early to jump into a plethora of short positions or sell every equity position owned simply because of this pattern. While I do not know where price goes from here or if this pattern will ever trigger, I think market participants should be aware of its existence.
It would take the perfect concatenation of events to push prices down to the March 2009 lows, but unfortunately the condition of social mood paired with all of the risks facing financial markets is notable. The recent selloff in August came on the heels of a head and shoulders pattern that was triggered. We all know how August played out, but this pattern on the Dow Jones Industrial Average has a long way to go before it can even trigger. Time will tell, but readers should at the very least put this chart pattern on your radar!
U.S. Dollar Index
The U.S. Dollar Index (UUP) has ripped higher by more than 5% since August 29th. The strength in the Dollar has likely been precipitated by fear based on the European sovereign debt and banking crisis. While the Dollar certainly has long term flaws, it may simply be the best of the worst.
If the situation in Europe begins to break down further based on any number of events it could likely push the U.S. Dollar Index considerably higher. There may be big potential still if Euro-Land fears continue to rise.
The daily chart of the Dollar Index futures is shown below:
Dollar Index Daily Chart
Conclusion
Including the FOMC, this week will be filled with a variety of news and headlines. The Greek government is meeting and a news release regarding the conference is also out this week. The news has the potential to move markets considerably.
Right now I am pleased to be sitting primarily in cash. I have a few positions open, but for the most part the trades are not directional and are profitable based on time decay. I'm still bullish on silver (SLV).
However, the best trade can sometimes be no trade at all and I intend to remain patient. Risk is extremely high!
Couresty of JW Jones, http://www.optionstradingsignals.com/specials/index.php
