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Don’t Trust This Market Bounce - More Downside [Wait For This Pattern Before You Buy]

Posted by Pete Stolcers on February 3

Posted 9:30 AM ET – Last week the market fell on concerns that the Coronavirus could impact global economic activity. Stocks tried to bounce on good earnings from mega cap tech stocks, but profit-taking pushed us to the low of the week. The market showed a loss for the month of January. This morning, the S&P 500 is up 15 points before the open and we will see if the early gains are able to hold.

This is an interesting week politically. The Iowa caucuses will be held tonight and the race is extremely tight. Tuesday night President Trump will deliver his State of the Union address and we can expect a very positive tone with a focus on economic strength. Wednesday the Senate will vote to acquit the President on impeachment charges. I don’t believe that any of this news will have a dramatic market impact.

This morning ISM manufacturing will be released 30 minutes after the open. This is a survey (forward looking) and it might give us a clue on the impact of the coronavirus. ADP will be posted Wednesday along with ISM services. The jobs report will be posted Friday and this is an important week for economic releases.

Earnings releases will also be heavy this week. After the close we will hear from the last of the tech giants. Google will post results and the reaction will have a market impact. Amazon, Apple, Facebook, Google and Microsoft account for 20% of the S&P 500. These reactions will tell us if the market has any “gas in the tank”. At a forward P/E of 18, stocks are trading at the upper end of their valuation range and I believe that the market will be flat for the next two months.

The Coronavirus is spreading and there have been 362 deaths. Areas that account for 69% of China’s gross domestic product remain closed. China’s oil demand has plunged by 20% since the outbreak and oil producers are cutting production. China’s travel is down 73% during the busiest holiday of the year and this virus will have a greater impact than the SARS epidemic.

Biotech companies are scrambling to find a cure and it was reported that a cocktail of antiviral drugs was successful on a patient in Thailand. This could be one of the reasons that the market is rattling this morning.

Swing traders need to be patient. The market will test support at SPY $320. I believe that bullish speculators are on the ropes and that they will be flushed out this week. Big tech will have reported and some of the excitement will wane (earnings season if front-end loaded). Once bullish speculators are out, we should see a deep trough and an intraday reversal. That capitulation low is what I will be waiting for and it will signal that it’s time to aggressively sell out of the money bullish put spreads – put your wish list together now. Look for companies that reported strong earnings and the provided excellent guidance. We will be looking for pullbacks to major trendlines, horizontal support levels and to major moving averages. We want to see relative strength and heavy volume. When the market gives us the bullish hammer off of the deep low that we are looking for, we will be ready. Until then, keep your bullish put spreads to a minimum and hedge with VXX.

Day traders should look for an opportunity to get short this morning. If the opening gap higher is a head fake it will crumble quickly. Look for long red candles that close on their low. If there are two or more consecutively (no overlap), it will be a sign that much of the gap will fill. I will also be looking for an early rally that crests with long tails about body forming. If the market quickly takes out the low of the day after that, I will know that we will fill the gap. We have seen heavy selling in the last week and I don’t believe we’ve seen the end of it. If the market is able to hold its gains for the first hour of trading I will consider buying. I would need to see long green candles closing on their high and stacking one on top of the other. The early action will tell me how the day will play out and I have to be patient. I suspect that I will be trading from the short side.

SPY support is at $323, $320 and $311. Resistance is at SPY $327. Even if a cure for Coronavirus is found instantly, it will get worse before it gets better. Stocks are priced for perfection and this virus is a dark cloud. Look for a stair-step move lower. Buyers will be engaged most of the way down. I need to see a deep intraday low and a swift reversal before I swing trade from the long side. Watch for that price pattern. It will signal that bullish speculators have been washed out and that the market is ready to bounce.
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