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Market Warning Sign - Watch This “Canary In the Coalmine”

Posted by Pete Stolcers on July 20

Posted 9:30 AM ET – PRE-OPEN MARKET COMMENTS TUESDAY – The S&P 500 tested support at the 50-day MA yesterday and it closed above that level. This morning the futures are poised to bounce. The tests of this support level have resulted in rallies the last 6 months and those dips have not lasted more than a couple of days. Earnings season should attract buyers and this pullback is a buy for day traders.

US Treasuries have been moving higher even though inflation numbers are extremely “hot”. The Fed has raised its inflation projections by 1% and we would typically see bonds decline. In the last two weeks I have questioned this “disconnect” and I suspect that the bond rally could be a flight to safety.

The Delta variant is spreading quickly and countries/states are imposing new restrictions. Booster shots might be required and it is uncertain how effective the vaccines are over time.

China’s market decline is a red flag. Their recovery is sluggish and the PBOC has eased. It has been the global growth engine for the last 20 years and this weakness is a potential “canary in the coalmine”.

Stocks are priced for perfection and surprise favors the downside. Any “fly in the ointment” can spark profit-taking like we saw the last two days. I have mentioned that there an options volatility skew to the upside. Calls are more expensive than puts and that is a sign that Asset Managers are unhedged. Bullish sentiment is extreme and big market drops happen when no one expects them.

We sold our half position of SPY at a tiny loss yesterday. I will not enter longer term swing trades until I see a sustained market decline lasts for more than a week. I view this as a low probability trading environment and once the mega cap tech giants report earnings in 10 days I believe we could see profit taking.

Day traders should be cautious early in the day. Opening gaps higher make it difficult to identify relative strength and a gap reversal is possible. I believe that the selling the last two days will spark an early morning probe for support. Once it is confirmed the market should rally the rest of the day. The 50-day MA has attracted buyers the last 6 months and I will be looking for trades on the long side today. If by chance the market makes a new low of the day after two hours of trading, favor the short side.

In one sentence I mention that big drops happen when no one expects them. In another sentence I say that these dips to the 50-day MA have been a buying opportunity. I am not contradicting myself. I can make a case for a market move in either direction. That is what makes this a low probability trading environment and that is why I suggest that swing traders with a 3-4 week trade duration stay sidelined.

Support is at SPY $422 and the 50-day MA. Resistance is at $426.50 and $431.
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