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Watch For This Market Pattern - We’ve Seen It For 6 Months

Posted by Pete Stolcers on July 21

Posted 9:30 AM ET – PRE-OPEN MARKET COMMENTS WEDNESDAY – The S&P 500 tested the 50-day MA Monday and we saw a massive bounce yesterday. This pattern has been repeating during the last six months and there is follow through this morning.

US Treasuries have been moving higher, but we saw a gap reversal on TLT that resulted in a bearish engulfing candle yesterday. The bond breakout Monday will be tested and that breakout is also the 200-day MA. Low interest rates are important to this market rally and I suggest keeping an eye on the $148 level. Inflation has been running hot and these are no longer “one off” numbers. In the next two weeks we will see if higher input costs are impacting profits and to what degree (earnings guidance) companies can pass that on to consumers.

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 Friday and Monday. I have mentioned an options volatility skew to the upside (rare). 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.

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 for longer term swing trades 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. The market ran hard yesterday and I believe the gap up this morning will be challenged. Back-to-back gap and go rallies are rare and there is no news to fuel the move higher. I will be looking for shorts early in the day. I am not going to jump on them. I want to see the opening burst run out of steam quickly. When the low of the day fails I will short on the notion that we will fill some of the opening gap higher. Once support is established the market will try to grind higher and then I will shift to the long side.

If you look at a daily chart of the SPY you can see that the drops to the 50-day MA have been fast and the snap back rallies that produce bullish trend days (green candles) only last a day or two. After that the candles are tiny and the market gradually floats higher. That means that we should not expect another explosive move higher today and that relative to yesterday, we should trim our size (if you sized up yesterday). Yesterday I posted two articles on the importance of “context”. I hope you had a chance to read them.

Support is at SPY $432 and $427. Resistance is at the high from Tuesday and the all-time high.
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