membership



The SPX and the Latest Technical Sell Signal in the Week Ahead



The SPX closed at a new 12-month high on the first day of March – then a major pullback last Tuesday – but what is the view of the technical back-drop now?



Share

March 12, 2012

Introduction

The bull market celebrated its third birthday last week in low-key style, as traders remained preoccupied with the latest Greek debt developments. At certain stages of the week, U.S. stocks looked like they were headed for a long-awaited pullback.

But that didn't happen! Stocks once again finished the week nearly flat, having recovered -- somewhat haphazardly -- from their worst daily performance of 2012.

After more signs of a healthier economy, stocks may still have room to run higher in the upcoming week.

Tuesday’s sell-off has the markings similar to the market's late-January pullback – but with skepticism still surrounding the three-year-old rally the analysts and technical groups recent sell signal will be put to the test!

"When will all this fun come to an end? With the Russell 2000 index of small cap stocks hovering around one-month lows and the Dow Transports continuing to underperform, it may be sooner than expected."
- The Wall Street Journal, March 6, 2012

"The drop in small-caps in the past 30 days or so, as well as a decline in the past month in the Dow Jones Transportation Average, are divergences from the broad market that investors shouldn't ignore. There is a complacency and lethargy to the market that suggests a quick and humbling 3% to 5% pullback could be in the offing, one trader says... Investors' worries have shifted from topic to topic in the past 12 months, just as a baton passes hands in a race. The European sovereign-debt situation was enemy No. 1 last spring. The worry next turned to whether U.S. economic growth would turn flaccid. Now it has morphed into concerns about rising oil prices, what with crude above $100 per barrel."
- Barron's, March 2, 2012

So did the pullback occur last week -- the pullback everyone was predicting -- or not? The Standard & Poor's 500 Index (SPX) lost more than 1% last Tuesday, after 46 consecutive days without a loss of this magnitude. In the process, the benchmark index closed below its 20-day moving average for the first time since Dec. 19 -- another streak that was worrying some technicians.

The Effectiveness of the Pullback

Did the pullback achieve its’ goal according to the technicians – and was the pullback enough? Did those on the sidelines waiting for a pullback miss an opportunity, with the SPX quickly snapping back to its February highs? It is common knowledge that many technicians key on the 50-day moving average. However, the SPX's low occurred 13 points above the current site of the 50-day moving average, with the index finding support instead near its previous highs in 2011. Moreover, if the excerpts above represent the group’s opinion, it is easy to believe that many investors are still on the sidelines waiting for a pullback of greater magnitude --somewhere in the order of 3% to 5%, or even 10%.

Daily Chart of SPX since January 2011

031212 SPX since Jan, 2011



The Risk of Waiting

A risk to those waiting for a deeper pullback is that the early March decline might be all that will occur for now. It is interesting that Tuesday's low marked a 38-point decline from the SPX's intraday peak of 1,378.04 on Feb. 29, matching the 38-point decline from the intraday high to intraday low that occurred Jan. 26 through Jan. 30. After the modest pullback in late January, the SPX rallied 60 points to its closing high on Feb. 28. In both cases, the 38-point SPX declines at the end of January and the beginning of March were preceded by low-volatility advances that spelled disbelief among many traders and investors.

An additional risk to the bears is that there is enough monies on the sidelines to drive another 60-point SPX rally. For example, a survey by the National Association of Active Investment Managers (NAAIM) revealed that the average manager was only 57% net long last week, down significantly from the 74% the prior week. For perspective, optimistic extremes during the past five years have been at 85% or higher net long, which was observed in early 2011.

Options Data Support

The options data, which has shown an increase in CBOE Market Volatility Index (VIX - 17.11) put buying, and a decrease in put buying relative to call buying on major exchange-traded funds (ETFs) confirms the attitude in the NAAIM survey that many investors are “market nervous”. Assuming the activity on VIX futures and major equity-based ETFs is hedging related; it would suggest that a bearish mentality suddenly gripped institutional fund managers ahead of the Greek debt swap last week. Continued bearishness among this group would be a negative omen for equities, and this is something that needs watching vigilantly. But with the Greece event now in the past, it is quite possible that an unwinding of these bearish views takes place in the week ahead and beyond.

Indicator to Watch

The indicator in the chart below needs to be scrutinized closely, as the 20-day buy-to-open put/call ratio on the SPDR S&P 500 ETF (SPY), PowerShares QQQ Trust (QQQ), and iShares Russell 2000 Index (IWM) has turned lower, and this has had ”bearish” implications in the past. Technical breakdowns in the SPY, QQQ, and IWM would be further alarming, but this has not occurred yet.

031212 20day BTO put/call ratio



Concerns Surrounding the Russell 2000 Index (RUT)

Among the many concerns voiced by technicians in recent weeks is the divergence of the Russell 2000 Index (RUT - 817.00) from the SPX. There are multiple ways to quantify "divergence" but the fact is, the SPX closed at a new 12-month high on the first day of March, but the RUT was trading 1.90% below its 20-day previous high.

Therefore, it can be identified early by specific study to see if a divergence like this has had historical bearish implications for the market. This is achieved by loosening the parameters and then taking instances when the SPX hit a 12-month high and the RUT was at least 1.75% below its previous 20-day high. Since 1986, the sample size is small, but ”bullish” price action actually followed, suggesting the small-cap divergence fears could be misplaced. Over the past few weeks, similar fears about the VIX futures term structure and the percentage of stocks trading above their 50-day moving average have been misplaced, as well.

SPX/RUT Divergence Study



Conclusion

The scenario remains bullish, as the technical backdrop of the benchmark equity indexes still looks healthy. Plus, there's short-covering potential, and sideline cash is still waiting to be deployed after only a modest pullback to begin the month. But, given the uncertainty with respect to the next major move among institutional investors, hedging your long exposure is prudent at this juncture. Sectors to consider are the homebuilders and retail/restaurants.

A Note of Importance

Next week is March options expiration. Since 2000, seven of 12 March expiration weeks have been positive, with three of the past four displaying bullish price action, and the average return since 2000 arriving at 0.73%. In 2011, however, the SPX experienced a decline of 1.92%.

Share


”Success is simple. Do what's right, the right way, at the right time.”



Option Tip for your Success!
Options traders are not successful because they win.
Options traders win because they are successful.



membership






Back to Home Page






Search Stock Options
Made Easy



Enjoy Relaxed or Fast-Paced Trading? Choose your Membership Style...

Whether you prefer to take a laid-back approach to your trading,

or to charge ahead in your options trading,

 Stock Options Made Easy Armchair Trader and Cut-to-the-Chase Trader Memberships put everything you need to succeed at your fingertips for just  $39 or $79 per month.





Search Stock Options
Made Easy




newsletter-free


Subscribe to our FREE
newsletter for all the latest options news!


Enter Your Email Address

Enter Your First Name











Follow S_O_M_E on Twitter











Subscribe to our FREE
newsletter for all the latest options news!


Enter Your Email Address

Enter Your First Name











Follow S_O_M_E on Twitter