Analysis, Perspective, Trading Strategy
It’s all on the line.
Gut Check Time for the Federal Reserve and the Markets.
Duarte in the Money Options
Newly sworn in Federal Reserve Chairman Jerome Powell is in the midst
of his Baptism of Fire. With stock prices gyrating wildly, robot traders
running amok, the public increasingly fidgety, and the potential for a
major contagion of the stock market’s volatility malady threatening to
extend to other markets, Mr. Powell’s mettle is being tested right out
of the gate. Indeed, the tone of his stewardship of the Fed may depend
on what he says and does over the next ten trading days.
Ripe for a Bounce
The market may have given Mr. Powell a gift on Friday afternoon, February
9, as stocks reversed yet another intraday crash ending the day significantly
higher as measured by the major indexes. Arguably, but in no way certainly
at this point, history may show that Friday’s turnaround was the bottom
for the cycle.
As I noted last week, the New York Stock Exchange Advance Decline line
– the most accurate indicator of the general trend of the stock market
since 2015 – was oversold. Guess what? It is now even more oversold, which
of course raises the possibility of some type of bounce in stocks over
the short term. We may have seen the start of that bounce on Friday, but
it’s still early in the process.
A review of the NYAD all the way back to April 2014 reveals several important
facts. First, the long term trend of the bull market remains intact as
the NYAD is still above its 200 day moving average. Second, NYAD is historically
oversold now based on RSI and the MACD histogram. Third, and perhaps the
more important fly in the ointment, momentum to the down side, as measured
by the ROC could still go lower. Note the October 2016 low on ROC, right
before the election was near (-) 7.0 percent. We are currently at a reading
of (-)3.29 percent. Still, it’s important to note that all the major bottoms
in 2017 did not reach the very extreme reading seen in October 2016 in
the presence of oversold readings in RSI and the MACD histogram. So, it
is possible that the current ROC reading may be good enough.
S & P 500 Is Oversold Enough for Significant Reversal
The NYAD may be close to a reversal but the S & P 500 (SPX) is already
at a point where a reversal of some sort is more likely than not. Consider
the following. SPX bounced just below the 200-day moving average, a classic
long term support level, and one which the robot algorithms were not likely
to ignore. Next, RSI, ROC, and MACD histogram levels for SPX are all at levels
which have launched major reversals to the up side in stock prices since
April of 2014.
Furthermore, SPX, despite the intraday reversal of February 9,
remained below the lower Bollinger Band. The longer this remains
in place, the more likely is a reversal to the mean, in this case,
a reversal to the 20-day moving average. Accordingly the market is
now set up for three possible scenarios: a V bottom, a W bottom,
or a total failure of recent support which would lead to further
losses and perhaps a real bear market.
A V bottom would mean that the February 9 bottom was “THE” bottom
and the market will be off to the races in the near future. In the
case of a W bottom the February 9 bottom will hold and become the
momentum bottom - after which there will be a failed rally. In this
scenario, sellers will return and prices will head to the recent
lows or just below the most recent price lows. This would be the
Panic bottoms are usually very dramatic selling climaxes which
usually feature lower volume than the momentum bottoms. After the
panic bottom, which is a washout event usually heralded by headlines
suggesting that the end is here, there is usually a very meaningful
rally followed by a consolidation period.
The Take Home Message
The stock market is now oversold enough to stage a reversal to
the up side, although there are no guarantees that such a reversal
will occur or last for any extended period of time. The first upside
target is the 20-day moving average near 2775. And here is the more
important technical factor; if the S & P 500 falls or closes
below 2500 without a meaningful reversal, stock prices will likely
fall for what could be a painful period of time.
Putting it all together, the market is ripe for an upside reversal
based on the current posture of reliable technical indicators. But
because the Federal Reserve has been the market’s backstop for the
past ten years, much of what happens now depends on what the Federal
Reserve may say or do in the next few days and how the robot algorithms
react. If the robots and the market interpret the Fed’s actions or
lack thereof negatively, we are likely to see significantly lower
stock prices in a hurry.
Joe Duarte is author of Trading
Options for Dummies, now in its third edition. He writes about
options and stocks at www.joeduarteinthemoneyoptions.com.
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