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It's Hard to Believe


The S&P was speaking on Thursday when it closed below its 20-day moving average, albeit only incrementally.

Crimson flames tied through my ears
Rollin high and mighty traps
Pounced with fire on flaming roads
Using ideas as my maps
"We'll meet on edges, soon," said I
Proud 'neath heated brow.

-Bob Dylan (My Back Pages)

It's hard to believe the S&P made a multi-year closing high on Monday. Psychologically, technically, structurally, that seems a long time ago and far, far away. The market turns on a dime - most traders can not.

On June 1st, I mentioned that the S&P would find "natural resistance" at 1541 as the index had moved up 1,541 days from where it all began on March 12, 2003. That square out in time and price certainly has exerted its influence. However, I've seen plenty of times when these kinds of setups are just grist for Mr. Market's mill. That is exactly the point: setups are only setups – it is the behavior of the market out of, or into, a setup that determines the posture, and defines the risk. As traders, our job is not just to take risk, but to define that risk.

The S&P was speaking on Thursday when it closed below its 20-day moving average, albeit only incrementally. The key, as always, was follow-through. In this case, the aforementioned square out above the market, and the break of a short-term three-point trend line, which coincided with the 20-day moving average on the S&P, spoke volumes on Thursday. That's the short-term picture. The big picture setup, described yesterday, looms large.

Ringing in traders' ears is the familiarity of the current pattern in as much as it is a fractal from the February/March break. The current dynamic is a near identical picture. That does not mean to imply that it will continue to play out the same way. However, the market owes us nothing from this point, and big declines start with small missteps, and in my work, the ingredients are present yesterday for a break to mushroom. Although there is an old adage that first sell signals are not the big kahuna – that traders jump on the first sell signal and many times get squeezed. The market has a propensity for Flush and Squeeze, wash and rinse patterns.

As you know the weekly S&P Swing Chart was overdue to turn down, having been up for nearly two months. That turndown occurred on Thursday with trade below 1518. In a strongly trending market, the first time the Weekly Swing Chart turns down a buy setup is almost always near – even if it is only just a near term bounce, in keeping with the Principal of Reflexivity. That would be in keeping with the possibility of another final fling higher.

But, bearishly, when the Weekly Swing Chart turned down on Thursday, the S&P continued lower – substantially so. Additionally the neon sign of the bear was blinking, as every rally attempt on Thursday was putrid.

Also bearishly, the S&P broke through 1500, which coincides with 150 Spyder. Because there are a substantial number of 150 Spyder puts outstanding, the normal expectation would be that the1500 S&P level would have held. Bearishly it did not. Breaking 1500 S&P opens up the potential for substantially lower prices. Why? Because all the puts at 150 Spyder and lower that have been shorted by the Street in order to collect premium could blow up in their faces.

The key will be a first hour low and stabilization on Friday, and a move that recaptures 1500 by the end of the day. If a first hour low and stabilization does not occur, more intense selling and accelerated downside momentum could result. If another solid down day dominates and they go much lower, a crisis could develop as a close by the S&P below its 50-day moving average at 1488 could lead to a cascade below the May low of 1476.70. Trade one tick below the May low will carve out an outside month down and put the market in a vulnerable position technically.

The February/March break also left an outside month down. However the S&P escaped unscathed. Will it give a repeat performance if another outside down month plays out here? There is an old saying – "The second mouse gets the cheese." Boo may be licking his chops tonight.

An outside down month on a Friday of the same week a new multi-year high was scored IS UGGGGLY, and sets up a possible cascade to the prior high – the February high of 1460-ish. Interestingly, 180 degrees down on the Square of Nine Chart from the recent 1541 high is – yup, you guessed it – 1464. This proves the geometry of the recent highs and lows, and underscores the importance of both the 1460 level and the recent 1541 high. In normal circumstances a break back to an old high becomes new support. But, as explained in yesterday's piece, there is a bigger picture, a larger whale swimming out there that may be hungry. And this is the time to bring out the big picture charts – the weeklies and monthlies.
In normal circumstances, the Thursday the week before options expiration is a "misdirection day". If this is so, the market will hold in this vicinity, recapture 1500, and rally next week. But it needs to hold here for that scenario to play out. The first hour will be important. Friday is a very important day.
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