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SPX and BKX Update: Market on Hold, Call Again Later


The market has refused to do anything meaningful to confirm or deny the crash count.

Yesterday gave us nothing in the way of meaningful price data. In a range-bound market, a day that stays well within that range doesn't help much. So the crash count is still out there -- but the market has really moved no closer to it and no farther from it, as not one key level was violated in either direction (this applies even to short-term levels not outlined).

Materially, there is simply not much to add to yesterday's counts. The short-term structure is still an ugly mess and leaves a lot to interpretation. The biggest challenge is that the structure is vague enough that it's very difficult to zero in on minute knockout levels. The key levels to validate the bear case are still SPX 1,215 and 1,190; the key level for the short-term bull case is still 1,292. There has been nothing to change my opinion that we are forming a significant top. My preferred view is that the top was made on October 27.

By now, all my readers know I have been strongly favoring a bearish resolution. During Monday's session, crude oil added further weight to the bearish view. On Friday, I presented some charts and a real-time update on the oil market and opined that crude would put in a top either that same day, or on Monday. So far, it appears I may have nailed it -- we'll see if the market continues to play along. Crude traded down throughout virtually all of Monday's session and seems to have traced out a first wave lower. Crude and equities have traded in pretty good lockstep for some time, so crude may well be leading the way lower for equities here.

At major turns, there are endless potentials. As I just mentioned, I am still favoring the bearish resolution by a large margin, as I have for several weeks. But I must stress there has been no objective confirmation yet, since 121,5 and 1,190 still haven't been broken.

Sometimes novice traders get annoyed with this type of market and demand that someone tell them whether they should be long or short. There is a problem with this type of thinking, and it's one of the reasons 95% of traders go bust: Long or short are never the only two options. Cash is a position, too, and if you, personally, are unable to trade a manic market like this, then it's usually the best position.

In range-bound markets, there is an interesting dynamic that comes into play with traders, and it can be described with something called Prospect Theory. Prospect Theory has shown that people become risk-averse when facing a gain, but they become risk-seeking when facing a loss. This is why many traders tend to hang on to their losers longer than they hang on to their winners. A losing trade actually makes people take more risks than they should, and this mentality seems built into our psyches. Conversely, when people gain a small profit, they become anxious to protect it. As a result of this psychology, people tend to trade in exactly the opposite fashion of the manner that's profitable.

The profitable manner is: Cut your losses and let your winners run.

It is this same psychology that causes this type of market to wear people out. The bears get more exhausted on every rally, and the bulls get more exhausted on every drop. Eventually, one side -- either the bulls or the bears -- throws in the towel. I believe Prospect Theory helps explain these types of markets and their eventual resolution. Here's how:

Let's use the example of a bull who buys some stocks at SPX 1,280, and the market heads down immediately after his purchase. He is facing a loss, so according to Prospect Theory, he becomes risk seeking and hangs onto the trade "hoping" to get even. Though his account is at a loss, eventually the market rallies -- and now he's getting close to even... but then suddenly the market sells off again. Next time it rallies again, he will now be willing to sell for a loss, and a bigger loss than he would have accepted on the first run-up. The same happens in reverse for the bears.

I think this psychology is a contributing factor to contracting triangle patterns. Each time the market runs up, the bulls who rode the elevator down are willing to sell for less just to get out, and each time it runs back down, the bears who rode it up are willing to pay higher prices to cover their shorts. Both sides are feeling beat up. Eventually, when enough traders have cleared out from one side of the trade, either buyers or sellers, the market finally breaks out of the pattern. Who wins will come down to which side has more conviction.

All right, on to the muddled charts. I'm not going to present all the charts I presented yesterday, so if you didn't read yesterday's update (see SPX Update: Crash Wave Still Unconfirmed; Fundamentals Still Bearish), you could do so to familiarize yourself with the potentials.

The SPX chart is still not terribly helpful over the very short term, I'm afraid; short and intermediate term potentials are too plentiful right now. My projected resolution to the pattern is for the market to turn south without breaking 1,292.

Click to enlarge

The short-term bullish count I want to call everyone's attention to again is the triangle, since it is readily identifiable. Some added information: The triangle count posted yesterday could be complete or could stretch out further, if that's the resolution the market is seeking here. 1,215 remains the knockout level for the triangle count. Also important to note is what I wrote yesterday:

If this is occurring, it usually plays out as a false breakdown from the triangle, in wave e (see chart), then whipsaws back up into the triangle and takes off upward in wave C. It's generally a strong rally out of the whipsaw, much like we saw on October 4. Be cautious of this, because you can see it when it happens, and there is no reason to get caught on the wrong side of a move like that (below).

Click to enlarge

While the short-term SPX is a mess, there is a potential setup in the Philadelphia Bank Index (^BKX) that's worth noting. The short-term count here seems a little clearer than the SPX, but I would still rate it at only 60% confidence. However, if the BKX rallies Tuesday/Wednesday, this setup might be worth looking at. The chart below describes the setup. Within the blue target box, be aware of the large gap in the 39.40 area that could be filled before the BKX heads lower:

Click to enlarge

The 10-minute chart (below) shows the short-term targets, if this count is correct:

Click to enlarge

Beyond that, not much to add to yesterday's picture. The market continues to run back and forth in the range and won't provide much in the way of additional clues one way or the other. Trade safe!

This article was originally published on Pretzel Logic's Market Charts and Analysis.

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