A 10 year chart of the S+P is probably the most interesting chart for showing the overall market dynamics at the moment. And though the S&P 500 tracks America’s 500 biggest stocks, it’s usually a good proxy for the Australian market too. As much as some people might like to believe our market is “de-coupled” from America, the correlation is still pretty strong.
My view, based on the chart you’ll find just below, is that the S&P is heading towards some major overhead resistance. This is the case even though momentum indicators are all pointing up. Whether you’re an ivestor or a trader, I think it is advisable to sit up and take notice.
Before I breakdown the chart, I should back up a second and explain where I’m coming from as an analyst. One of the cornerstones of market profile theory of price action is that a distribution of price occurs around what’s called a Point of Control (POC). This is the area where most of the trading has occurred. It is the fulcrum to the rest of the price action that occurs.
My own ideas on price action are that we often see two or more “false breaks” of either edge of a range, with a final retest of the midpoint, or POC occurring, before a final move outside of the range. I know it sounds complicated. But it’s not, once you get the hang of it. So bear with me and I’ll show you what I mean on the S&P 500 chart above.
If you have a look at the price action in the S&P you can see that a clear range has developed between 770 and 1550 over the last 10 years. We have had a “false break” of either edge of this range. We are now screaming towards the point of control around 1160.
We are also nudging up against the downtrend from the all time highs in 2007. The market will often spike through a trend line before turning back down again. For example, look at the last big sell off that we had between 2000-2003. I have drawn in all of the different trend lines that people would have used as the down trend progressed.
You can see that each trend line had a spike through it which ended up turning back down, making the trend shallower and shallower over time.
Therefore I would expect the current trend line to be breached to the upside. That would take us to the POC at around 1160.
Up at 1260 we have the midpoint of the last visible distribution to occur before the crash. These midpoints also act as resistance in downtrends. (See chart)
I think any selling done between 1160 and 1260 will be seen as the perfect entry point in the next 6-12 months.
I would advise protecting portfolios with long term put options around this level, or simply buying some long term out of the money puts for a punt.
When the music does finally stop in this market, there will be a huge race for the exits. The memory of last year is very fresh in everyone’s minds. The great majority of this rally is being fed by the Fed with cheap money and a nudge, nudge, wink wink to their banking buddies to repair their balance sheets via the carry trade.
They are going to need to sell all of their new stock to someone, and I’m afraid they will be able to hear a pin drop when they finally pull the trigger.
I have been banging on a bit recently about the possibility that this carry trade nonsense could get out of control. And it is a distinct possibility. If this market just powers through that POC on volume and doesn’t even pause for breath, then that will be the big warning signal to me that this thing could get completely out of control.
But for now I am going to stick to my guns and say that any blow off rally to the upside now will be contained by the 1160-1260 range. Even if it only leads to a retracement of the last eight months rally it will be worth covering longs, getting short or protecting portfolios in this region.
Editor, Slipstream Trader
for The Daily Reckoning Australia