The Case for Trend Reversal in the Equity Markets

09/20/2010 11:09 am EST


It feels like a lot of investors have been holding their breath over the past couple of days as the market indexes have stalled at key resistance.

The SPDR S&P 500 ETF (SPY) is right back up to the $113 level, which has been an impenetrable brick wall of resistance for the past few months. We have not been above $113 and change since May 24, when the world economy slipped on some Greece and couldn’t get back up. (I’m sorry…I had to.)

That’s history and everyone’s heard about it relentlessly for a while now. So here’s what I see moving forward:

  1. The technicals are looking weak for the short term
  2. The medium term looks range-bound until the markets decide otherwise
  3. I am biased to the downside for the longer term, which is for about another 12 months or so

Right now, I will cover only technicals on the short term, as the range-bound action will need to be broken in order for any breakout targets to be set.

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Looking at the SPY on a daily time frame, Tuesday saw a slightly higher volume, near-doji day. This is interesting because a doji is when the price closes nearly at the same price as the open, but with an upper and lower intra-day range. This often signifies a trend or momentum change and is often found near tops or bottoms. As mentioned earlier, upper resistance resides at about $113.40 and still holding. We are above the 200-day and all other shorter-term moving averages, which is good, but this has not helped in the past. When a stock gets too far away from it’s ten- or 20-day moving averages, I always tend to be weary and expect a pullback.

Looking at the four-hour chart, we can get a clearer picture of how momentum is shaping up. We can see the MACD starting to narrow and flatten out:

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If we get a hard cross of the MACD lines on the four-hour, the trend reversal could be as steep or steeper than the most recent pullback. Should we revisit the $105 level, it would signify a 7% drop in the S&P 500. The MACD has not yet crossed over on the four-hour chart, but the shorter-term look may give us more clues.

Looking at the hourly chart reveals, underlying weakness in momentum and adds to my case for a trend reversal:

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The SPY has made new highs since the MACD peaked on the September 7 and is now diverging. This is textbook trend reversal and would represent an excellent selling opportunity and short signal.

In addition to this ETF looking weak, my analysis of the financial sector via the SPDR Financial Select Sector ETF (XLF) reveals a similar scenario and has already shown early signs of weakness having started to pull back already.

What I would do:

Sell large-cap stocks that track index performance and get short via inverse ETFs like the ProShares UltraShort S&P 500 ETF (SDS) and the Direxion Financial Bear 3x Shs Daily ETF (FAZ) to not only hedge, but profit from a drop in stocks. I would hold these inverse ETFs until I see a momentum shift to the upside, possibly with the same indicators as used in this article.

By Jordi Perez of
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