A Post-Mortem on the Sell-off

02/22/2013 6:00 am EST

Focus: STRATEGIES

Corey Rosenbloom

Founder and President, Afraid to Trade

Wednesday’s FOMC minutes finally gave market participants an excuse sell off, and technician Corey Rosenbloom of AfraidToTrade.com presents his analysis and key levels to watch.

What happened Wednesday (February 20) and what are internals and market (price) structure suggesting about the present and short-term future of the S&P 500?

Let’s take a quick look at the sharp post-Federal Reserve minutes announcement and make sense of the current environment and key levels to be watching this week.

First, a look at S&P 500 Price Structure (with Momentum):

chart
Click to Enlarge

First, we define structure as the series of price swing highs and swing lows that comprise a trend (or directional movement).

Structure can also refer to the volatility environment or character of the price swings themselves (that compromise a trend movement).

Let’s first talk about a definitive change in structure that I highlighted—and we can now see updated—in my prior post Market Moves from Stability to Instability.

We can see that clearly in the chart above where the market moved from a typical (stable) progression of visual swings in both directions during December and then devolved into instability from January to present.

The instability referred to the “creeper trend” or low-volatility directional movement that DID NOT form visual swings.

We cannot meaningfully assess structure when the market moves in one direction without a corresponding swing (retracement) in the opposite direction—it all counts as a single, extended “swing.”

We can view instability another way by assessing the momentum oscillator (or just the price itself) and referring to the two highlighted periods of visual instability (sharp, seemingly random movement in both directions).

Short-term instability refers to sharp price movement one direction that is immediately reversed in the opposite direction with no movement.

It occurred in early February and now we see a second period of short-term instability this week.

In simplest terms, if you feel uncomfortable with instability or sharp/violent price movement with no clear direction (also known as “chop” or “noise”), use extreme caution (focus on very short-term/intraday trades) until the market can return to a relatively normal or ’stable’ environment of bi-directional swings with visual trend movement.

NEXT PAGE: Instability in Market Internals

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We can take a look at the current environment and note the key levels while we update the picture on market internals:

The main idea is that market internals reveal the underlying strength or weakness (a form of confirmation/non-confirmation) with a directional price movement (trend) in motion.

Internals also highlight periods of compression in price as well, as was the case going into this week when internals formed a visual compression or symmetrical triangle pattern.

chart
Click to Enlarge

To highlight the instability of the current market—as if we needed another reminder—internals and price broke above ‘resistance’ yet Wednesday’s session (February 20) reversed both price and internals in a vicious trap situation.

Keep in mind also that while price itself made new recovery highs, neither breadth nor VOLD (Volume Difference of Breadth) made corresponding new recovery highs above their early February peaks.

This non-confirmation suggested that the upward break was not as strong as otherwise assumed (volume also registered average to below average levels on the breakout).

Now we have the market in a similar “diamond” or broadening formation as we saw at the start of February.

Notice the similar—yet smaller—broadening trendlines that then compressed into a type of diamond formation though price continued its ‘unstable’ creep higher with a breakout on February 8.

There are two interesting facts and the first is that both breadth and VOLD registered new chart lows (breadth is slightly above the February 4 low).

VOLD clearly made new chart lows not seen since December 21, 2012.

The second fact is that price closed the session AT a key inflection level, which is the lower “broadening” trendline and prior price polarity level into 1,510.

Bearish plays will be favored under 1,510 (targeting 1,500 to 1,490) while bullish ’support bounce’ plays will be favored above it (again, referencing the early February smaller broadening trendline pattern.

For now, keep in mind that the market remains in an unstable state and the goal is often to survive these periods with as few losses as possible and be ready to strike again when the market returns to relative stability or at least starts ’swinging’ (moving) meaningfully both in pro-trend and retracement/counter-trend directions.

Stability will return, but these periods of instability often mean we have to work harder and drop our timeframes so that we’re not chopped in both directions with swing trades that would otherwise work well in ‘normal’ periods.

By Corey Rosenbloom, CMT, Trader and Blogger, AfraidToTrade.com

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