Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...
Sprung Bear Trap Forecasts New Market Highs
11/10/2009 12:01 am EST
Well, folks, the bulls have done it again! It looks like buyers have sprung an amazing fifth bear trap in the last few months that, if recent history repeats, will lead to another new high in the S&P 500.
Let’s take a look at the prior four traps that led to new highs:
What I’m showing is the daily S&P 500 from early-June 2009.
The highlighted regions represent the unyielding price rise (almost literally straight up for eight or nine days at a time) that came directly after a classic breaking of support via the 20- (or 50-) period exponential moving average.
Generally, a break in a moving average triggers sell orders in the expectation that support is broken.
Stop losses are placed above the entry (usually back above the average) and any sort of upward movement triggers a vicious cycle where stop losses become “buy to cover” orders, further driving prices higher with buying pressure.
A bear trap is thus sprung when a valid or classic sell signal is generated and then price moves upwards into the “pocket” of stop losses from the short sellers. To be a bear trap, a valid sell signal has to occur.
1. The head and shoulders pattern neckline was broken, in addition to price breaking under the 200-day SMA, generating a very powerful sell signal, which led to an even more powerful rally when the signal failed.
2. A break of the 20-day EMA after a strong selling bar (down day) triggered entry, and as price moved higher back above the 20 EMA, a flood of stop losses helped drive the index higher four days in a row.
3. Using the exact same logic as before, but this time, the melt up avalanche yielded almost nine up days in a row with only a one-day doji candlestick pause.
4. This time, price broke solidly on another strong selling bar under the 20 EMA, but technically supported off the confluence of the 50-day EMA and the lower Bollinger. Still, the rise back above the 20 EMA coincided with another (almost) nine-day price rise with only a minor pause.
5. It looks like it’s happening again in that a break of both the 20- and 50-day EMAs triggered in more short sellers, and now we’re having their stop losses taken out yet again, which, if history since July is any guide, will lead to a new price high in the S&P 500.
Be aware of the current “character,” or behavior, of the market and realize the nuances like this that can help prevent losses or translate into gains.
By Corey Rosenbloom of AfraidToTrade.com
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