Stock Market Expectations For a Pull Back

By: Angelo_Campione

General Commentary: The system remains on a Neutral signal.

Well, the market keeps holding up and I'm sounding like a broken record by saying that we're due for a pull back. We didn't get the "musical chairs" effect I spoke about last week and it seems that the market is taunting the bears by reversing higher the moment we get a small dip.

A lot of people are now saying that we're way overbought here and we should start to drop, but the old adage that the market can stay irrational for longer than most people can stay liquid seems to be prevailing.

Be that as it may, I'm not convinced that it's blue sky ahead. We may continue nudging higher to squeeze as many of the shorts out as possible but the tide will turn soon and I remain confident that the short side will prevail.

What seems to be happening now is a case of "expectations", after what we went through last year, the expectations were for Armageddon. But with governments all around the world throwing huge sums of cash at their economies, financial Armageddon was averted and so when data begins to flow that things are not as bad as first thought, everyone starts to feel better about entering the market again.

It reminds me of a guy I once met, he told me that he would tell everyone that his girlfriend was really ugly so that when they met her, they'd say "oh, she's not that bad!", it's not difficult to impress people when their expectations are low!

Having said this, what do you think will happen now that expectations are being adjusted higher? The human psyche is fickle and the more you understand it the better you'll trade. When expectations and reality meet there is often a reaction that gives rise to a positive or negative sentiment. One of the keys to trading (and life) is to flow with whatever is happening right now.

For the week ahead we may see a drop as the S&P has now cleared the 1000 level. The psychology is that people will be feeling that resistance has been broken now, which could make a good case for catching out the fresh bulls.

On to the analysis..

SPX Chart - Bigger Picture

Not a great deal has changed from last week even though we've had a weekly close above 1000. The likelihood is that the circled area will be the range for the rest of the month as the bearish wedge pattern develops to a point somewhere around the 1040 level.

SPX Chart - Shorter Picture

The shorter term is looking increasingly tenuous. After Thursday's close lower, it looked as we we're finally going to dip but Friday's new high changed all that, or so it seems!

We still have a bearish wedge and a MACD that is weakening, the indicators are screaming for a breather but the market is being defiant. The overbought conditions can continue but I wouldn't want to be buying here.

For the week ahead, support on the SPX is 950 - 975 and resistance is at 1020 - 1030.

The VIX Picture

The VIX is probably giving us one of the best signs that the current uptrend is coming to an end soon. We have a bullish divergence on the MACD and over the last week, the index stayed relatively flat. It could be that more participants are becoming wary of the up draft.
At this point the 50 DMA at around 28 is the target in the short term but there's potential for a larger move up in the medium term. We'll need to see the linear MACD rise above zero though before we get more bearish on the general market.

The VIX measures the premiums investors are willing to pay for option contracts and is essentially a measure of fear i.e. the higher the VIX, the higher the fear in the market place. It tends to move inversely with the markets.

Current Position:

The current position from July 20 is a full position in an SPX August 1020/1030 Call Option Spread for a net credit of $0.60.

The premium received if you entered this trade is $60 per $1,000 of margin required per spread (before commissions).

In relation to our open position, we have 2 weeks to expiry and 10 points from the sold strike. It's getting even more uncomfortable as we get closer again to our strike. While it's our aim to get into positions that don't get this close to our strike, it will happen from time to time, we'll have to see how the week progresses on whether we need to cut this position.

Current Performance for 2009:

(Please note, this performance is in percent and raw, i.e. without brokerage/commissions taken into account)

Quote of the Week:

The quote this week is from Ludwig Wittgenstein, an Austrian-British philosopher, "A man will be imprisoned in a room with a door that’s unlocked and opens inwards; as long as it does not occur to him to pull rather than push."

Feel free to email me at angelo@stockbarometer.com if you have any questions or comments.

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By Angelo Campione

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© 2009 Copyright Angelo Campione - All Rights Reserved
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