The market direction outlook for today was for stocks to attempt to advance but for there to be weakness in any further advance as the market is extremely overbought and there are no support levels beyond 1870 in the SPX. For market direction to continue to move higher, there needs to be a base to build from. At present the base is down at 1870 and with the SPX trading at 1924, we are 54 points above any kind of support. This represents 2.8%. It is too wide a gap for the advance to be able to continue without some back filling to try to build a support level. That means a pull back could commence at any time and as my principal method of profiting is through selling options, I am keeping a close eye on the market direction. Once the market direction begins to turn down I will be looking through my watch list of stocks to pick those for additional Put Selling.
At this stage though I am not selling naked calls or even credit call spreads. The market has to demonstrate a solid move lower and not just a back filling pull back before I am interested in turning to short call option strategies. Back filling can be misleading. It can take weeks or it can take just days. With so many trade strategies to profit from I never see a reason to “gamble” on being right and stepping out of my comfort zone to sell call options when the market trend at present is still up. I believe strongly in setting up trades to succeed and that means no gambling.
S&P 6 Month Daily Market Direction Chart
To understand the present market direction and the environment investors find themselves in, all we need to do is look back at the previous 6 months. The chart below seems busy, but once taken apart you can understand it easier.
The 4 main support levels that I keep discussing each night are shown. These are 1750, 1775, 1840 and 1870. Those are the principal 4 support levels. All of these levels will slow any severe pull-back in stocks. They are therefore good points to build strategies against whether that strategy is simply to buy spy put options or close trades or put in place in the money covered calls or a myriad of strategies that both protect and allow for profit as well.
Let’s pull apart the rest of the chart. I have marked all the key aspects through A, B, C, D, and E.
A. This marks the bottom of each pull back before stocks recover from weakness and begin to push higher.
B. Marks the rally back up following point A bottoms.
C. Is the top of each action higher before stocks move again back lower.
D. Are the tests for support or the dips in each of the attempts to move higher.
E. Is the inevitable pullback once the move higher ends for that action.
You can see that we have had three solid actions since mid December. The first action started off of support at 1775 and pushed to around 1840 in January. That was followed by a dip down to 1750 in early February which was immediately recovered. This commenced the second action.
The second action quickly pushed right back through 1775 which re-established it for support. 1750 however became the major support point. If it should break and then a rally back fail to hold above 1750, that normally would signal the end of the bull market and the beginning of a new market, most likely a bear market.
The second action pushed above 1840 to the 1870 level before collapsing back in mid-April. That collapse took the S&P to just below the 1840 level which was quickly recovered commencing the third action.
The third action is what we are in now. 1840 is the support level for the third action. 1840 was built throughout the second action. The 1840 level pushed the market direction in late April and much of May up to 1870. You can see from all the D points that stocks have been retesting the 1870 level successfully and as a result we have the action at point B which is a second move higher which is what we are in now since late May.
Problems With Third Action
If you look at the third action you can see the problem. There is no point A from which the latest point B move higher originated from. The third action therefore did not actually bottom but instead pushed higher off of the constant retesting of the 1840 level of support. Note how the previous two actions all had a point A which originated the move higher. The previous two actions all pulled back to test their support levels and then in the final test, fell lower than the support level which I have marked as point A. This did not happen in the most recent action. Therefore the present action we are in right now shows the S&P as simply pushing higher above 1900. This action is 90% likely to fail simply because there is no higher support level than 1870. Stocks needed to try to break through point D in mid-May to set a bottom to the third action to commence the fourth action. This did not happen so we are still stuck in the third action.
6 Month Daily Chart of the SPX to June 2 2014
Technical Indicators
You can see in all the other technical indicators that we have quickly become overbought. A move lower before the latest rise to above 1900 would have created the conditions to move above 1900 without being overbought. Normally we have a period of being oversold which then results in the move higher. That would have happened at the end of the third action if stocks had fallen below point D.
Both the Fast Stochastic and the Slow Stochastic are almost to the point of being neutral on market direction but both the %K and %D signals in both stochastic indicators are extremely overbought. This will make further advances very difficult.
Rate of Change, Momentum and MACD are all positive but only MACD is actually climbing.
The Ultimate Oscillator is extremely overbought as well.
Not Up Then Down
Once the market direction stalls, investors will take profits yet again which will assist in working out the overbought condition. This will also though mean a pull-back in valuations. When that happens we as investors need to know what to expect and where the “line in the sand” rests.
Support Levels For The Next Pull Back
The support levels that we should be watching closely are 1897 and then 1870. The next pull-back will move down to what was once the upper resistance at 1897. This still keeps the S&P market direction move higher intact and above the 50 day simple moving average (SMA). If that breaks as long as the index stays above 1870 there is no problem with continuing to sell put options for income in my opinion. But 1900 is a psychological level for a lot of investors and when the market direction pulls back and falls below 1900 a lot of investors may turn nervous. Most assuredly the media outlets will be swamped with doom and gloom articles and interviews primarily because every pull back brings out all those who want to try to be the “first” to have a called a top in the market.
Support level for next pull back in the S&P
As investors we need to forget all of that. Instead focus on the two support levels above. 1870 is critical because it is just below the 50 day simple moving average (SMA). A pull back to the 50 day as you can see in the chart above has not meant an end for the rally higher. It has instead built a support. In mid-April you can see that the 100 day was tested by the S&P, held and then stocks moved higher. That dip in mid-April was down to 1840. The 100 day exponential moving average (EMA)is now above 1840.
Leaving aside all the doom and gloom predictors and their “I called it right” rhetoric, what we want is to make profits. The rest of this article is for FullyInformed Members, either USA or Canada as the remainder of the article is posted to both sections.
Summary – 90 Percent Chance Of Failure
I will post the trading strategies for members for the next pull-back later today but I felt this article was important to get posted now. I am staying cautious now with further Put Selling until I see some solid signs that the market direction up can actually hold without testing for support. I have never seen a market manage to keep pushing higher without required support. But there are no fast or golden unbreakable rules. Stocks this year have had a much tougher time moving up. The break-out of the S&P above 1900 means stocks are in unknown and virgin territory and could surprise with further upside.But the last move higher which I show as action three in the chart above, has been done without support from the NASDAQ and especially the small caps. I have never been in a market that can keep moving higher without support from tech stocks and in particular small caps. That fact, combined with the overbought market conditions and support sitting back at 1870 is signaling to me that the market will pull back to 1897 at the very least. I would rate the chance of the latest rally failing at easily 90 percent. Just remember I have been wrong as many times as I have been right.
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