I See a Pattern Forming in the S&P 500 and So Should You

It's the same price pattern I've been highlighting for quite some time now, but perhaps now is a good time to define the pattern, show it, and state what it means for traders.

Reference my prior post:

"Magic Mystery Buyers in the S&P 500 Define Bull/Bear Battle."

First, the pattern:

A lot of people are picking up on this pattern - or at least they should.  What is it?

So far, every other day, the S&P 500 has tested the key 1,040 level exactly, and each time - including this morning - buyers have rushed in to support the market, causing a sudden up-burst in price immediately following the test.

The pattern can be described as such:

1.  Market falls to test 1,040 (usually on a bad economic morning data-point)
2.  Surge of buy-orders flood the market
3.  Market bounces very sharply
4.  Bears rush to the exits, buying-back shares in a short-squeeze
5.  Market rallies to the 1,060 level (or beyond)

That's the short-term pattern that has been in effect since last week that appears to be repeating into this week.

It's like a cycle - sort of like Groundhog Day (the movie) - where you wake up and the events of the day repeat themselves exactly.

Traders who have caught on to this pattern early may have made a LOT of money this morning as the pattern repeated.

But this isn't the only time this has happened - let's take a look back at the two prior tests of 1,040.

May 25, 2010 (after the "Flash Crash"):

June 6, 2010:

An almost identical pattern of sharp downside move to 1,040 followed by a rush of buy orders that supported and then bounced the market higher occurred just after the Flash Crash and in early June.

To be fair, this pattern failed as the market broke under 1,040 to bottom in early July at 1,010, but one has to admit this pattern is well-entrenched.

By pattern I don't mean "head and shoulders" or any classical sense of the word, but rather a sequence of events that happen that repeat.

So far, this pattern has successfully repeated 5 of the last 6 instances since May.

While it's tempting to attribute this to manipulation, it is supply and demand that move market prices.

From where that demand comes -we can debate that all day - if demand/buyers are able to overtake supply/sellers, then the price will rise.

It's not important to know from where the demand originates - just that it does.

And as price moves - perhaps unexpectedly - off a key support level when traders expected the level to shatter and break, then those traders who bet against support holding -in other words, going short - are then forced to take their stop-losses and cover (buy-back shares).  This action helps add demand to the price rise in motion - perversely driving price higher and higher.

So, as long as this pattern is in place - or should I say, these same buyers continue to rush in to buy shares to support the market at 1,040 - we can expect the pattern to repeat.

By the same token, should the market break solidly under 1,040, we can expect these same buyers - assuming they have not been selling shares on the bounces to the 1,060 level (and then re-buying shares at the 1,040 level) - to rush for the exits and take THEIR stop-losses, creating a potentially harsh downside move.

Corey Rosenbloom, CMT
Afraid to Trade.com

Nice try but no cigar Let's throw out the noise in the system or reflexive drop that occurred in late May as a secondary event tied to the flash crash and the "Sell in May" axiom. Looking at early June -- the market kept dropping. All buying efforts by big brokerage house couldn't turn the market positive. Then "Ah" speculative bidding up of oil futures (i.e. on off shore accounts if oil is $71/barrel bid $74)and since we now have a 1 to 1 linkage between oil futures and prosperity, the economy must be improving so commodities and all the stocks must be improving. In essence, a June rally. An “Oh my gosh”, the markets up 8% in 7 days -- where did this come from. Then we go to July and "Ah", it’s another oil led rally. In Aug notice that each time the S&P gets close to 1040 there is a big buy signal on CNBC and talk radio that stocks are cheap, buy now and the market goes back up but cannot get out of a narrow trading range. But look at the trend the S&P is slowly dropping and will cross the 1040 support line probably in the 1st week of September. There are two problems with the 1040 support line this time. The first is the Feds are on the sidelines but will jump in with strong action when the S&P drops below 970. This is just above the 940 support line. The second is the oil storage tanks are running over and world oil reserves are the highest level in history so an oil led rally will only be short lived at best. Thus look for the 1040 and 1000 supports to be broken in September. If these support lines are not broken, look for a narrow trading range till January but if the S&P drops below 970 look for a big rally back to the April highs (i.e. 1200s) before the end of the year. Submitted by Anonymous (not verified) on Wed, 2010/09/01 - 2:41am » reply |

What if all the supply at 1040 is absorbed? Then the market rushes ahead. It begs the question of whether the market over the past year is in consolidation or reversal. It's probably been in both as it's trying to sort out the future. But IMHO, just about anyone who has been frightened by the uncertainty and wanted to sell has already done so. It's going to take a higher and higher price to coax out more supply. Submitted by stockchartist (not verified) on Wed, 2010/09/01 - 12:02pm » reply |

Pattern? It would not be too surprising to see this pattern continue through the November elections. Submitted by Bud Wood (not verified) on Wed, 2010/09/01 - 4:03pm » reply |

Pattern The why of what is causing the market to oscillate in the larger trading range is relatively unimportant. As Corey mentioned, we can debate that all day. Simply letting the market tell you where it wants to go is the only thing that matters as traders. Submitted by Brian Olson (not verified) on Fri, 2010/09/03 - 9:37pm » reply |