The SPX closed below a key channel line yesterday, which is a technical red flag. It’s certainly not a guarantee of further weakness, but it greatly increases the odds.

It wasn’t much of a breach, but it was a breach.

Arguing against that scenario:

• SPX tagged its SMA 50
• USDJPY has reached potential Fib and channel support
• the USD has still not broken out

If the market does find support here, we should get a nice bounce at a deep retracement of the 1598 – 1648 rally. We can call yesterday’s close below 1617 (the purple channel bottom) a momentarily lapse (or market maker fakeout, take your pick) and get on with the bull market.

If not, however, there is much additional weakness to come.  In sum, this is an important inflection point.

We’ll resume our short position on the opening, as we came up a few points short of our targets from yesterday afternoon:  the red .786 at 1609.30 or the .886 at 1603.98.

UPDATE:  9:40 AM

Just tagged the red .786 at 1609, so I’ll switch to the long side with tight stops (@ 1609) in case the .886 comes into focus.

The shape of the downturn from 1648 suggests a Bat Pattern — which would complete at the .886 Fib level.

Of course, at 1603.98 we should assume that the round number of 1600 would be more appealing.

The purple channel with the best fit on the daily chart is shown above.  The solid red TL just below it is drawn off the daily lows of Nov 16 (1343) and Apr 18 (1536.)  And, the dashed red line is the trend line off the 1994 and 2003 lows.

Needless to say, channels get redrawn all the time as markets overshoot by a few points here and there.  This could be one of those times.  But, the first step in a market that’s turning is the establishment of a slightly flatter channel slope.  Stay tuned.

UPDATE:  10:00 AM

SPX has broken through the white channel midline but is coming up on the critical purple channel bottom (previously support, now potential resistance) which is in close proximity to the red .618 Fib level at 1617.51. We’ll watch for any signs of weakness here, as a reversal would likely mean a quick trip to 1600-1604.

UPDATE:  10:06 AM

Running into resistance here just below the intersection mentioned above.  I’ll likely open a short position with any sustained fall through the white channel midline.

It would be a more compelling trade if it came at the top of the white channel or the bottom of the red or purple channels.  But, midlines can make for nice reversals, too.

BTW, here’s the situation with the USDJPY.  We’ve been watching this pair closely for the past couple of weeks as there’s a high positive correlation between it and the US equity markets.

First, the channel picture.  The falling blue channel is a pretty good fit except for the lows in 2010-2012.  Otherwise, its midline accounted for at least a dozen reversals and its top and bottom signaled several highs and lows.  We’ll come back to it in a moment…

We’ve been tracking the purple acceleration channel in the lower right corner of the chart that faithfully guided the pair higher since September 2012.  It failed on Jun 5.

Since then, the pair retraced .886 of the rise from the April low of 92.56 and — just today — bounced off the midline (the dashed line) of that channel from the 90’s.  No guarantee it’ll stay “bounced”, but this is potentially a very big deal and potentially quite bullish for stocks at a time when seemingly the whole world is waiting for a collapse.

UPDATE:  10:46 AM

SPX just reached the bottom of the purple channel where it intersects with the falling white channel.  It will also complete an A-B-C corrective wave where A=C at 1620.77.

I’ll play a short position here at 1618.40 with stops at 1620ish.

This might just be a reaction to the channel bottom, but the red .886 at 1603.98 is still out there.  If we push up through the purple channel, I’ll gladly revert to the long side.

UPDATE:  11:05 AM

Nice reaction so far.  It’s too early to say how far this dip might go — if at all — but even a .786-.886 corrective wave would take SPX back to 1609-1610 and make for a nice 1-1.5% day.  [I like big moves as much as the next guy, but 1% daily, 3-5% weekly is a great return over time.]

The potential Bat Pattern is shown below in red. Note that Point B came at less than a .618 retracement, which is required under the rules for Bat Patterns.  Though, as we’ve pointed out before, a .786 retracement is perfectly normal for corrective waves.

UPDATE:  11:55 AM

We have a nice little rising wedge forming on the 5 min chart.  But, these do break out instead of down about 1/3 of the time.  And SPX is back above the purple channel bottom and white channel top.  So, the odds of a decline are diminishing.

I’ll give the short position a little extra leeway up to 1621, the .886 of the decline from 1622.31, before pulling the plug.  There’s a competing bullish pattern setting up as well: an Inverted Head & Shoulders Pattern (IH&S) targeting 1640 (shown below in yellow.)

UPDATE: 12:35 PM

SPX just exceeded the white .886 and the 100% extension of A-B — not to mention the purple channel bottom and white channel top.

I’m closing my short position and reverting to long here at 1620.

The first hurdle for bulls to overcome is 1622.92 — Tuesday’s low.  And, remember, every reversal at a .786 Fib is a potential Butterfly Pattern.

They complete at the 1.272 or 1.618 extensions, meaning 1584 or 1567.  It’s a possibility that doesn’t go away until SPX clears 1649.

NOTE: I’ll be sending out an update on the Fund after the close to members who have expressed an interest.  If, for whatever reason you don’t receive one, please contact me to be placed on the list.

continued for members…

UPDATE:  1:45 PM

Back with a cleaned-up 60-min chart.  Note some of the colors have changed to make it slightly easier to identify patterns (often a losing battle…)

Note that the yellow IH&S target of 1640 falls around the vicinity of the light blue .786 (assuming it completes at 1625.42.)  It’s easier to see here on the 5-min chart, along with a crack at a channel that might take us there (at this rate, tomorrow morning.)

But, if it waits until the purple channel .25 comes along, it’ll be more like Monday.

Note also that an 18-20 point pullback at 1640 (tomorrow’s pop and drop that turns into a surge?) would match up nicely with another one that occurred from Jun 10-11.  So, a normal pullback at the .786 would conceivably set up an IHS targeting 1672.

This is unadulterated spit-balling, of course.  But, it’s worth keeping an eye on — as it coincides with our forecast of a return to the white .886 (1677) to complete a Bat Pattern at the intersection of the yellow TL from 1994/2003 and the purple channel midline around Jun 25.

UPDATE: 2:40 PM

Just tagged the light blue .500 Fib.  Might get a pullback here to backtest the yellow neckline at 1625-1626 or lower.

I’ll try a ST short position here at 1629, but will leave the core long position in place unless we drop through the neckline.  Stops at 1630.

UPDATE:  2:58 PM

Never mind.  Closing the short here at 1629.

While the melt-up resumes, lets take a quick look at the big picture.  Remember the USDJPY chart we looked at this morning?

The .886 held and the pair moved back up beyond the neckline of a potential H&S pattern that targeted 86.50.  Since a close below the neckline s required in order to trigger the H&S, the crisis is averted.

Allow me to introduce the new, improved white channel.  Next stop, a measured move to the .618 retracement of the 2007-2011 crash from 124 to 75 at 105.57…at which point (July 5?) the white channel might be replaced by a nifty yellow channel.

UPDATE:  3:16 PM

SPX just tagged the .618 — also the .500 extension (red) of the first wave up.  Probably worth taking a shot at an 6-10 point pullback here at 1633.51.

Full short with stops at 1634ish.

My objective is 1623-1628.

UPDATE:  3:40 PM

Foiled again.  Full long at 1634… wondering if we might actually reach 1640 today.

Note that we’ll reach the purple channel .25 line at about 1637.50.  Definitely full short again at 1637.50…

UPDATE:  3:48 PM

I intended to short at the purple channel line, but SPX suddenly accelerated out of the little red acceleration channel and poked right through the purple channel line.  In the process, it tagged the red .618 extension at 1639.25.

I’ll close my long position here at 1639.25 and see if we can get a pullback into the close.

If so, we’ll look for a pop in the morning to that 1640 level, then a respectable drop to establish a right shoulder for another IH&S.

BTW, I’ll stay in cash overnight.  My son, who is working with me this summer, studied the overnight and over-weekend trades from the past several months and tells me I hit about 60% of them right for only a few percent incremental return.

For my money, that’s not reason enough to toss and turn all night wondering what ramp jobs might occur or what some nutty banker/politician might say in a moment of candor halfway around the world.  I’ll confine such trades to those instances when I have a highly confident viewpoint and the risk/reward justifies them.

I’m going to take a little break, then work on getting the Fund update out.