ORIGINAL POST: 9:00 AM
There comes a time in the construction of every channel when the market either obeys a presumed channel boundary, morphs it into something else or breaks it entirely.
We’ve had a very well-behaved channel off the 1266 bottom on June 4. I’ve had to make small adjustments to the channel on the daily chart a few times. But, the 60-min chart shows just how precisely yesterday’s low fits with the previous lows.
A decline below those lows would be very damaging to our notion of a rebound to the 1389-1404 range before a larger decline. I’ll be watching the opening very carefully, as the eminis are still down 8.5 pts just 30 minutes prior to the open.
I’m still long from 1349 (though I’ve done some scalping over the past few days), but a breakdown of the channel would be cause to cut my modest losses here and play the downside — with a target of 1316-1319.
The 60-min RSI has formed a nice falling wedge and shows significant positive divergence — and a possible slight breakout yesterday. We’ll see if there’s any follow through.
I’ll post more shortly.
UPDATE: 9:40 AM
We just cruised past the smaller pattern .382 at 1329.97 and are closing in on the larger pattern’s .382 at 1326.19. The little channel has run out of room, though, so I’m going to close my shorts from the opening and try to go long again here at 1327.
If this little channel breaks down… wash, spin, repeat.
BTW, I like what VIX is showing us, too. There’s a nice channel on the 60-min that looks like it will run out of steam around 19.65 – 19.85.
UPDATE: 10:12 AM
There’s the .382 tag of 1326.19 we were watching for. That should be it for the downside, but I’d put in stops at 1320 just to be on the safe side.
The EURUSD just completed a pretty clean looking Butterfly pattern at 1.2163. The daily RSI looks like it’s setting up for some upside.
UPDATE: 1:00 PM
Remember the question from a few days ago [see: They’re Back] about whether we were building a channel or a rising wedge? In a healthy market, the rising wedge might morph into a channel by establishing new highs that force the upper bound to expand. Here’s the “before” chart.
In a sickly market, the opposite happens. The lower bound is being forced to expand to accommodate lower lows. Another few points to the downside would establish a lower bound that’s parallel to the former rising wedge upper bound and would make for a new channel with a shallower slope.
This is the most bearish rendering of the channel I can envision.
The upper bound (solid purple) is drawn as flat as I can make it, taking full advantage of the candle shadows. Drawing a parallel lower bound means we ignore the Jun 25 1309 low and put our faith in a tag over the next few days as low as 19.50.
The upper bound looks pretty solid with 4 tags. The lower bound? Not so much. It could turn right now and leave a big, honking tail on today’s candle, leaving a less aggressive rising wedge instead. We won’t really know until we get a reversal.
RSI hints at some possibilities, but the picture’s still a bit murky. Our 1389-1404 target followed by a large decline would work better if we had some serious negative divergence. So, a lower high on RSI would be indicated — maybe something like the pink circle — a back test of the prior channel. The only question is whether we get down to the presumed new channel bottom first or not. (the purple circle.)
My gut tells me we’ll close to flat or up today, leaving a bit of a wedge in place. We can ignore shadows, but not candle bodies. So, maybe it’ll look something like this (with the dashed white line below):
But, the line in the sand is down around 1319.50-1320, when the channel can’t simply be redrawn any more. We also have one of our white channel lines right about there — which should provide extra support if this we get more carry through from this morning’s sell off.
VIX finally reached our target from back on the 6th and seems to have fleshed out its channel very nicely — along with a back test to the last H&S neckline. The possibility of a falling wedge is pretty remote now. (We could get a day or two of sideways motion before running out of room to the right.)
If you’re skeptical of the upside potential, I suppose you could view the latest neckline as a line in the sand. A close below that (crosses the Fib line 17.12 tomorrow) would be very positive for stocks.
Comments
13 responses to “Shakeout or Fakeout?”
PW – Just trying to understand your methodology when it comes to re-drawing channel lines. How do you decide what the final line in the sand is that would trigger a trend change? Just using the most generous CL combined with the RSI? Thanks man.
Most channels have wiggle room in how they’re drawn, based largely on whether you include particular shadows/tails or not. It can make a big difference in the slope, etc.
In this excercise, I wanted the lines with the smallest slope possible (without ignoring candle bodies) in order to determine the most pessimistic of the bullish scenarios (how low can the slope go?) You get a line that, if broken, would represent a departure from the channel and would preclude the channel being redrawn; i.e. no more wiggle room.
I did that with the larger purple channel by drawing the upper bound as flat as I could without leaving any real bodies hanging outside the channel. Then, I draw a parallel lower bound (that also has to include any real bodies.)
The current value of this line can be the “line in the sand.” It changes daily, of course, because the channel slopes — but today looks to be about 1318.6. That’s also the value at which the little red channel intersects with the purple channel — which gives it extra validity.
The only tricky parts are:
(1) you can break a channel intra-day, but close back within it — leaving only a tail outside the channel that doesn’t necessitate a re-draw. It can be tough to make the sell/don’t sell decision in the heat of the decline — will it or won’t it snap back in?
(2) what if the channel morphs? e.g. a channel into a falling wedge or megaphone. The current channel could still form a wedge of sorts.
(3) Which candle shadows to include. I constantly fine tune channels to get what looks like the best fit.
Often, other indicators such as RSI, MACD, stochastics, various chart patterns can help determine proper placement. More often than not, there is a system of other parallel trend lines that (hopefully) reinforce the choice.
Hope that helps!
Helps a lot, thanks for the thorough response PW. I’ve found myself often tweaking my lines to fit the price action and candle bodies/shadows, but I wasn’t sure how legit that made my analysis as a result. Glad you mentioned the parallel lines, I’ve found that if there’s a parallel CL or TL that lines up (and there usually is), then it adds a higher degree of confidence and “firmness” to the new line being drawn as well, getting confirmation from you about that helps.
My pleasure. Thanks to you, I think I just came up with the basis for a good post.
Nice, looking forward to it!
Hello PW, as most of us aware, you are generally bearish. Still, you have short term bullish forecast. Somehow, these past few trading days have the most bearish outcome from your bullish forecast. (don’t get me wrong, I am not commenting on your forecast). It seems like the market is way oversold (in short term) and more bearish than it should be. Maybe the market is forcing BB to do something.
You’re so polite, Tommy. Thanks. It’s definitely made more headway to the downside than I thought. I believe it is oversold, but of course that doesn’t keep it from going down further. I’ve put up a new chart above that shows the worst possible case before the forecast bounce gets into serious trouble. And, you’re right about BB. With “good” employment numbers making QE3 more difficult, TPTB need something to shake the money loose. A little crash might do the trick.
PW – Expand the SPX RSI channel to use the 5/17 low. Today’s sell off touched the bottom of that channel will see if it holds at EOD. I’m looking at this as just a channel expansion of the RSI in something less steep … guess will find out soon enough
Couldn’t agree more. Only question is whether it gets down to the parallel lower bound on this swing or saves it for later. At least it sets the stage for some nice negative divergence – with a back test of the prior channel. See chart above.
BTW folks, like many of you, dillzs is a very good analyst in his own right. I encourage you all to read his comments when you get a chance.
Thanks PW …
ZH has a great article up today how the big banks are simply mismarking CDS in order to enhance profits. I’ve read your posts on the pending derivative disaster (https://pebblewriter.com/there-is-nothing-wrong/)
and now with this info has got me thinking … how can we have a derivative crisis when the banks will simply mark these instruments to whatever value they want in order to make their balance sheets look good …
I think there would need to be some external factor that causes a run on the banks. What that is, I have no idea … but I don’t think it will be an internal problem from within the banking system that will cause the crisis.
Anyways that bank run would be the only way to force these fraudsters into marking to market the actual value of these derivatives, as they would need to move them to access liquidity. When the truth is shown that these instruments are significantly overvalued, and there is no way they can meet depositors demands … then we realize our SHTF moment …
Agreed. They won’t admit to the losses until they have to. And, no doubt, the regulators are well aware that the S will HTF if they press the issue.
One potential trigger event would be a significant failure (AIG, Lehman) that necessitates a reckoning amongst counterparties. One big player going down — and not getting the love and support they want from their bankster counterparties — might cause a melt down.
It’s worth keeping an eye on, as it dwarfs the mortgage crisis, the student loan crisis, even the fiscal crisis all together. Thanks for your thoughts.
I vote fakeout…Sucking in some bears shorting into the hole this AM and then voila, squeeze as they close the gap. I’ve been watching the SPY Level II stack and there was lots of buying in big blocks during the pre-market. They may be wrong, but there has been lots of accumulation this AM.
Plus, DAX hasn’t broken 6400 level yet. If I see that…I’ll get more worried. Rally time!