Buy The Dip or the Beginning of a Reversal?

January 7, 2013 (11:20 am)

The market began selling off this morning. Is this the start of a correction from the highs, or just a near-term sell-off before new money comes in to “buy the dip”?

We’re seeing a three push up pattern on the SPY. The occurs when it puts in a higher high, forming an upward sloping trend line, that the next test (the “third push up”) fails to touch. It tends to precede a two-legged sell-off. This morning, after seeing new highs on Friday, the market couldn’t complete that third push up and is now consolidating after a first leg down. It’s also forming a rising wedge, which increases the likelihood of a bearish set-up here.

SPY push up

SPY Rising Channel Still In Tact (For Now)

We’ve discussed previously that the SPY has been trading within a well-defined rising channel for almost 8 weeks now. The shares are sitting near the top of the channel, although they were not able to actually touch that trend line during this rally. Similar to the three push up pattern explained above, the fact that it couldn’t test the upper trend line does not bode well for the bulls going forward. Further, the shares are forming a rising wedge in the near-term. There’s a big gap down to the $142 level. Will the SPY fill this gap in the near-term?

SPY Channel

Bollinger Bands

The Bollinger Bands on the SPY have signaled the end of significant rallies in the past. This signal takes place when the SPY opens and closes above the upper bband for multiple days in a row (see the orange circles). When the shares fall back within the bands, it tends to precede at least a near-term pullback. Along with the other signs we’ve been commenting on, it wouldn’t be surprising to see the SPY fill the gap before regaining momentum to the upside.

SPY BBands

Apple’s New Trend Line

Last Monday’s rally brought Apple shares up to the important $555 level, before reversing to the downside. This created another important trend line to keep an eye on (orange). We’ve discussed the blue and purple trend lines multiple times, so will not be explaining the important of those again. But be aware that whether we’re able to break the orange trend line to the upside with volume will be a significant factor in determining when the shares can have a sustainable rally.

AAPL Trend Lines

Falling Wedge Still in Play

The enormous falling wedge on Apple is still firmly in play. The sell-off this morning can be viewed as a re-test of the upper trend line before reversing for a significant move to the upside.

AAPL Falling Wedge

Closing Thoughts

Most of the evidence in the market points to significant risk to the downside. The extreme and quick drop in volatility, the upper Bollinger Bands, the overbought conditions, the huge gap at $142, etc. The two factors we need to keep in mind arguing the other side of the coin are (a) the strong upside momentum we’ve witnessed and (b) the enormous amount of liquidity the Fed is injecting into the market.

As far as Apple goes, it seems fairly clear that the weakness we’re witnessing is a great opportunity for those with a long-term investment horizon. The near-term is very tricky. Momentum shifts so quickly from the upside to the downside that it is extremely challenging to call. For the time being, we view the very high $400’s as the limit to any downside risk. The upside risk is becoming increasingly larger with the recent evidence of a strong potential for blowout earnings. But we may have to wait for earnings to see a resolution of the share price volatility.