February 4, 2013 (1:10 pm)
The markets took a nosedive this morning, with the SPY falling $1.60 from its closing price on Friday. With this gap down, it has formed clear RSI negative divergence. It found support at the $149.60 level (blue line) as it reached oversold conditions. We exited a number of our short and put option positions as the SPY and QQQ hit support levels on oversold conditions. We expect a recovery to test the highs formed on Friday. Typically, the first pullback after a strong multi-week rally is bought. Only after the market fails to take out the previous highs is a more significant correction likely to commence.
SPY Support. On the chart below, there are a few things to notice. The first is that the highs on Friday failed to reach the “3 push up” trend line. That’s the first crack in the market. A failure to take out this trend line is a sign of waning momentum. So is crack number two – negative divergence on the RSI. As the SPY has been forming higher highs, the RSI is weaker than it was during previous highs. Buying momentum is slowing here.
SPY Rising Channel. The SPY has formed a rising (green) channel since the middle of November. We tested the top trend line on Friday at the highs and are now quickly testing the lower trend line today. This lower trend line coincides with the $149.60 support level above. We closed our shorts at this level, expecting a rebound due to the strong support at this level combined with an oversold RSI. That said, after a rebound, we expect to re-enter our short positions. A failed re-test of the recent high will likely precede a more significant sell-off.
SPY Long-Term Rising Wedge. Just to re-iterate our view, this long-term rising wedge is extremely bearish for the SPY in the intermediate term. Just something to keep an eye on.
QQQ Consolidation. We showed the chart below with the blue double top expectation last week. That has come through to fruition. However, the double top has not been confirmed. A drop below $66.50 should lead to a more significant sell-off down to the $65.25 level. Interestingly, this level happens to be the beginning of the gap created on the fiscal cliff resolution.
QQQ Resistance Level (and the H&S). Over the weekend, we read a number of investing newsletter’s and articles explaining that this head and shoulders pattern isn’t anything to worry about yet. We disagree, especially with the price action today. Just as we were re-testing the very important $67.75 resistance level, we see a large sell-off in the shares. Without a decisive break above the left shoulder at $67.75, the significant of this potential pattern is very real.
Netflix. On a positive note, shares of NFLX have been reacting well today. The bull flag is becomming even more well-defined. We took initial positions in both the long/short portfolio as well as the multi-strategy portfolio (with March call options).
Conclusion. The oversold conditions and significant support levels being reached by both the SPY and QQQ’s will likely lead to a near-term recovery. This rebound will test the recent highs, either creating a higher or lower high. Only after this re-test do we expect a more significant and sustainable correction. But we do believe it is still coming. We’re just trying to take advantage of a reactionary rebound first.