|As of December 16, 2010, the market had dipped a bit in price just after trading up through upward resistance from a congested trading range that has existed since April 2010. For almost eight months, the major indexes such as the Standard & Poor's 500 (SPX) has been trading back and forth, both high and low, as the market experienced falling off its highs, finding a bottom to mount a rally and, eventually, trading back up to test the former highs and finally managing to trade up through resistance.|
From a technician's point of view, now that the SPX has traded up through major resistance, it would stand to reason that traders will take the market down to its former resistance level to find minor support before pushing the index higher. However, at year-end, another important factor must be taken into consideration that could either complement that point-of-view or nullify it altogether. And that is what is called the December pattern. See Figure 1.
|The December pattern is a seasonal pattern where traders must take into account both the price action as it exists at the present along with the context of what underlies that price action. For example, in the summer, trade volume dries up and results in the market oscillating back and forth in lackluster trading, with many smart traders anticipating this and using option spreads to take advantage of the low volatility and to keep income coming in.|
The reason for the lackluster activity as well as the context for what underlies it is that many floor traders or institutional trading teams go on vacation during this time of the year, and this lack of participation is why trade volume dries up. Therefore, price action is rather lacking and adjustments must be made.
This does not always happen, but experienced traders know that it occurs often enough that they can both anticipate it and make trade adjustments to exploit it at the same time.
In the December pattern, the market has a bias to trade higher because selling pressure eases up as it gets closer to the New Year because most investors and traders, if they're going to sell their shares, would prefer to wait until next year for tax purposes.
|FIGURE 1: S&P 500. After breaking free of an eight-month trading range, the SPX is now poised to make strong a runup following the annual December pattern.|
|Graphic provided by: www.freestockcharts.com.|
|The other critical part that forms the context for this pattern is that many hedge fund managers and mutual fund managers, who are paid for their fund's performance, are desperate to run up the market in order to increase their overall returns for the year. The better their fund's performance, the higher their incentive fees or bonuses are going to be, since they are typically tied to that overall annual return.|
Since they control enormous sums of capital, then they have the ability to run up the market and inflate the value of their holdings, at least in the short term.
|As a result, this sets up the market for a big pullback in the early part of the following year, but if the market is acting strong, then those pullbacks in price action are also another opportunity for a smart speculator.|
For now, look for any big runup to occur between now and the end of the year, but be cautious going into the middle to late January 2011 for a sharp pullback.
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