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The SPX And A Jump Out The Window

05/22/12 08:35:33 AM
by Billy Williams

The SPX looks like it could reverse at any point, and the decline could fall as hard as jumping out of a window.

Security:   SPX, ALXN
Position:   Sell

The SPX looks as if it could jump out the window at any moment due to a mixed bag of US economic reports. After a promising morning of substantial gains, the bulls didn't have the strength to hang on to them and dropped the ball to the bears who were all too ready to lead the charge downward once again.

Tuesday's trading ended with losses once again for the third consecutive day as the specter of the European debt crisis reared its head once again. The tingle of fear raced up and down the weakened spines of bullish traders who lacked the confidence to take control of the price, but with three hard consecutive downward days, have the bears hit a wall? Or is the market about to give hungry bears on the sidelines an early gift before summer vacation in the form of a downward plunge in the market?

May is historically the most bullish month of the year where price typically has a hard runup in price and then passes the ball to the bears as the month comes to an end. If that pattern runs true, then you can see that things are shaping up just as expected.

However, the market has a potential black swan event in the making after Greece has failed to cobble together a coalition government and the country now faces a new election next month. At stake is the country's dire straits and the austerity measures implemented to get Greece's finances on the road to solvency.

FIGURE 1: SPX. The SPX has declined steadily since early May, but the last three trading days have declined into the lower Bollinger Band and suggest a sharp bounce upward. But will it be enough to give control back to the bulls?
Graphic provided by:
Meanwhile, in the US, the New York Federal Reserve's Empire State Manufacturing index jumped to a surprising 17.1, as analysts had initially expected a gain to 10. The Fed described the gain as moderate but said the shipments index shot up 18 points to 24.1.

Though this reversed the trend from April, the rest of today's economic news was anemic and gave no clear vision as to what lies ahead in the economic future for the country.

On the technical side, the SPX has made a new lower low in its price, though it is still within the 0.382 Fibonacci retracement zone and a price bounce can be expected at some point due to the three consecutive bearish trading days that have led price into the lower Bollinger Band (Figure 1). This confluence of factors could act as a short-term support, but for now, it is pretty meaningless to the bulls until price makes a significant climb back to the 1415 price level or at least a steady series of higher highs and higher lows in its price action.

FIGURE 2: ALXN. ALXN is a stock leader that is in transition. It has broken minor support, only to trade back up into minor resistance. If the bears plunge the market lower, ALXN is set up to lead the charge downward, which could translate into big profits for a smart put option trader.
Graphic provided by:
What is at stake is a strong move downward as bears could assert their growing strength and force the market lower, which would offer a big opportunity for a smart option trader. In such a scenario, bulls may give up and charge out of the market, adding to the force and velocity of the decline. Strategically buying put options in stocks that find themselves at a crossroads where they could go either way could yield tremendous gains. See Figure 2.

Look for stocks trading at resistance or minor resistance where price could reverse and begin a series of lower highs and lower lows. Remember, the initial move downward can be a terrible thing if you're on the wrong side, but if you're on the right side, when the initial plunge occurs, you could make a lot of money very fast. But be sure to respect risk at all times and use a stop-loss point.

Good hunting.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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