Last week the two biggest clouds over-hanging the financial markets appear to have been removed … at least temporarily.
Those clouds are interest rises (never good for the debt markets) and the China trade war.
For interest rates, US Fed Chair Powell indicated last week that, "...we are a lot closer to neutral (on interest rates)" which investors interpreted to mean one more rate hike in December and then no more. But while investors interpreted the speech one way, subsequent Fed minutes, don’t suggest there’s any such shift in plans and I remain skeptical that the Fed meant to signal a change on Wednesday.
On the trade war front, President Trump announced he was postponing further tariff hikes with an announcement that effectively “bought” three months for the two parties to work out many intractable problems. Color me skeptical.
In the end, it seems like nothing was really resolved on either front. Other than kicking the can further down the road, of course. None of the systemic and important underlying issues were adequately addressed or resolved.
Now having said that, I’m always hesitant about espousing my thinking or opinions, because they don't matter a wit in the end. The only thing that counts is how the market reacts. Price is the ultimate referee. Remember, the Market is Always Right.
So what are the markets telling us?
Well, a study done by Deutsche Bank has revealed that a record share of asset classes have posted negative total returns this year — and that’s on a chart going back to 1901. Yes, well over a century!
That means that (almost) no matter what you’ve been holding this year, you’ve lost money.
That’s not good news for buy and hold investors, obviously. However, here at the Pattern Trader this is one of the best years we’ve ever had. That’s because this year has been a trader’s market, not a buy and hold investment market.
Here’s a recent example of what we’ve been up to …
Given this fluid and uncertain environment, I’ve been seeking asymmetric opportunities where the risk-reward is heavily weighted in favor of reward thanks to the price action. I saw what looked like a "bear trap" in Home Depot (HD), last Tuesday.
On this long term HD (Home Depot) chart, you can see what looks like a double top. The price even went through the neckline.
But what happened after that? The market failed to follow through. Even though we saw a multi-year low, the price couldn’t drop any more.
That’s a bear trap.
Here’s what it looked like on a daily chart:
See how the market hovered and couldn’t make new lows after breaking the short term neckline?
The little inside bars at the end of a large range often herald the end of a trend. (I’ll show you another example using the S&P 500 later in this article.)
Since the market couldn’t force itself lower, it was likely to go up instead. So I bought HD 172.50 Call options at $0.59. They closed the week above $8.00 just three days later. That’s a 1400% return and a perfect example of how you can use long term patterns to find short term trading opportunities that REALLY pay off.
You’re not going to see this kind of pattern every day, of course. I’m just using this as an example of how to think and then exploit huge opportunities in markets like this. Look for the patterns and what the expected behavior should be.
Now let’s look at what our next moves should be in these very interesting markets.
Now that we have the supposed “Powell Put” and the (probably temporary) cessation of hostilities between the US and China, stock market prices are likely to bounce within a wide range and with a lot of volatility.
To that end, the key resistance levels are 26,500 in the Dow Jones, 2625 in the S&P500, and 7200 in the NASDAQ 100. Those are critical areas to watch.
If prices are contained below those price levels, it would indicate we’re likely in a long-term bear market. However, meaningful penetration above those levels would indicate otherwise.
As an example, here’s the S&P500.
Firstly I’ve drawn a red circle around the tiny inside bar at the end of a long trend. This little bar heralded the crash to lower prices. When the market simply can’t keep pushing any more, the energy gets coiled up in an inside bar and then released explosively, as we soon saw.
So is the raging volatility a correction in an ongoing bull market … or something more meaningful for a true bear market?
Well, there’s still an existing support line under the recent price action. So any penetration below the 2550 level will be a long term bear market.
And if the uptrend line holds instead, this is likely a correction in an ongoing bull market … for now! Ultimately, the market is going to tell us where it wants to go.
By the way, it’s important to take note of the growing discrepancy between the lackluster performance of small cap stocks relative to others.
Here’s the Russell 2000 small cap index as represented by the IWN ETF:
That’s a well-defined bearish head and shoulders right there.
You can't have a sustained rally in the S&P 500 without some sort of participation from the Russell 2000. So now it’s a question if investors buy the dip in the Russell, or the Russell rolls over instead and drags the other indices lower. At this point, I am inclined to reside in the latter camp. I think we’re probably about to enter a prolonged bear market if we haven’t entered it already.
I suspect, for the next month or so, this may not be a bull or bear environment, but a shift from one sector to another. For instance consumer staples and utilities are likely to be the winners, and energy, defense and agriculture the losers. This offers a lot of potentially great trading opportunities just like the 1,400% Home Depot winner I showed you earlier.
Meanwhile, the tech sector is also likely to be a loser too.
Here’s the QQQ ETF which acts as a proxy for the tech sector by attempting to mirror the NASDAQ100 index.
Right now there’s a battle between two opposing patterns: we have a bearish double top where the neckline was broken pitted against a possible double bottom where the neckline has not yet been crossed.
So far the bearish double top is ‘winning’. The key area to watch is the downtrend line. If QQQ can rise above that and breach the neckline(s) of the double bottom, then the tech sector will likely rally much higher …
However, this rally didn’t get very far! Here’s an updated QQQ chart I inserted into this article just before going to publication:
See how the price rose to and then was rejected by the downtrend line?
I think tech stocks are in for a very torrid time in the near future. The next areas to watch are the recent lows at 161 and 158. If those are breached then look out below.
Meanwhile, what’s up with gold?
With current support in USD, I believe it will be difficult for XAUUSD (spot gold) to make any progress on the upside. Should XAUUSD penetrate below the low (around 1193) of the November monthly bar, it will open up a move lower in the yellow metal.
I’m more bearish than bullish due to the double top at the 2000 area and then the triple top at the 1400 area.
While there’s been a minor uptrend recently, spot gold still looks like it’s in a bear market.
Having said that, you can still put a buy stop above 1245 to go with a sell stop below 1193 if you’re undecided and think there’s a bullish case for gold too. Entering on a breakout outside last month’s high and low is likely to be quite profitable if all that coiled energy gets released explosively.
Of course, it’s also possible that spot gold just slides sideways with low volatility and no real movement at all. That’s why I won’t enter the market yet and will only consider entering on a breakout outside last month’s high and low.
There are 5 stocks that are rapidly about to move. And i will show you how i intend to make a fortune trading them. Just check out the link below.
I hope that gives you plenty of ideas to consider and trade in the weeks to come.