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What Could Lie Ahead for the S&P 500 & Gold

JW Jones & Chris Vermeulen – http://www.optionstradingsignals.com/specials/index.php

Now that Mr. Bernanke’s speech is old news, what was the financial media thinking exactly? A significant number of financial writers have been anticipating discussion of QE III or QE III Lite which clearly were never even on the Fed Chief’s radar this week. The focus of the Jackson Hole Summit was how to achieve long-run growth, not conduct discussion of monetary policy.

QE III will not be discussed openly until the next FOMC meeting in September, which noticeably was extended to two days. Besides the extension and the Fed Chairman’s prediction of growth in the back half of the year, the remainder of Mr. Bernanke’s speech was nothing more than a brief synopsis of what he has already said in the recent past.

While Chairman Bernanke focuses on the U.S. economy, I have been more inclined to monitor the action across the pond. Price action in Europe is having a major impact on financial markets here in the United States. Traders are monitoring credit default swap (CDS) spreads on European sovereign debt as well as on domestic and European banks.

Recently U.S. banks have seen the CDS swaps on their debt rising indicating that the marketplace believes their debt is a greater risk to investors. While the price action is nowhere near the 2008 & 2009 levels, current prices are relatively consistent with what was seen during the correction in the late spring of 2010. While there is no reason to panic at this point, this is a trend that I will be monitoring closely going forward.

For now, I continue to believe that equity markets will rally in coming weeks as conditions are extremely oversold. The price action so far today makes sense as the wild price swings helped flush out weak hands that were long. Consequently, the snap back rally pushed shorts into stop levels as well.

A significant move lower does not seem likely at this point, but a retest of the recent lows is possible, if not probable. I would remind readers that stock market crashes generally happen within the context of an oversold market. While the likelihood of a crash is remote, it is still possible and tight risk definition in this environment is warranted regardless of which side of the tape a trader is playing.

One price chart that I have been watching closely is the German DAX. The German DAX is presently a thermometer for traders to monitor the situation in Europe. The reason the German stock market index is so important is due to the financial strength of Germany within the Eurozone. Without Germany, the Eurozone would crumble in on itself and the Euro currency would be in trouble. Recently Germany’s equity markets have been crushed and the daily chart below illustrates the recent carnage:

Another metric I monitor regularly is market momentum. The chart below illustrates the number of domestic stocks trading above their 200 period moving averages. As can be seen below, the U.S. equity market has not been this “oversold” since back in 2009. Chart courtesy of Barchart.com.

In my previous article posted back on August 18th, I discussed the likelihood for stocks to pullback and put in some form of a basing pattern. I wrote the following statement in that article:

“It is entirely plausible that Mr. Market thrusts lower from here to shake out longs. If that scenario plays out it could potentially carve out a double bottom or another basing pattern which would give active traders another entry point to get long.”

Since August 18th, we have seen the S&P 500 push lower and there is a double bottom on the daily chart which is capturing quite a bit of attention in the trading community. I would also draw your attention to the wedge pattern that is also present. A breakout higher or lower out of this wedge pattern will be the clue that will indicate Mr. Market’s short term price direction. I continue to believe we will see a breakout higher, but a retest of the lows is always a possibility. The daily chart of the S&P 500 Index is shown below:

In the short to intermediate term, I believe we will see higher prices and a test of the key S&P 1,220 area or possibly a re-test of the key S&P 1,250 price level which corresponds with the March 2011 pivot lows. Additional resistance would come in around the 1,260 – 1.270 area which marks the neckline of the recent head and shoulders pattern which triggered the selloff in the S&P 500. The daily chart of the SPX below illustrates the key resistance areas:

Gold Analysis
My most recent article argued that gold prices were going parabolic and that a pullback was likely. We have seen a major pullback in gold prices. Admittedly, I was about $200 an ounce early on my call, but members of my service were able to capitalize on an option trade that captured 32% based on maximum risk through the use of a double calendar spread. While my timing was not precise, the juiced volatility in the GLD options allowed me to roll contracts forward and make additional adjustments to produce a strong gain for the service.

Some traders argue that gold prices are going to rally back sharply in short order, which I find hard to believe. Instead, I am of the opinion that we could see additional downside in the weeks/months ahead in gold prices. There is an ominous pattern starting to form on the gold daily chart which if it is carved out and triggered, it could produce the next leg of this selloff. The daily chart of gold is shown below:

While it is far too early to determine if a head and shoulders pattern will be carved out or if lower prices take place, I am of the opinion that this selloff will offer an attractive entry point for longer term investors. At this point it is a bit too early to get involved, but if my analysis is accurate the next leg of the gold bull market will be potentially extreme.

While I believe stocks will rally in the short to intermediate term, I am of the opinion that we have officially entered the next phase of the bear market. The next wave lower in stocks is going to be just as severe as the likely rally in gold.

The reason I believe gold will rally is primarily due to future weakness in Europe. If European banks have a credit crisis, a sovereign nation unexpectedly defaults, Germany leaves the Eurozone, or a currency crisis transpires gold prices should soar while U.S. equity prices tank.

While it is far too early to make that determination, if the S&P 500 puts in a lower high on this next advance higher and consequently takes out the recent lows on a selloff, the bear will be in full swing and gold prices should take off. The chart below illustrates my expectations for the S&P 500 in the future:

The next few weeks are going to be very telling about the future in domestic markets. Is this just a correction that pushes stocks higher by the end of the year, or is this the beginning of something far worse?

For now I am going with the latter, but price action in coming weeks will offer clues about what lies ahead for U.S. equity markets. Right now this is nothing more than speculation, but the next few months should be very interesting. Risk remains exceedingly high.

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JW Jones & Chris Vermeulen

This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the OptionsTradingSignals.com website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.

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How to Take Advantage of Panic Selling for SP500 and Gold

Did you close out any long positions today? Well if not then you are one of a few!

Today (Wednesday) the market gapped down 1.5% at the opening bell which set a very negative tone for the session. Volume was screaming as protective stops triggered and traders close out positions before prices fell much further. This gap seemed to have caught several traders off guard but those of you who follow my newsletter knew something big was brewing and to keep positions very small.

Just before the close on Tuesday I had a buy signal for the SP500 which was generated from the extreme readings on the market internals. After watching the market chop around and get squeezed into the apex of the rising wedge the past 3 weeks I knew something big was about to happen and I did not want to get everyone involved because I felt a large gap was about to happen and the odds were 50/50. Instead we passed on the technical buy signal and waited to see what would happen Wednesday.

Below are a few charts showing one of my extreme reading indicators I use which helps me to identify possible short term bottoms.

SP500 – SPY Exchange Traded Fund

This daily chart of the SPY etf clearly shows that when we see panic selling in the NYSE which I consider 15+ sell orders to each buy order to be PANIC SELLING. This is shown using the purple indicator at the bottom of the chart. Today there was an average of 37 sell orders to every buy order which tells me the majority of traders are closing out all their long positions.

In an uptrend this indicator works very well and can help time a bottom within 1-4 days. As you can see on the chart below we just had a huge sell off and everyone seemed to be exiting their positions. This panic selling tends to carry over for a couple sessions until the majority of traders around the globe are finished selling.

The problem with this indicator is that in a down trend we tend to get these panic selling spikes regularly which means this time it may not work out because of the trendline break today which I think has officially changed the trend from up to down. Because of this possible down trend starting I feel its best to wait and see if it’s a dead cat bounce or if there are real buyers behind it, then we will take action to go long or short the market.

Market Internals – Put/Call Ratio & NYSE Advance/Decline Line – 60 Min Charts

Here are two charts which are currently at extreme levels. This typically means we a bounce should occur the following day or a gap higher. If you did not know there was a strong trendline breakdown today you most likely would have taking a small long position into the close.

The Put/Call ratio when above 1.00 means more people are buying put options, meaning they are leveraging themselves to make money if the market drops. As a contrarian indicator, if everyone is buying leverage to the down side then they should have sold their long positions already. That would mean most of the selling has already taken place in the market thus it should have some upward bias in the near term.

On the other side you can see the NYSE A/D line which shows how many stocks on the NYSE are advancing and how many have moved lower. When this indicator is below -1750 then we know the market is oversold on a short term basis and there should be some upward bias in the near future.

Now Lets Take A Look At Gold

Gold was left on the side of the road today as traders and investors focused on the equities market. I was actually a little surprised that it didn’t make a big move today because the US Dollar rocketed higher for the entire session. Anyone who has been watching gold closely already knows that gold is doing its own thing now… Some days it moves with the dollar, other days it does not… its become much more random than it used to be.

Anyways it looks to be forming two patterns… first one is a bull flag. If a breakout to the upside occurs that would send gold to the $1230-40 level.

The second pattern is a mini head and shoulders pattern which would send gold down to the $1180 area if the neck line is violated. It is a very tough call for gold.

Mid-Week Technical Traders Update:

In short, it’s going to take a day or two before we get a feel for the SP500 as we wait to see if it bounces with volume behind it. I personally would like a bounce so we can short it. It is unfortunate how the market broke down today. We were so close to getting a really good setup in either direction but the FOMC meeting shook things up and caused the large gap which in turn made a large group of traders miss that beautiful drop… It’s frustrating when you wait for something only to have a piece of news mess things up. That’s just part of trading though.

As for gold, I feel it’s a 50/50 trade and could go either way so I am not going to take a position right now. I’m just going to wait for the market to tip its hand a little more before I jump.

I hope you found this information useful. If you would like to receive these trading reports, updates and ETF alerts be sure to visit my service at: www.TheGoldAndOilGuy.com

Chris Vermeulen

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