Tuesday, October 18, 2011
The stock market is nuts...
It gaps 2% higher in one day. Then it gaps 2% lower the next day. One week, sellers freak out and stocks drop 5%. The next week, we get a 6% rise as buyers go crazy.
Yet despite all the erratic behavior, stocks are still stuck inside the same trading range they've been in for the past three months. It's still all just about support and resistance levels.
Well... that... and maybe a little bit about the dollar.
But we'll get to the dollar in a moment. For now, let's take a closer look at the trading range. Check out this 60-minute chart of the S&P 500...
You can see the well-defined support line at about 1,120 on the S&P. There's equally well-defined resistance at 1,220. Traders could have done quite well by simply buying stocks as the S&P 500 approached support, and then selling them each time it approached resistance. We tried to tip you off to this pattern here, here, and here.
Oh sure, there was that break of support and sudden drop down to 1,075 on the S&P a couple weeks ago. But the index recovered just as quickly as it broke down... And there was nothing but upside until last Friday, when the index tapped 1,220. Sellers stepped in on Monday. And we're repeating the same old pattern. So it looks like we're headed back down to test the support line at 1,120...
But... not so fast.
Remember the dollar.
The dollar has been signaling moves in the market all year. A falling dollar leads to rising stock prices. And a rising dollar is a bad omen for the market. It's no surprise the weakness in the market in September came with a strong move higher for the greenback. It's also no surprise that the dollar has been falling in October as stocks have pushed higher.
The dollar was strong yesterday. Predictably, stocks were weak. So if we're looking for the S&P 500 to follow its trading-range pattern and drift on down to support at 1,120, we ought to be looking for signs of continued strength in the dollar.
Last week, I pointed out the bearish rising-wedge pattern that was developing on the chart of the dollar. I figured the dollar probably had one more rally left before it broke the wedge to the downside.
I was wrong.
Here's how the dollar chart looks today...
The greenback broke down through the support line of its rising wedge. That action increases the likelihood that the rally is over. The greenback has peaked for the year.
If that's really the case, stocks have probably bottomed for the year. So instead of looking for the S&P 500 to fall back to the bottom of its trading range, we should look for the index to form a higher low. In other words, we're not going to get a chance to buy the S&P 500 at 1,120 any time soon.
Instead, traders need to step in and buy stocks when the current dollar bounce ends and the buck turns lower again.
The weakness in stocks yesterday occurred as the dollar bounced off oversold conditions. There's resistance on the dollar index chart at 77.5 and then at 78.5. Stocks will likely stay weak as the dollar index approaches those levels. Neither of those points is too far away. So we may only get a small pullback in stocks before the dollar signals it's time to buy into the market.
I'd rather see the S&P 500 fall back to 1,120 and give us another chance to get into the market at a bargain basement level. But I doubt that will happen. Instead, be willing to jump into stocks as soon as the dollar turns lower. That will probably happen sometime later this week.
Best regards and good trading,
Jeff has spent the last couple months tracking the S&P 500 and calculating the best time for investors to jump back in. Catch up on his research here...
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