How High Will The Market Bounce?

 

NOTE: Please click on the charts below to enlarge them if they do not appear clearly.

Over the past week, we've been discussing ETFs with the most relative strength or weakness to the broad market, rather than the technical state of the main stock market indexes.  Because the broad market was in such a persistent downtrend, there wasn't much of a point to analyzing projected reversal levels until stocks at least caught a bid.  But now that we're in rally mode, at least in the near-term, let's take a look at how far this counter-trend bounce (that's all it really is for now) may carry the benchmark S&P 500 Index:

Whenever a sharply trending index, stock, or ETF enters into a counter-trend bounce, the 10-day moving average is the first line of defense that will act as minor resistance (in counter-trend bounces of downtrending markets) or support (in counter-trend pullbacks of uptrending markets).  On the chart above, the 10-day moving average (MA) is represented by the dashed purple line.  Notice that yesterday was the first time since June 5 that the S&P 500 managed to close above its 10-day MA.  All preceding touches of the 10-day MA quickly led to a sell-off and resumption of the primary downtrend.  As such, the S&P 500's ability to convincingly close well above its 10-day MA (currently at 1,247) at least hints at a change of character in the general behavior of the stock market.

The next resistance level the S&P 500 will soon encounter is the 20-day exponential moving average (EMA).  This is indicated as the beige line, currently at the 1,273 level.  The 20-day EMA is more difficult for a steadily trending market to overcome during a counter-trend retracement than the 10-day MA.  However, because the May - July downtrend was so intense, a bounce to the 20-day MA does not even represent a 38.2% Fibonacci retracement for the S&P 500.  As such, pure momentum of the current rally should at least enable the S&P 500 to test its 20-day MA sometime next week.  If you happened to scoop up a few long positions near the lows, a test of the 20-day EMA in the S&P 500 may be a good place to take your profits, or perhaps tighten protective stops to lock in gains.

Although the 20-day EMA may provide a decent amount of price resistance to the S&P 500, we would advise against initiating new broad-based short positions at that level until the market provides some sort of reliable indicator that the downtrend will resume.  We feel the current bounce has the ability to carry the major indices to at least a 50% retracement of the losses from their May highs to July lows.  There's a good chance the main stock market indexes may rally all the way back to test pivotal resistance of their 50-day MAs, which are currently just above the 50% retracement levels.  However, since all the 50-day MAs are now descending, they may actually fall to meet the 50% retracement levels by the time stocks muster up enough strength to bounce that far. 

Open ETF positions:

Long - BBH, GLD, RSX

Short - (none)

NOTE: Regular subscribers to The Wagner Daily receive daily updates on the open positions above, as well as new ETF trade setups, including trigger, stop, and target prices.  Intraday Trade Alerts are also sent via e-mail and/or mobile phone text message on as-needed basis.

Deron Wagner is the head trader of Morpheus Capital Hedge Fund and founder of Morpheus Trading Group (morpheustrading.com), which he launched in 2001.  Wagner appears on his best-selling video, Sector Trading Strategies (Marketplace Books, June 2002), and is co-author of both The Long-Term Day Trader (Career Press, April 2000) and The After-Hours Trader (McGraw Hill, August 2000). Past television appearances include CNBC, ABC, and Yahoo! FinanceVision. He is also a frequent guest speaker at various trading and financial conferences around the world.  Wagner is currently working on this third book, scheduled for publication in early 2008.

For a free trial to the full version of The Wagner Daily above, which includes detailed ETF trade setups and daily position updates, or to learn about our other newsletters, visit morpheustrading.com or send an e-mail to deron@morpheustrading.com.

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