Bear Trap, MACD, 50 DMA S&P 500

One of my favorite phrases to describe market action is “Only Price Pays”™ There are times when people question me about various oscillators and indicators and wonder why I dismiss them all. The fact is, I do not dismiss them, but I do not assign much value to their usefulness compared to price and timeframe analysis.

The $SPY has pulled back down trough the 50 DMA (as we were expecting last week) and now we are seeing some of the signs of stability we look for to take action on the long side. As I often point out, the 50 DMA or any other technical event, is rarely the reason to take action, instead it is the reason that we want to take a closer look at the stock on a shorter term timeframe to look for clues that buyers are actually taking control.

When we look at the chart on the right (constructed with 30 minute candles) you can see the the SPY has not only undercut the 50 DMA and the low from mid September, but it has now bounced back up through that broken support level. This move back up creates a scenario I wrote about last week when I questioned who sells after such a decline. It is not uncommon for a market to breach a wideley talked about level (or moving average) and then to reverse back up quickly, this action has the recent sellers question why they sold and traps the new short sellers from the break of the “obvious level.” At the same time, the more savvy participants will begin to either; cover their shorts profitably or the long participants who scaled out of positions profitably will begin to deploy new capital to the long side. These actions combine to create an environment of diminished supply and increased demand, a powerful combination which often leads to a “fast move resulting from a failed move.”

Back to the 30 minute chart for a moment, the oscillator below price is the MACD (Moving Average Convergence Divergence Oscillator) MACD Tutorial When the MACD makes a higher low at the same time that price action makes a lower low, it is called a divergence which you can generally interpret as the intensity of selling is not as strong as it was on the prior low. When this happens, it often indicates there is a short term turning point at hand. Now that price as moved back up through the prior level of broken support, the price action confirms this reading and a bounce should be expected to continue. The key level for SPY to hold up above will be Friday’s low and if you are taking a long position the job is to manage risk by raising stops under higher lows on the timeframe which you trade on.