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Just a quick update – when we last chatted here on the blog, I noted that we were set to test the 50 day moving average (the red line on the graph above). We did that and predictably bounced back to the underside of the 20 day moving average (the blue line on the graph above) where we were rejected and pushed back to the 50dma where we broke through it intraday, closing above. Today, if the market closes at or below the high we put in earlier today, we have formed a pattern of lower highs and lower lows. Tomorrow is key to knowing what will happen on a going forward basis.
1. If we can put in a positive day and close above the 20dma, then the market is telling us that this was just a blip of a correction and that we will probably be heading back toward the previous highs.
2. If we have a down day, we could be working on a third lower low and potentially a close below the 50dma.
My gut feeling is that based upon the movement of the price action, we are going to break below the 50dma and head toward the 200 day moving average (I mentioned this on the blog last week one day).
So what is the strategy? If we close above the 20dma and can sustain it for three trading days (our Rule of Three for breaking above or below support), then you get a signal that a return the previous highs are likely. It is relatively safe to commit some liquidity and put some of your money to work. However, we still have the same issues present from two weeks ago when I wrote that we were due for a correction: high valuations and the distance from the 200dma. Today, intraday we popped above the 10% envelope discussed on the blog a couple weeks ago.
More than anything else, this psychologically important level which shows how stretched the market has gotten should keep us in the correction with a falling market headed toward the 200dma which is around 3100 on the S&P 500.