SPY vs. SPY: Which Chart Pattern Will Prevail?

The SPDR S&P 500 ETF Trust (SPY) looks set to break out of its trading range, but the next direction for stocks is unclear

Senior Vice President of Research
Oct 31, 2016 at 8:34 AM
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"... SPY remains locked in a trading range that began with a weekly expiration Friday sell-off on Sept. 9. Since that date -- a period that has encompassed 31 trading days -- SPY has closed between $212 and $217 on 30 of those days... Additional resistance is in the $219.50 area, the August-September peak, which is: 1) 20% above the February 2016 low; 2) 10% above the late-June "Brexit" trough; and 3) just below the round number $220 level that equates to the 2,200 century mark on the S&P 500 Index (SPX).

"... there is strong support below. In addition to the importance of $212... the 125-day moving average -- a generally under-the-radar indicator -- is situated just above $212. This moving average equates to about six months of trading. It's not a widely followed trendline, but it's one that played an important role on a multitude of pullbacks from 2013 through the third quarter of 2015... A strong rally from this moving average, followed by a breakout above the August and September highs, would potentially indicate the market is about to embark upon a trending phase higher. But, buyer beware; breaks of this trendline have sometimes led to sharp, short-term selloffs of 5-10%."

-- Monday Morning Outlook, October 24, 2016

Not much has changed since our last commentary -- except for the fact that, since a Friday sell-off on Sept. 9, the SPDR S&P 500 ETF Trust (SPY - 212.54) has now closed between $212 and $217 in 34 of 35 trading days. The support levels we discussed last week remain intact, albeit barely. One thing we did not mention last week, for you Fibonacci retracement followers, is that the $212 area represents a 38.2% Fibonacci retracement of the late-June closing low and August/September highs.

Midday Friday headlines indicated there may be more to the email debacle of presidential candidate Hillary Clinton, as news surfaced that FBI Director James Comey wrote a letter to a congressional committee indicating additional steps in the investigation should be taken. Evidently, additional emails were found in the course of a separate inquiry into former Rep. Anthony Weiner, the husband of top Clinton aide Huma Abedin, but it was not yet known whether the emails were material. Later in the afternoon, about an hour before the market's close, reports indicated that the emails did not appear to be from her private server.

The initial headlines sent the SPY swiftly lower, from the 214 strike to support in the $212 area. Meanwhile, the CBOE Volatility Index (VIX - 16.19) quickly spiked from 14.70 to 16.00 in a matter of minutes.  

vix 30 minute oct 25-28

The VIX advance last week and pop on Friday is interesting, in that it tracks closely with what VIX has done historically in the run-up to a presidential election. In the graph below, we capture the average VIX action in the two weeks before presidential election day and the two weeks after presidential election day, beginning with 1992. The VIX usually peaks six trading days before the election.

In other words, if the VIX follows its historical pattern, as it has done so far, its short-term peak would occur today and be followed by a decline to the 12 area by the middle of November. For equity exchange-traded fund (ETF) and index premium sellers, this chart is noteworthy.

vix election day returns

Turning to the SPY, a couple of technical patterns on a daily chart are indicating the potential for a breakout from the $212-$217 range could be on the horizon, although these patterns are in conflict in terms of the direction of the breakout.

For example, as we diagrammed on the daily chart below, a bearish "descending triangle" is emerging. A close below the $212 level would heighten the chances for a move to the $205 area in the short term.

However, as we mentioned last week, there is strong potential support in the round $210 area. In fact, if support did emerge in this area, a bullish "falling wedge" pattern would be in play. A bullish falling wedge is corrective behavior that follows a directional move higher, such as the rally from the late-June low to the early September peak. The base of this wedge is currently just above the round 210 strike, as you can see on the dotted line in the graph below.  

spy daily descending triangle falling wedge

Finally, we compiled S&P 500 Index (SPX - 2,126.41) component total short interest data as of mid-October. In this latest report, short interest declined, following increases in prior reports. This data could be a welcome sign for bulls, as builds in short interest have pressured stocks. Continued short covering as we approach the final stretch of election-related uncertainty could be supportive of stocks, as we enter a traditionally strong seasonality period for equities. That said, if you are a short-term trader, be open to all possibilities -- especially with conflicting technical direction patterns at work.

spx short interest

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