Doji Candle Could Be Signaling Market Bottom

The SPX's monthly candle was a doji in May

Senior Vice President of Research
Jun 5, 2022 at 4:18 PM
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“… there have been a couple of technical developments that are encouraging for bulls. The first is the area at which the SPX troughed earlier this month, which was a round 20% below the SPX’s all-time closing high and 2021 year-end close. Note that this low was also in the vicinity of 3,852, the SPX’s close when President Joe Biden took office in January 2021…one need not look any further than March 2020, when the SPX troughed in the 2,270 area, which is where the index was trading when Biden’s predecessor Donald Trump took office in January 2017. One major difference between now and then is in 2020 we were on the cusp of major fiscal and monetary stimulus, whereas now, the Fed is hiking rates and no longer buying bonds, and fiscal stimulus is a thing of the past

            -Monday Morning Outlook, May 29, 2022

With the month of May ending last Tuesday, long-term bulls added another piece to a difficult puzzle, with the S&P 500 Index (SPX—4,108.54) closing above its 24-month moving average, rallying from a multi-pronged support area – as discussed in the excerpt above – earlier in the month. Specifically, the index closed the month above its 24-month moving average, giving new life to bulls who were on life support just weeks earlier.

While the May close does not definitively mark a bottom, as I suggested last week, it may give some of you reason to tip-toe back into the waters, or if you have the urge to do more than tip-toe, use the three-week retreat in volatility, as measured by the Cboe Market Volatility Index (VIX—24.79), to hedge long positions.

As a quick side note on this retreat in the VIX, note on the three-month daily chart below that since moving back above the level that coincides with its year-to-date 50% gain on April 22, it has been pinging between levels that coincide with 50% and 100% above its 2021 close at 17.22. Call buying on VIX futures is still relatively low relative to put buying, suggesting the VIX may retreat further in the coming weeks and break the current pattern.

VIX Three Month Gain

There was another interesting piece to the May close in that the monthly candle was a doji. In other words, the opening price for May (4,130.61) and closing price (4,132.15) were about the same.

Such doji candles on a monthly chart are not that common. And with doji candlestick patterns used as a signal for the potential end of an ongoing trend, this doji candle piqued my interest, as it occurred in a month in which the 24-month moving average was tested. As such, I referenced a monthly chart of the SPX in order to seek other occurrences in which the SPX experienced a monthly doji in the midst of a correction or bear market.

I found eight prior instances since 1990. All but one (August 2002) signaled a major bottom. In the case of August 2002, the SPX did not trough until six months later, which ironically was a doji month too.

In the case of October 1992, a strong rally followed months of sideways movement. While there is a chance that this is August 2002 and the May 2022 monthly doji on the SPX does not signal an end to the trend, bulls can rely on this history for now. Per my comments in parenthesis, there is some commonality in the May doji occurring at its two-year moving average, although most instances saw troughs at the SPX’s 12-month, or one-year, moving average.

SPX dojis

SPX doji months 90-99

SPX Doji months 2000-2010

SPX Doji months 2010-2023

 

But if you make a commitment to equities, you may want to consider easing back in, as there is still major potential resistance from 4,170, the March closing low, and 4,375 above. How the market behaves around these levels, if tested, may further clue us in as to whether this is a short-term rally in a bear market or a longer-term rally. For example, if the SPX fails to take both these levels out and subsequently moves back below its 24-month moving average, the odds increase that the recent lows will be violated. But a move above these resistance levels would enhance odds that a longer-term rally is on the horizon.”

            -Monday Morning Outlook, May 31, 2022

 

While longer-term charts look encouraging for bulls, this is far from meaning that the “all-clear” sign is flashing, especially in the context of sentiment indicators being mixed – some showing negative extremes, such as those buying options on SPX and Nasdaq-100 Index (NDX—12,548.03) components. At the same time, we have seen inflows into leveraged technology exchange-traded funds (ETFs), and outflows from broader market ETFs.

The bounce from the May lows has been impressive, but per the excerpt above, there are resistance levels immediately overhead that one may use for confirmation that last month’s trough has staying power.

For example, my Thursday June 2 comment on Twitter proved premature, as the SPX’s close barely back above its June 2021 and March 2022 closing lows in the 4,165-4,170 area was met quickly with sellers in Friday’s trading.

This might suggest that if using this level for permission to leg back into the market with additional dollars, it may be better to await a weekly close above this level or at least two daily candles in which the SPX’s high, low and close are above this area of resistance. Additionally, I find it interesting that the Thursday close was about the same as the May 3 close of 4,175, the evening before the Fed’s last rate hike.

There are other resistance levels to keep in mind, whether that is the October 2021 and January 2022 lows at 4,300, or the trendline connecting lower highs in March-April, which begins the week at 4,280 and ends the week at 4,250.

Finally, the 4,375 level should not be forgotten, as this is the level from which the SPX experienced a short-lived breakout above a trendline connecting lower highs in January and February, with the April 22 break back below this level leading to sharp selling into the latter part of last month.

In summary, a monthly candlestick graph of the SPX with its 24-month moving average is encouraging for bulls, as there is a lot of history on their side. But with the Fed hiking rates and an unclear path as to how far it will go to fight inflation, the jury is out as to whether several resistance levels overhead will prove impenetrable.

If you remain patient about committing more dollars and use SPX price action to guide you, you will have little at risk if sellers emerge in these resistance areas that I have been pointing out to you. But if the SPX makes a convincing move above each of these levels, you can steadily increase your dollar allocation to equities if last month proves to be significant trough.

SPX Daily Leg-In

Todd Salamone is a Senior V.P. of Research at Schaeffer's 

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