Keep Tabs on This SPX Trend Reversal Candle

Why investors should emphasize closes over intraday action

Senior Vice President of Research
Jun 3, 2024 at 9:12 AM
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The bad news is the Thursday, May 23 candle, when the SPX made a new high relative to the prior day’s high but closed below the prior day’s low. This is known as a bearish “outside” day, the last of which occurred on April 4, ahead of a 3.5% decline that lasted about 2-1/2 weeks. The early April bearish outside day occurred when the SPX was trading around its all-time high, which was also the case last Thursday… the low VIX reading, and the bearish outside day late last week are two short-term risks that bulls face as we enter the holiday-shortened week

          -Monday Morning Outlook, May 28, 2024

Bears were in control of the holiday-shortened week that closed out the month of May. Equities retreated, and the pattern after the S&P 500 Index’s (SPX — 5,277.41) bearish “outside day” indeed foreshadowed weakness, just as it did after a similar candle in early April.

Looking ahead to a new week and month, bulls are hoping the bearish candle on May 23 only foreshadowed a move down to potential support levels, whereas bears are wishing for a break of support.

By late last week, the SPX was testing potential the support levels we discussed in prior weeks. The first region of support came into play on Thursday, when the range between 5,235 and 5,254 was tested. The former is exactly 10% above the 2023  close, while the latter is the previous all-time high in March.

By Friday, another layer of potential support at lower levels came into play, with an intraday move below 5,220, or the site of the breakdown level below a bull channel in early April. The eventual Friday low of 5,192 was in the vicinity of the upward-sloping 30-day moving average at 5,185. This moving average marked support in mid-January and a brief period in early April, before the cross below hinted at short-term trouble.

However, judging by Friday’s close, it might be considered more of a victory for bulls than bears. While the SPX moved below many of the key levels mentioned above on an intraday basis, the end-of-week closes were above those levels, including the previous all-time high in March at 4,254.

In fact, Friday’s bullish “hammer” candle looks like the early May “hammer” that occurred prior to a two-week rally, including a gap higher that marked the first inning of that advance. A hammer occurs when sellers push stocks down throughout the day, but by the close, bulls seize control with the underlying close significantly above the intraday low.

A hammer is considered a potential trend reversal candle and, as such, it is very possible that the bearish effects of the May 23 bearish “outside day” candle have been replaced by the bullish “hammer” on Friday, especially in the context of a major support area holding.

The price action last week is exactly why we prefer to emphasize closes over intraday action.

SPX Hammer

“…on Friday, the VIX closed at its lowest level since November 2019 and just above the intraday lows of December 2023. The Friday close is just above 11.54, which is one-half its October 2023 peak, and might help explain why a trough was made in this area in December 2023. As such, a risk to bulls is the VIX lifting sharply off these prior lows amid lower stock prices.”

          -Monday Morning Outlook, May 20, 2024

During the SPX’s decline to support from the pre-Memorial Day high, the Cboe Market Volatility Index (VIX — 12.92) popped after moving down to its December 2023 low and the 11.50 area, which is half the VIX’s October 2023 peak that preceded the perceived Federal Reserve pivot to lower rates that kicked off a rally.

The low VIX reading was a risk I had been discussing for the past couple of weeks. Its peak last week was short of the 15.40 level -- or one-half the 2023 high -- that has been key this year, marking peaks in February and March, with crosses above and below marking sell signals and buy signals, respectively, in April and May.

Now, there is a little bit of breathing room for the VIX to move back to its lows prior to the recent decline in equities.

VIX Daily June 2024

I am continuing to monitor the action among option buyers on SPX component stocks, as more puts are being bought-to-open than calls relative to two weeks ago. This implies the direction of the put/call volume ratio is turning higher, which often runs concurrent to lower stock prices as sentiment grows more negative.

If the SPX breaks and closes below the support, the potential bearish implications of the direction of this ratio become more meaningful.

Other sentiment indicators suggest that there is not a lot of buying potential from active investment managers, as this group is near fully invested. But retail investors could be buyers, after bulls decreased in the latest survey.

Moreover, there is still a relatively large short positions on SPX component stocks, and with earnings season about over, companies involved in buyback programs could be buyers, as they typically are not buyers in the period ahead of earnings.

SPX pc ratio June 2024

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

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