The S&P so far is collaborating with my December rally
scenario. Moreover, the index is tracing patterns that allow us to identify
pivot points, ie levels at which a certain movement has to be considered
exhausted.
These levels can be exploited in many ways, depending on the
type of trading one employs. I think that the
best way of using them is in conjunction with options. More specifically put
options bought today should have a strike around 1740-1780.
Please see below for full analysis.
Analysis
The wedge pattern
As you know from the middle of this year I’ve highlighted
multiple times the appearance of “wedge” patterns, where the market oscillates
in shorter and shorter cycles with higher highs and higher lows.
This pattern normally signals *distribution*, ie a
period when larger investors (or strong hands) slowly exit their positions.
Buyers are retail investors (or weak hands) who are relatively undercapitalised
and therefore unable to keep their positions if the market rolls over. This is
why a break from a wedge on the downside is normally a sharp retracement to the
base of the pattern.
This is obviously what has not happened this year
since wedges have actually been *accumulation* periods. This is
relatively more common in commodities but quite rare in equities. The end
result is an acceleration on the upside, ie an increase in the rate of ascent
that creates the long term parabolic rise that is evident from the chart.
Implication
The most important implication of these bullish breakouts is
that we can use the breakout level as a pivot/threshold level. As you can
observe from the chart below, every time there is a break, the market spends
some time consolidating above and then starts a new pattern.
-
1740-1780: a break of this level would imply
that the latest move (3rd wedge) is now over and argues for a full
retracement of the 2nd wedge. This implies a move down to the lower
pivot point at 1530-1600
-
1530-1600: this level should offer more
resistance than the one above: the pattern is much larger (and therefore more
time and volume has been spent here to accumulate a position) and also
coincides with the 2000 and 2007 tops. A break of this level would be highly
significant but it is not something that we should be worried about in the
short term (1-3 months).
Given what I said above, I would use the 1740-1780
area as a strike for our put options, so that our exposure is reduced if the
market corrects once this parabolic move will stop.
