The Market Dive Begins (XLF)

By Oakshire

New York, Mar.3, swing trading .- We’ll start with the big news first.
For those who didn’t notice, the Dow Jones Industrial Average yesterday bested its previous bull market high, rising to end the day at 14,075, just 89 points (about a half a percent) lower than it’s previous all-time high set back in October of 2007.
And that raises the question – are we now going to see fireworks and hear hosannas as the Dow moves into record territory?
And the answer is – it doesn’t matter.

Well, o.k., it matters, but insofar as it’s an inevitability, it makes little sense to quibble about whether it will be next week or next month. The bull is moving, and a new high is around the corner.

A more important question is whether the market has temporarily topped here and is headed lower – and, of course, just how far lower the bottom lies.

Take us through it, Matt.

You got it.
Let’s start by looking at a chart of the broad market.
Here’s the S&P 500 since New Year’s.

The S&P 500 had a steady rise from New Year’s until the second week of February. At that time, the market began to stall, flattening and tightening its range. Intraday moves for those five trading sessions were compressed (red oval at top), while volatility (see chart below) fell to 52 week lows.
That period, we have labelled the ‘calm’.
What immediately followed, we’ve termed the ‘storm’ (in black). Daily trade ranges for that latter period were significantly wider, and volatility, as seen on the chart below, began popping like ligaments in a jiu-jitsu death match.

This pattern of ‘quiet’ topping action followed by high amplitude turbulence is very often the mark of a turn in trend. It may signal a short term retracement, or it may be intermediate – everything depends on how long the storm persists and how much volume gets churned. The longer the volatility and the greater the share turnover, of course, the deeper we should expect the downturn to be.
As of now, the duration of the pattern points to a brief spill.

Leaders are Struggling

We note, too, that the financials, which have been among the most consistent, outperforming sub-groups in the market for well over a year, are now starting to show signs of weariness.
Take a look at the Select Sector SPDR Financial ETF (NYSE:XLF) for the last four months – from the move off its November bottom.

The stock’s sluggishness can be seen in the RSI and MACD indicators, which have traced lower even as the stock has risen (in blue, at bottom). That divergence will eventually be resolved either via a sudden drop in XLF, or a slow, persistent sideways move that flatlines both these indicators before price once again advances.
More recently, we’ve seen two bearish engulfing patterns (in black box, at top). On both February 20th and 23rd, price action engulfed the prior days’ trade activity entirely, with the latter doing so egregiously.
A bearish engulfing pattern paints a very unhealthy picture of a stock’s immediate future. Two in one week should convince even the meanest sceptics of a coming down-move. And the fact that the latter pattern was also a perfect marubozu should have short term market timers out or short without further adieu.
As to how far the financials could ultimately drop, we point to the two gaps that require filling on the chart, one at $16.30, the next at $15.25. Those markers constitute declines of 8% and 14% respectively.

Hey! That hurts!

It’s not our intention to scare you – just to remind you that the market looks like it’s ready to cramp up.

You mean a face-cramp?

We’re on record as saying that this is the Facebook Market – that the web’s biggest time-waster owns this market in the same way that Lehman Bros. is forever associated with the 2008 crash. As Facebook goes, so, too, will this final breakneck equity rocket to Mars go, and that means we should pay close attention to the stock.
And she ain’t looking so pretty.

Facebook’s RSI and MACD indicators (in black) are now both below their waterlines for over a week – that’s full-on bearish.
A head and shoulders top (in red) is nearing completion that could send the stock into the low 20’s. It’s too early for a formal count on the decline, since the pattern is not complete. But we feel it’s safe to assume that, at the very least, the gap at $24.50 (in blue) will be filled, necessitating a 10% drop from current levels.
To sum it up, buy volatility, sell the indexes, mind those joints(!) and get ready to dive back in sooner than you think.