This SPY setup may trigger today

The major indices closed mixed
Thursday as the broad market attempted to put
the brakes on this month’s downward slide. As anticipated, the Semiconductor
Index
(
SOX |
Quote |
Chart |
News |
PowerRating) bounced off support of its 200-day moving average and pulled the
Nasdaq into positive territory along with it. The 2.3% gain in the $SOX helped
the Nasdaq Composite
(
COMP |
Quote |
Chart |
News |
PowerRating) to close 0.5% higher. Both the S&P 500 and Dow
Jones Industrials
(
DJX |
Quote |
Chart |
News |
PowerRating) lagged behind and closed less than 0.1% lower.
Midcap stocks of the S&P 400 Index
(
MDY |
Quote |
Chart |
News |
PowerRating) continued to show relative
weakness, as the index fell another 0.4%. The smallcap Russell 2000 Index
(
RUT |
Quote |
Chart |
News |
PowerRating),
however, shook off early weakness and gained 0.3%. Unlike most days this month,
the major indices closed near their intraday highs.

Although the Nasdaq turned in a decent gain Thursday, the
rally was not confirmed by higher volume. Total volume in the Nasdaq declined by
11% yesterday, while turnover in the NYSE was 4% lower than the previous day’s
level. Given the abundance of “distribution days” we have seen this month, it
would have been more positive if the first reversal attempt occurred on higher
volume. Yesterday’s drop in volume indicates the bears were taking a rest, but
the bulls certainly did not rush on to the scenes. Market internals were mixed
overall. In the NYSE, declining volume marginally exceeded advancing volume, but
it was the opposite scenario in the Nasdaq.

If the broad market attempts to recover next week, it may have
a difficult time making much headway because a lot of overhead supply has been
created and extensive technical damage has been done over the past several
weeks. Looking at the S&P 500, major resistance will be found at the 1,196 to
1,200 level. Both the short-term 10-day moving average and the long-term 200-day
MA will provide resistance in that vicinity. Additionally, the 1,200 level
corresponds to a 50%
Fibonacci retracement level from the October high down to yesterday’s low.
We have highlighted the area of resistance on the chart of the S&P below:

Because of all the resistance near the 1,200 level, we feel
any rally into that area will provide a low-risk opportunity to short SPY. The
corresponding area of resistance on SPY is 119.70 to 120.00 range, so you may
wish to set an alert in case SPY rallies to that level. However, just as likely
of a scenario is that the S&P (and SPY) will trade sideways and consolidate at
the lows instead. Such action would indicate a correction by time, rather than a
correction by price. If this occurs, we would be prepared to short a break to
new lows, below the range of consolidation. We are prepared for either scenario.

Due to strength in the $SOX and the probability of a recovery
attempt, we covered the remaining shares of our MDY short position into
yesterday morning’s weakness, netting a gain of 3.47 points. We now have no open
positions, but locked in substantial profits on several ETFs we closed this
week. Based on our analysis, being flat seems like a good idea right now. After
getting slammed throughout the first half of the month, the broad market is now
due for at least a short-term recovery attempt. As such, this is not an ideal
time to initiate new short positions. Conversely, buying the broad market in
anticipation of a substantial bounce is equally risky because market internals
remain overly bearish. Therefore, the best plan over the next several days is to
wait patiently in cash and see how the market behaves.

Novice traders rarely have the discipline to be fully in cash,
but professionals realize that cash is often the most profitable position.
Remember that consistently profitable traders are out of the markets more than
they are in the markets. If you had a good run on the short side over the past
two weeks, don’t be greedy. Odds are good that you will have a chance to
re-enter your short positions at better prices and with less risk next week. And
if you happened to miss the whole downside move, this is certainly not
the time to be chasing the market lower. Patience and discipline to sometimes do
nothing are essential elements of a professional trader mindset.

Open ETF positions: