Fine-tuning a pullback

  • SPX approached its six-week low yesterday as trade-war fears increased
  • Penetration of the May 13 low could set up support-level tests

When the news is bad and the tape is red, as both were yesterday, it’s a good idea to look past individual stocks and see what the indexes may be signaling about the situation.

As stock markets around the globe tumbled yesterday amid the latest negative turn in trade-war sentiment, the S&P 500 (SPX) dropped toward the May 13 low that was the departure point of the pullback analysis in “Looking for a bounce.” That article highlighted two recent SPX relative lows (around 2,785 and 2,722) that were potential targets if and when the index fell below its May 13 low point:

S&P 500 (SPX), 3/7/19–5/23/19. S&P 500 (SPX) price chart. Prepping for a test?

Source: Power E*TRADE

In dropping more than -1.5% intraday and coming within 0.2% of the May 13 low of 2,801.43, yesterday’s SPX price action likely had many traders thinking about the possibility of the market challenging various support levels in the next several days.

Chart analysis is one thing, but there’s another way to fill in the picture of the market’s potential near-term action—price-pattern analysis. And yesterday provided a great opportunity to take this route, since the day’s sell-off was large enough that it represented a fairly unique event, but not so huge that it doesn’t have any analogs in the past.

Here’s one way to generalize yesterday’s SPX sharp down move in precise “mathematical” terms:

1. The index closed 1.25%–2% below the previous day’s close.

2. The index’s low was below the previous day’s low.

This isn’t the whole story, obviously, but it reflects the size of the day’s down move and the fact that the SPX dropped to a lower low in the process.

The SPX has had 595 down days like this since 1971 (the most recent example was May 7), and if that sounds like a lot, keep in mind there have been more than 12,000 trading days in that span, which means that days like yesterday pop up a little less frequently than 5% of the time. Here’s a summary of what happened the next day:

1. The SPX’s average return was slightly negative, and the index closed higher just less than half the time (49.9%).

2. The SPX fell to a lower low 79% of the time.

So, while the odds of a higher close the day after one of these down days appears to be more or less of a toss-up, the odds of the SPX falling to a lower low are much greater.

Of course, there’s a big difference between a down day that occurs after the market has already sold off 20% in a steady three-month decline, and a down day that occurs when the market has recently enjoyed some upside.

So let’s add two more rules to the pattern definition that make it a closer match to the SPX’s specific condition yesterday: The down day’s low has to be lower than the previous eight lows, but higher than the lowest low of the past 20 days. In other words, prices have fallen below their short-term lows, but they’re still above their intermediate lows. The SPX has had 123 of these days since 1971, and here’s what it did the next day:

1. The SPX average return was slightly negative, but the index closed up a little more than half the time (52%).

2. The SPX fell to a lower low 73% of the time.

Yep—pretty similar results to the more general price pattern, with a slightly more bullish bias. But the fact that in both cases the SPX made a lower low after days like yesterday may give some bulls reason not to freak out if the market is trading lower early today, and to ponder whether the index will tag one of its looming support levels before rebounding.

Reminder: US equity markets will be closed on Monday for Memorial Day.  

Market Mover Update: Stocks weren’t the only market weighed down by yesterday’s heightened trade-war worries. Crude oil took its biggest one-day hit of the year, with the July futures contract tumbling more than 6% intraday and falling below $58/barrel—its lowest level since March. 

Today’s numbers (all times ET): Durable Goods Orders (8:30 a.m.), Baker-Hughes oil rig count (1 p.m.).

Today’s earnings include: Foot Locker (FL).


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