Stocks face key test

  • Wednesday was the US market’s worst day since June 11
  • SPX fell more than 3%, VIX spiked
  • What’s the significance of the September lows?

Traders who thought that this was shaping up to be a relatively uneventful October saw the month’s famed volatility crash the party in the 11th hour, as a modest pullback got a little more real after yesterday’s 3.5%- drop in the S&P 500 (SPX).

While investors may be talking about the COVID second wave, stimulus gridlock, and the election—macro catalysts that are certainly in play right now—traders are likely in the process of getting a handle on the key price levels that may chart the market’s near-term course.

Looming large is potential support around 3,210—the level of the July upside breakout that culminated in the index’s early-September record high. The September pullback reversed after testing this level, and yesterday’s drop left no obvious technical barriers to another challenge:

Chart 1: S&P 500 (SPX), 5/14/20–10/28/20. S&P 500 (SPX) price chart. Line in the sand?

Source: Power E*TRADE

One reason this level could represent a key test for the SPX is that a clear breakdown below it would, for many technicians, confirm a so-called “double top” pattern (consisting of the September and October highs) that implies a more significant sell-off. There’s nothing mystical about this potential scenario: A double top simply means an up-trending market rallies to a new high (in this case, the September high), pulls back, rallies to challenge that high (the October high), but turns lower again—a lack of bullish conviction that suggests the uptrend could be running out of steam. A breakdown below the low separating the two highs effectively confirms the “top” and opens the door to further selling.

That’s still a bigger-picture consideration. Getting back to the here-and-now, there were a couple of other interesting aspects to yesterday’s price action. First, the Cboe Volatility Index (VIX) jumped to its highest level since June:

Chart 2: Cboe Volatility Index (VIX), 5/14/20–10/28/20. Cboe Volatility Index (VIX) price chart. Fear higher yesterday than in late Sept.

Source: Power E*TRADE

That suggests the market was experiencing more fear yesterday even though the SPX was still trading above where it was at the September 23–24 lows. Ideally, the VIX should be lower—less “fearful”—than it was in late September, since the SPX itself is higher than it was then. In other words, some traders would see yesterday’s development as a signal the market still has more potential downside.

There’s also the fact that days like yesterday, while rare, have typically been followed by at least a day or two of additional selling. Here’s what happened after 29 other times the SPX fell more than 3% intraday and closed 3-4% lower:

1. Over the next three days, the SPX closed lower more often than it closed up.

2. After two weeks the SPX was higher in 16 of 29 instances (55% of the time).1

How closely this coincides with a test of support and a potential bounce remains to be seen.                                                                                                                                      

This year has repeatedly illustrated how uncertainty and emotion can challenge the best-laid plans of all types of traders and investors. But the odds still favor those who makes plans, adjust them when necessary, and manage risk to protect them when they’re wrong.

Today’s numbers (all times ET): GDP (8:30 a.m.), Weekly Jobless Claims (8:30 a.m.), Pending Home Sales Index (10 a.m.).

Today’s earnings include: Alphabet (GOOGL), (AMZN), Apple (AAPL), Activision Blizzard (ATVI), Carvana (CVNA), Starbucks (SBUX), US Concrete (USCR), Twitter (TWTR), Facebook (FB), Penn National Gaming (PENN), Moderna (MRNA), Shopify (SHOP), Spotify (SPOT).


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1 Based on S&P 500 (SPX) daily prices, 10/28/57–10-28/20. Performance reflects gains/losses after days the SPX falls at least 3% intraday and closes 3-4% lower. Supporting document available upon request.

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