$ SPX Daily candles for the past 3 days look like patterns in January and February that preceded short-term withdrawals … Doji-like candles (open and close at about the same level) – a “three-star” in candlestick terminology with three in a number pic.twitter.com/CPiV8W4l2x
– Todd Salamone (@toddsalamone) April 28, 2021
All eyes were on the Federal Reserve and Chairman Jerome Powell last Wednesday when the Federal Open Market Committee (FOMC) met. For those who think the Fed has been a strong supporter of the economy and the stock market, these six-week events are important as any surprise change in policy could have a significant impact on the stock market.
There were no surprises on the money front on Wednesday, and that was reflected in the behavior of the S&P 500 Index (SPX – 4,181.17)that was opened within three points of the previous day’s close and less than two points before the morning.
From a tech standpoint, I noticed the price action on the SPX on FOMC day and over the last two days which I posted about on Twitter above. In particular, after the Fed meeting, the SPX completed a third straight day with opening and closing roughly the same. I’ve called them “doji-like” because the opening and closing weren’t exactly the same, but close enough that it was easy to see.
My immediate reaction was to see if three consecutive Doji candles as described have recently appeared. Sure enough, I spotted similar patterns in late January and mid-February, both of which preceded short-term withdrawals within a few trading days.
An image of the three day pattern – known as the “Tri-Star” – is shown in the daily SPX table below. The circled areas are the three star candle patterns. Investopedia describes and interprets the pattern very well Here.
In this link you will find the following words:
“A single one Doji candle holder is a rare event used by traders to indicate market indecision. A series of three consecutive Doji candles are extremely rare, but when they are discovered the intense indecision of the market usually results in a sharp reversal of the given trend”
The above description and effects are exactly what happened in January and February. It remains to be seen whether last week’s reversal pattern will precede an immediate decline as we saw in January and February.
Friday’s action could be the start of something bigger, but it’s worth noting that Friday’s low was just above a channel’s top trendline since mid-November when positive headlines surfaced about a Covid-19 vaccine. The top of this channel line is the first tier of short-term support, which is 4,174 today and 4,194 over the weekend.
A switch to the channel suggests a loss of momentum since last month’s breakout and the risk of another retreat into a second line of defense at 4,131, which is exactly 10% above the 2020 close. A third potential support level is 4,100. This is the level at which the breakout occurred over the top of the channel on April 9th.
If Friday is indeed the start of a sell-off, the main area of support is between 4,020 and 4,060. The 4,020 level will be the approximate location of the rising 50-day moving average over the weekend.
As discussed last week, this popular moving average could be instrumental in whether such investors continue to buy or run into the mountains if they see a break below it.
The 4,060 level is key this week from two perspectives:
- On the weekend it will be the location of the lower part of the canal, which has existed since November, and:
- It’s near 4,057, which is six times the 2009 closing low that marked the end of a bear market. Two, three, four and five times that closing low has marked large spikes or long areas of hesitation since that bear market low. So far, however, six times that low is not a major problem for the bulls. This does not mean the bulls are clear, as any move above five times the 2009 low early last year was temporary before a pandemic sell-off.
“…In cases where sentimental risk is increased, consider hedging or make sure you have a plan for such action if the diagrams suggest it. If the charts continue to look strong, as they do now, it is best to keep the uptrend and have a plan in place to hedge if technical risks increase due to a higher outage of support. ”
– –Monday morning outlook, April 26, 2021
Just as the candlestick pattern discussed above suggests a pullback, various sentiment indicators we are tracking show optimistic extremes that leave the market vulnerable to selling. Plus, option activity on CBOE Market Volatility Index (VIX – 18.51) Futures continue to point to a pullback.
For example, the 10-day put / call volume ratio for stocks only when buying (to open) is 0.32. A value of 0.31 preceded the retreat that began in mid-February. According to the weekly National Association of Active Investment Managers (NAAIM) survey, the average portfolio exposure was 103.72, with 100.0 considered fully invested and 200.0 leveraged long term. The last time there was a reading of 100.0 was in mid-February. The current reading implies that this group is not a large potential source of purchasing power as it was in April when reading was 52.02 or only about halfway invested.
In addition, market participants continue to buy VIX calls at a faster pace than puts. As I mentioned a few weeks ago and as shown in the graphic below, such behavior has preceded volatility pops in the past, as measured by the VIX. In fact, the 20-day buy / sell volume ratio for VIX purchases (to open) recently hit its highest level since late May 2020, which preceded a VIX pop two weeks later. These VIX pops coincide with a decline in the stock market as the demand for portfolio insurance increases as the market turns south.
Perhaps the bulls can take some comfort that this ratio isn’t at 5.0, which preceded the big pandemic sell-off in February 2020 that saw the VIX surpass 80.
According to my comments last week, this suggests a plan of action to hedge long positions if support levels collapse. This has not happened until Friday. But gaps below support are also at risk, and given the bearish candlestick pattern that emerged last week, this may signal some of you to take a hedge or other action to avoid a sell-off protect before it’s too late.
Todd Salamone is Schaeffer’s Senior VP of Research