Technically Speaking: Bulls Back In Town Or Passing Through

The market started the week off with the bulls in charge pushing the markets up to key short-term resistance levels as shown in the chart below. (Note: as of this writing the markets are failing at resistance. If the market ends this week below resistance, the downtrend will be confirmed.)

With markets back to very overbought levels short term, the question is now whether the “bulls are back in town” or were they “just passing through.”  The following chart attempts to prescribe the most likely path for prices in the short-term.

There are quite a few moving pieces here, so let me explain.

The shaded areas represent 2 and 3-standard deviations of price movement from the 125-day moving average. I am using a longer-term moving average here to represent more extreme price extensions in the index. The last 4-times prices were 3-standard deviations below the moving average, the subsequent rallies were very sharp as short-positions were forced to cover. The vertical blue bars show the previous two periods where bulls regained footing and pushed markets from lows towards new highs. The current setup is indeed similar to those previous two attempts. All we are lacking is some serious “jawboning” from a Fed official about accommodative support to push markets higher.  

The bottom of the chart shows the overbought/sold conditions of the market. The vertical dashed lines show that oversold conditions lead to fairly sharp rallies. The recent rally, while the “best rally of the year,” has responded as expected from recent oversold conditions. With more than half of the oversold condition now exhausted, the potential for further upside has been reduced.

With the 125-day moving average trading below the 150-dma, and with both averages declining rather than advancing, the easiest path for prices continues to be lower as downward resistance continues to be built. The arching dashed red line shows the change of overall advancing to now declining price trends. 

Given the current oversold condition, there is a strong possibility that prices could advance back towards the cluster of resistance now forming at 1990 on the S&P 500. As I have indicated, such an advance would correspond with a rally in the ongoing downtrend and a return of the markets back to extreme overbought conditions. Such would set the markets back up for the next retest of recent lows.