After panic selling late last week, Monday morning provided an interesting host of outcomes. The action Friday was particularly dispiriting as a market that looked extremely oversold looked ready to finally – at minimum – have a dead cat bounce, but it never happened and the market closed out at its lows. So walking into this week we had an even more oversold condition which most likely would lead to one of two outcomes – a bounce or a crash. Why the latter probability? Crashes generally happen from an oversold condition – not in a market happily moving along at new highs or in a middle of a range. While a low probability event one must allow for it. Obviously the higher probability event happened. So what now?
Just as we use Fibonacci levels to predict pullbacks, we can use it to predict snapback bounce areas. First let's quickly discuss what has happened in May. The S&P 500 has pulled back almost perfectly to its first major Fibonacci level – a 38.2% retracement of the October to early April move, we discussed this last week. Within the context of the big picture if Friday's lows were "the low" a 38.2% retracement would be a very healthy intermediate term sign. Obviously we won't know to be true until we have the benefit of hindsight down the road. If Friday's lows are eventually broken, then the 50% and/or 61.8% retracement levels discussed last week come into play, but that's a discussion for another day.
In terms of this bounce we see a 38.2% retracement of the May drop would take the S&P 500 to just under 1340 and a 61.8% retracement to just under 1370. Both of these are key levels that have come up repeatedly in the past. The market spent all of February bouncing off 1340 and 1370 was the 2011 high. Ironic how these levels keep repeating.
Obviously we are just speaking price levels in a vacuum, and dismissing the ever present news flow which continues. Yesterday's bounce was attributed by the media to comments out China's premier that they will focus more on growth, and some push pull in Europe between growth and austerity. The truth of the matter is any reason would have been fine as an excuse since the market had been so extremely oversold in the near term.
If one is bearish one would expect this bounce to peter out most likely as the S&P 500 gets closer to 1340… at max 1370. Then the market at minimum to retest lows of last Friday, if not lower. If one is bullish one would like to see an IBD "follow through day" 4 to 10 days from Monday….i.e. any day Friday forward. This would be a 1.7% upward move in a major index on higher volume than the previous session. To repeat, a follow though day does not mean a new bull move must happen (it fails 3 out of 10 times, as it did in late April), but there must be one for a new bull move to happen.
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