Testing the Waters First
When you are about to enter a pool with potentially freezing water, you can decide to jump into the water or you can try it first, see how cold it is and then decide what to do. The worst thing that can happen is that you get a cold or you suffer a couple of minutes while your body gets used to the new temperature. Unfortunately, in the Markets there can be much more damage if you jump right into a trade at the wrong time. I have been doing my own testing with a few trades during the past month and I haven't seen yet a great success trading on the long side.
Market Overview
Reviewing the S&P 500 daily chart, I was expecting to see a First Higher Low pattern on Friday April/8, but it hasn't completed yet. What I'm waiting to see is the S&P 500 pulling back to the -1 Keltner Channel (orange arrow, currently at 4,415), then having a false breakout and then rallying.
Like any other pattern, this one can fail too. Even if it fails, it will give clues about the selling pressure and how strong the Bears are now. My personal definition of the First Higher Low being successful is that it can get past the previous high, in this case the high at 4,637. If the Bulls are really strong, the rally should be able to form higher lows and higher highs, not just get stuck at the same level than the previous rally.
The S&P 400 (mid-cap) could potentially develop the same pattern. I like more the way the in which the S&P 400 closed the week, it's already in the -1 KC. The most important thing to remember is that even if the pattern develops during the next week, it's important to understand that this pattern like any other pattern will NOT work every single time.
The S&P 600 (small-cap) is very weak, it's closer to test the support than having a rally that goes past the 1,378 resistance. The First Higher Low pattern is not an option at this moment in the chart below.
The New Highs and New Lows numbers in all the timeframes are moving from neutral to bearish. That signals that there is selling pressure entering the Market. If the demand is not able to absorb that supply, lower prices will eventually follow.
Industries
I haven't seen a big change in the number of Industries where I see strength, 40% of them are still in defensive Industries (the ones in the Consumer Staples and Utilities Sectors). From the 68 Industries that compose the Global Classification Standard (GICS), 13 are the ones that, from my point of view, still show strength.
Scenarios:
Scenario #1: I still believe that the rally can continue. In order for that to happen, the S&P 500 and the S&P 400 need to hold above the -1 KC. The New Monthly Lows need to get back below 500 and then the S&P needs to rally higher than the previous high. I already opened another test position, Berry Corporation (BRY), and if this is the scenario that develops during the next trading week I'll open more long positions.
Scenario #2: I was going to pick this second scenario as the most likely, but I started to write the article in a very optimistic mood so it went to second place. In the second most likely scenario, the selling pressure starts to increase considerably. The -1 KC doesn't hold for the S&P 500 and S&P 400. The New Monthly Lows keep increasing and that sends us to the price levels that we saw around Sept/2021 and Jan/2022. In this scenario, I'll close the two long positions that I'm using to test the Market, or the stop will trigger if the decline happens too fast.
Scenario #3: In this scenario, the S&P just keeps moving sideways, testing the current level between the -1 and +1 KC. I don't think this scenario is very likely, we haven't seen this kind of calm for a while, there can be positive or negative catalysts that make the S&P move, on 2022 the indexes have experienced volatility. It's especially unlikely now that we are in earnings season.
Summary
Back in March/15 a rally started that gave some hope that the Correction was over. Now we are experiencing a pullback, which starts to generate uncertainty. We start to wonder whether the rally is over or not. If it is over, is the selling pressure going to be strong enough to send the indexes down to test the lows that we saw in January?
Trading is not about forecasting. I have the same questions and there is no one in the world that can be completely sure about what's going to happen next. The Markets are just too complex to reliably forecast the future. I'll just follow the price action, as long as I preserve my capital and keep the losses under control I'll be fine. Eventually a new Bull Market will form and I'll be ready to trade it, but that can be next week or next year.
We are about to start an abbreviated trading week, Friday 15 the USA Markets will be closed. We also need to consider that besides the old news about inflation, the virus, the Ukraine war which have been the usual catalysts moving the Markets now we also have to add to the mix the earnings season. It will be a short but exciting week.