I See a Pattern Forming in SP500 and So Should You

Aug 31, 2010: 12:46 PM CST

It’s the same price pattern I’ve been highlighting for quite some time now, but perhaps now is a good time to define the pattern, show it, and state what it means for traders.

Reference my prior post:

“Magic Mystery Buyers in the S&P 500 Define Bull/Bear Battle.”

First, the pattern:

A lot of people are picking up on this pattern – or at least they should.  What is it?

So far, every other day, the S&P 500 has tested the key 1,040 level exactly, and each time – including this morning – buyers have rushed in to support the market, causing a sudden up-burst in price immediately following the test.

The pattern can be described as such:

1.  Market falls to test 1,040 (usually on a bad economic morning data-point)
2.  Surge of buy-orders flood the market
3.  Market bounces very sharply
4.  Bears rush to the exits, buying-back shares in a short-squeeze
5.  Market rallies to the 1,060 level (or beyond)

That’s the short-term pattern that has been in effect since last week that appears to be repeating into this week.

It’s like a cycle – sort of like Groundhog Day (the movie) – where you wake up and the events of the day repeat themselves exactly.

Traders who have caught on to this pattern early may have made a LOT of money this morning as the pattern repeated.

But this isn’t the only time this has happened – let’s take a look back at the two prior tests of 1,040.

May 25, 2010 (after the “Flash Crash”):

June 6, 2010:

An almost identical pattern of sharp downside move to 1,040 followed by a rush of buy orders that supported and then bounced the market higher occurred just after the Flash Crash and in early June.

To be fair, this pattern failed as the market broke under 1,040 to bottom in early July at 1,010, but one has to admit this pattern is well-entrenched.

By pattern I don’t mean “head and shoulders” or any classical sense of the word, but rather a sequence of events that happen that repeat.

So far, this pattern has successfully repeated 5 of the last 6 instances since May.

While it’s tempting to attribute this to manipulation, it is supply and demand that move market prices.

From where that demand comes -we can debate that all day – if demand/buyers are able to overtake supply/sellers, then the price will rise.

It’s not important to know from where the demand originates – just that it does.

And as price moves – perhaps unexpectedly – off a key support level when traders expected the level to shatter and break, then those traders who bet against support holding -in other words, going short – are then forced to take their stop-losses and cover (buy-back shares).  This action helps add demand to the price rise in motion – perversely driving price higher and higher.

So, as long as this pattern is in place – or should I say, these same buyers continue to rush in to buy shares to support the market at 1,040 – we can expect the pattern to repeat.

By the same token, should the market break solidly under 1,040, we can expect these same buyers – assuming they have not been selling shares on the bounces to the 1,060 level (and then re-buying shares at the 1,040 level) – to rush for the exits and take THEIR stop-losses, creating a potentially harsh downside move.

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade

14 Comments

14 Responses to “I See a Pattern Forming in SP500 and So Should You”

  1. JeffreyLin Says:

    yeah corey, one of the hardest things in successful trade executions: keep it simple!

  2. Bizzat Says:

    “by the same token, should the market break solidly under 1,040, we can expect these same buyers – assuming they have not been selling shares on the bounces to the 1,060 level (and then re-buying shares at the 1,040 level) – to rush for the exits and take THEIR stop-losses, creating a potentially harsh downside move.”

    Oh and you can be assured that will happen too…these patterns work until they don't- and when they stop working, they will bite HARD for those positioned the wrong way…and nobody knows when the music stops, or what shell the pea will be under…except the criminal insiders and PPT.

  3. Terlyn12001 Says:

    I think things will change when everyone is back from vacation. Also, these patterns are daily consolidations.

  4. Itgoes Says:

    Corey,

    what does your gut say; will 1040 hold?

    – Sam

  5. ricgold Says:

    Thanks Corey I like the easy readablity way you wrote todays article! ( such as #1,2, 3 etc

  6. amehrich Says:

    If the market really wanted to move higher from these levels why would it keep retracing back to 1040? That's the question I keep asking myself.

    Seems to me like it's a matter of WHEN not IF we move below 1040. Take a look at the S&P weekly chart if you haven't already.

  7. Corey Rosenbloom, CMT Says:

    Good point! That's a skill I've had to learn too – sometimes taking all the indicators off helps.

  8. Corey Rosenbloom, CMT Says:

    Agreed 100%. For now, the pattern seems to be working but that's only the case as long as the buyers continue buying – or computer programs keep firing their signals – at 1,040. If not, … we could contend with a flood of sell orders from both bulls (stop-loss) and bears (new positions).

  9. Corey Rosenbloom, CMT Says:

    We are in a long-term consolidation from October 2009 to present, and short term one from around June 2010 to present.

  10. Corey Rosenbloom, CMT Says:

    Hmm. I think under normal circumstances, 1,040 would already be shattered but I think a lot of funds know the importance – psychologically – of the S&P 500 above 1,000 and of course the Dow Jones above 10,000 and the fact that anything under that could create a panic on main street. People won't be willing to endure back-to-back 40% losses so they'll be much more likely to panic sell when the tide turns… and if it's in the power of those with vested interests to keep the market above 1,040 and 10,000, I think they'll certainly try to keep it above. Again – if they can.

  11. Corey Rosenbloom, CMT Says:

    That's true too but it comes down to if we have true buyers who really believe in the improving economic future of the economy and that the 1,040 level is a good buy for the future and that we won't see it again… or if this is computer algorithmically driven – or worse.

    Generally, the more times a level is tested in succession, the more likely it is to FAIL, not hold. So we'll see if that old-time axiom holds up here.

  12. Corey Rosenbloom, CMT Says:

    Thanks!

  13. Osikani Says:

    Now that they have established the pattern, and they know that the market knows it, the next time we test the level, they will look at the order to see if there are plenty of retail traders playing the bounce, and screw them royally by dropping it hard through the level.

    The next time we touch the level, I will cover all my short puts and reverse to long puts.

  14. Chris Fulker Says:

    Lots of chartists and technicians expecting rise to @1100 this month. But this market has confounded everyone since early 2009: be ready for the pundits to be wrong again later this week, as market drops to @1130…certain stuff – usually big caps, dividend-payers and yield-providing financial issues – has constituted most of the upward momentum, so this is really nothing more than a Flight to Bond Safety in equities! The rest, save the miners lately, has slumped…can't continue in these macroeconomic conditions, can it?