The S&P 500 is compressing between a shorter-term and broader consolidation pattern, so it could make for an interesting breakout resolution yet to come.

Let’s take a look at the bigger picture of Market Structure and then zoom-in on the intraday structure to note key reference levels.

First, the broader picture starting with 2011:

To recap, when we say “Market Structure,” we’re referring to the progression or sequence of price highs and lows.

In simplest terms, a series of higher highs and higher lows comprises an uptrend – vice versa for a downtrend – and a series of compressing highs and lows indicates a sideways consolidation structure.

Unfortunately, 2011 was more of a broader consolidation or sideways trend structure than anything else, which makes it very difficult to trade.  Traders often do best in trending environments.

Anyway, I highlighted “Value Areas” or Midpoints of known consolidation periods – Rectangles – in the context of the bigger picture.

We see three distinct “Value Areas” to watch:

• 1,330 is the upper range for most of 2011;
• 1,165 is the lower range from August to October 2011;
• 1,250 is the current short-term Value Area from November to present.

Beyond the Value Areas, we have the Price Structure itself which shows the Swing Highs and Lows themselves.

The other thing to watch is the falling Trendline (black) that connects the recent swing highs as labeled.

Price currently rests ABOVE the trendline as well as the long-term horizontal pivot point at 1,260.

In simplest terms – we need to reference price relative to 1,260.

The immediate levels to watch are 1,300 (upper resistance) and 1,260 (lower confluence support).

These would be levels to watch for any sort of breakout which could extend into a continuation/breakout move, target 1,375 if firmly above 1,300 or else 1,200 again if under 1,260.

That’s not much help at this exact moment, as price relaxes in the “Will it or Won’t it Breakout” zone between these two levels.

Let’s zoom in to the hourly structure for a tighter perspective:

I mentioned the broader compression pattern, and we’re seeing a similar visual trendline and price-swing compression developing in an even narrower range which just underscores the indecision – and tension – building in the market at the moment.

Price tends to eject powerfully from compression patterns, which was the case in the short-term Triangle compression in November (highlighted above with the “Break” arrow).

Here’s what we can conclude in terms of supply/demand at the moment:

• Sellers are dominant near 1,280, rejecting price and forcing reversals there to create a resistance barrier;
• Buyers are dominant at increasingly higher levels, forcing reversals off 1,100, 1,160, and recently 1,210.

You could call this a type of Ascending Triangle and use that logic to plan strategies from there.

Current Short-Term Value exists near 1,250 – it’s the spot where we can draw the most price-bar overlap and it was the Midpoint of the November Triangle pattern.

Hang in there – don’t get frustrated in this tightly compressed price environment.

Keep these levels objectively in focus as you trade the intraday or swing opportunities that you find.

Corey Rosenbloom, CMT
Afraid to Trade.com

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The fact that the S&P 500 “did nothing” in 2011 fails to take into account the performance of the individual sectors of the stock market, some of which returned as much as 15% in 2011.

Let’s review Sector Performance in 2011, learn insights into the Sector Rotation Model, and see where capital flowed during the “lackluster” 2011.

First, the classic Sector Performance Chart for 2011:

According to the Sector Rotation Model, we divide the market into two major categories:  Offensive Sectors and Defensive Sectors.

Offensive Sectors tend to outperform the S&P 500 during rallies or bullish phases, while the Defensive/Protective Sectors tend to outperform the S&P 500 during declines or bearish phases.

From the two categories, we then break the stock market down into 9 main sectors which are easily reflected above using the AMEX Sector SPDRs.

From the Model, we glean information where to focus our capital or look for individual trading opportunities:

Traders look to buy leading stocks in outperforming sectors during up-phases, short-sell or hedge with weak stocks in weak sectors during down-phases, or otherwise play a combination of the two broader strategies.

So what did 2011 tell us in terms of Sector Performance?

The DEFENSIVE or Protective Sectors outperformed the Offensive Sectors and the S&P 500 in 2011, suggesting investor caution.

All three Defensive Sectors – Health Care, Consumer Staples, and Utilities – roughly tied for best performance of 2011 near a 15% annual gain – that’s compared to the 0% gain of the S&P 500.

In terms of the Offensive Sectors (Consumer Discretionary, Financials, Technology, Industrials and Materials), two beat the S&P (Discretionary and Technology), one tied it (Industrials) and two underperformed it (Financials and Materials).

Again, this is NOT the picture of Stock Market confidence or outright bullishness – if investors are optimistic about the future, you’d expect to see them concentrate their investments (or trading activity) in the OFFENSIVE Sectors instead of the Defensive ones.

Let’s pull the picture back to see the performance of Offensive and Defensive Sectors with the S&P:

What we’re seeing above is the full 2011 Percentage Chart Performance of the Three Defensive (XLP, XLV, XLU) Sector ETFs with the S&P 500 (red).

Take a look at these in terms of rallies and declines in the S&P 500.

Being Defensive, these stocks tend to hold up (fall less) during down-phases yet underperform (rise less) during big bullish moves.

You can also see that these Three Sectors made HIGHER LOWS (did not push to new 2011 lows) during the October S&P 500 bottom – that’s worth referencing.

With the exception of the August sell-off and the November retracement, these sectors maintained a consistent upward pathway throughout 2011, unlike the Stock Market.

Again, this suggests investor caution, hedging, or otherwise lackluster enthusiasm for a bullish stock market.

Let’s turn now to the Offensive Performance Chart for 2011:

This chart is more jumbled due to the 5 Offensive Sectors, but follow along with the general patterns relative to the red S&P 500 line.

Notice how Consumer Discretionary, Technology, and Industrials mostly followed the performance of the S&P 500 all year, particularly into the close where the lines are almost identical.

Discretionary outperformed the S&P 500 for most of the year, ending as the strongest Offensive Sector with an increase of 5%.

The other interesting points are the Materials (XLB) sector which underperformed the S&P the whole year, ending down 10% and of course the Financial (XLF) sector which grossly underperformed the S&P 500, ending the year down almost 20%.

I can’t tell you how many times I heard the logic:

“I’m going to buy the Financials because they’re the underperformers and just have to bounce back.”

Wrong.

The main insight from the Sector Rotation Model is that sectors which are OUT-performing tend to CONTINUE to out-perform, while sectors which are UNDER-performing tend to CONTINUE to under-perform – the same logic is generally true with individual stocks.

Yes, there’s something to be said about contrary thinking, but “because something is cheap” should never be the sole reason to purchase a stock or sector – always look for other factors because without support, that which is currently cheap often continues to get cheaper.

That’s probably the main take-away from the Sector Rotation Model of 2011 – Sectors that started off strong continued to be strong throughout the year while sectors that started out weak tended to remain weak all year.  This was true for Materials as well.

For the most part, the sector performance relative to the S&P 500 (Defensive/Offensive) by May/June tended to continue throughout the rest of the year.

Anyway, continue studying the line and performance charts of the Sector Rotation Model and be ready to apply these lessons to 2012.

Corey Rosenbloom, CMT
Afraid to Trade.com

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Will history repeat or will this time be different?

That’s the famous question we’re all asking right now as Google shares break to new multi-year recovery highs not seen since late 2007.

Let’s peek at the Weekly chart, note the key level to watch, and then compare that with what’s happening right now on the Daily Chart.

Cutting through all the clutter, the $630 to $640 price level served as formidable resistance after peaking there in early 2010.

Each time price reached the $630 region, sellers stepped up to prevent a breakout and further rally into new recovery high territory.

And each time a sell-off resulted, buyers stepped in at higher prices (higher swing lows) to establish $500 as the current floor of support.

That gives us two possibilities to watch for confirmation as we begin 2012:

Either “History Will Repeat” and we’ll see a similar movement back towards the $500 level as sellers step in,

OR “This Time Will Be Different” where we will see buyers push shares into breakout/impulse mode above $640, resulting in a potential feedback loop (shorts covering; buyers buying).

That’s stating it as simple as possible as you look to your other indicators for confirmation/non-confirmation or additional signals.

To throw two of them quickly into the mix – volume is negatively diverging with price as we see an ‘overextended’ movement into the upper Bollinger Band on both the Weekly and Daily Charts.

Speaking of the Daily Chart, let’s take a closer look at the recent action:

I highlighted the recent peaks and reversals into the $630 level.

Note that November gave us an initial collapse (on schedule) towards lower targets, but buyers reclaimed the balance to force a short-squeeze and thus Bear Trap as December began.

The short-squeeze/power rally (busted bear trap) brings us to the current push to new recovery highs, though again on negative volume and momentum divergences.

We can account the negative volume divergence in part to end-of-year holiday volume, but still watch volume to see if any spikes or unusual activity occurs early in 2012.

The simple structure gives you a binary game-plan to use as a foundation:

Bullish above $640 for impulsive breakout, or else cautious/Bearish on continued movement under $640 ( that declines beneath the daily EMAs at $626 and 606 respectively).

Watch the daily chart – in conjunction with the weekly ‘open air’ – closely as we turn the corner into 2012.

Corey Rosenbloom, CMT
Afraid to Trade.com

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What a year it’s been!

Unless there’s a major surprise in the next few days, the S&P 500 will end 2011 right where it began the year – at the 1,260 price region making this a stagnant year despite two big volatile periods.

Let’s take a pre-end of year view of where the S&P 500’s been, what major patterns developed, and why in the world 1,260 was so important all year long.

As 2011 began, the Federal Reserve was in the middle of a second round of Quantitative Easing – an aggressive policy designed to combat deflation by creating inflation whereby stock and commodity prices benefited.

The QE2 program officially ended on June 30, and despite one final swing up that fell shy of the 2011 high, the market collapsed in August in part due to the deterioration of the situation in Europe and in another part by the “Debt Ceiling” debacle and the subsequent US Credit Downgrade by Standard and Poors.

Price stabilized, the Fed began Operation Twist, the index bottomed with a vicious Bear Trap under 1,100 on October 4th which gave-way to a 15% power-rally.

Since then, price formed a small Symmetrical Triangle Pattern, it broke to achieve its target, and then December was its own narrow consolidation in the context of the confluence resistance at – surprise – 1,260.

Quantitative Easing, Operation Twist, Europe, Sovereign Debt, Greece, the “Arab Spring,” US Congress gridlock, Japan Earthquake, Central Bank Intervention – all these major headline events contributed to stock movement in 2011.

Let’s now shift to a “pure percentage” view of the Big Three US Equity Indexes:

Despite these big headline events and crises, the Stock Market stayed contained within well-defined ranges and shallow percentage moves for the majority of the year – August and October being the major exceptions.

At the peak – comparing with the 2011 January open – the market increased by 8% while at the bottom, the market fell by 12%.

It may feel like the market gyrated beyond those levels but it didn’t – 2011 was a range consolidation, flat sort of year despite everything that happened.

The picture is the same in the NASDAQ and Dow Jones percentage charts:

Dow Jones:

Be sure to read year-end-reviews and learn as many lessons as possible from 2011 as you prepare for making improvements to your strategies and tactics as you begin the new year – every day and of course every year is a learning experience!

Corey Rosenbloom, CMT
Afraid to Trade.com

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Gold recently broke from its larger Symmetrical Triangle daily chart pattern, but the S&P 500 (Stock Market) hasn’t followed suit yet.

Let’s update the current “Bigger Picture” Triangle Price Pattern, note key boundaries, and what to expect next.

First, the S&P 500 standard Daily Chart:

A Symmetrical Triangle Price Pattern – or any major consolidation/compression pattern – has the following three components:

• Upper Resistance “Expensive” Line
• Midpoint “Fair Value” Area
• Lower Support “Cheap” Line

This is true also of standard Rectangle Patterns as we saw from August to October 2011 in the S&P 500 recently.

At this moment, these levels exist at the 1,260 confluence with the very important 200d SMA (recent resistance), 1,200’s confluence support, and of course the 1,220/1,230 “Midpoint” Area which has proven important (as both resistance and support).

To keep it as simple as possible, those will be the short-term levels to watch for any sign of a breakout as we turn the corner into 2012.

Triangle Patterns classically forecast a Range Expansion or Impulse (trend) phase after the initial breakout from these boundaries, as we saw with November’s successful Triangle Pattern formation and completion (a really great example).

You can always go beyond price to determine the odds of an upside or downside break (including volume, momentum, internals, etc) but sometimes it’s best to play the pure pattern for a breakout once the market “tips its hand” and confirms movement in a direction (instead of trying to guess which side – bulls or bears – will win).

However you decide to play it (swing, intraday, play ahead of the break, play after the break, play the first reaction after the break), it’s often important to strip the chart of all indicators and focus on pure price structure when planning trading strategies:

What we’re seeing above is the 120m S&P 500 Chart (for clarity – you could use an hourly chart but the bars get too compressed) with the larger dominant Triangle Trendlines (black) drawn.

I’m showing an alternate, steeper rising lower trendline that accounts for the two “nips” or “false breaks/traps” from the larger – arguably more important – trendline but the end result at the moment is identical:  both are converging under 1,220.

I’m also showing the minor/smaller Symmetrical Triangle pattern that developed and achieved its goals in November (blue).

And above the price chart, I’m showing a basic “textbook” Symmetrical Triangle ideal pattern.

Again, the classic expectation is for a range breakout/trending move (price expansion) to develop on a breakout from these compression trendline boundaries (via the “Range Alternation Principle”).

Minimum targets – which could be hit quickly – include 1,300 on the upside and 1,160 on the downside.  Further movement beyond these levels expands the playing field for 1,375 (up) and 1,120 or even 1,100 (down).

We’ve had a few good examples lately about similar triangle patterns, so let’s monitor this situation as it develops and be ready to act as needed, depending on our trading stragies and aggression levels (aggressive traders try to position as quickly as possible on a break, while conservative traders prefer additional confirming signals).

Corey Rosenbloom, CMT
Afraid to Trade.com

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

Corey’s new book The Complete Trading Course (Wiley Finance) is now available!

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