The sense of negativity in the markets for the past two weeks has been overwhelming. Economic weakness in Europe, continued fighting in Ukraine, and the spread of the Ebola virus all played their role. Volatility has returned, accompanied by jarring selloffs and sharp rebounds. If you didn't want to buy at all-time highs for fear of top-ticking the market, now might be the time to dip your toe in the water -- but only if you're willing to exercise caution and discipline.
One great way to deal with the emotions generated by a gyrating market is to look to the charts. The cold calculus of price and pattern is unaffected by fear and greed. We've already noted the importance of the 100-day moving average (green) to the S&P 500 Index, as it has held firm on six consecutive tests. Each of these tests led to rallies of varying degrees. Are we witnessing the seventh consecutive bounce (red arrow)?
S&P 500 Index ($INX) ¿ Daily Chart
Source: TradeStation
If we move to the weekly chart, we can see a bullish candle formation on the S&P 500 called a "hammer." Hammers are candles with long lower wicks that occur after a selloff (arrows). The body of a hammer can be either green or red. Hammers are effective reversal candles, as sellers get "burned" on that long lower wick. For shorts, the hammer pattern represents the equivalent of placing your hand on a hot stove. The longer the wick, the hotter the stove.
S&P 500 Index ($INX) ¿ Weekly Chart
Source: TradeStation
Last Wednesday, I explained why it wasn't time to panic -- at least when it comes to small cap stocks. Despite suffering through a "Death Cross" (shaded yellow), the Russell 2000 Index still had major support nearby. That support level, located near $107.40 on the iShares Russell 2000 ETF (IWM), served as a launching point for two big rallies earlier this year (A and B). Last Thursday, the index pivoted off that level for a third time (C).
iShares Russell 2000 ETF (IWM)
Source: TradeStation
The S&P 500 appears to have survived yet another test of the 100-day moving average, and the IWM's $107.40 level is still intact. These two levels hold the key; they were tested simultaneously last week, and their fates are likely tied together.
How should we interpret this resilience at key technical levels? Does it mean another leg up is imminent? Possibly, but how can we buy with the market seemingly on the brink of turmoil? Simply put, we must define our risk. We can take long positions here, with the understanding that if either of these levels break, we'll exit. This creates a low-risk, high-reward scenario.
At the time of publication, Ed Ponsi had no position in any of the securities mentioned.