With the market trading as poorly as it has over the past few weeks, and given that earnings season is now well underway, we need to pay close attention to how traders react to companies reporting both good and bad numbers. For those who don't follow Alcoa (AA): we saw that company post perfectly respectable numbers last week, only to be immediately sold the moment the market opened. Intel (INTC) also released what appeared to be relatively good numbers after Tuesday's close. That stock also failed to attract much love from buyers during Wednesday's session.
A big test come Thursday's open will be how the market treats Ebay (EBAY) and Netflix (NFLX). Both stocks released earnings after Wednesday's close, and both stocks lost ground in after-hours trading. Granted the 1.1% decline in EBAY doesn't quite compare to the 25% haircut NFLX endured. In the end, however, all we want to know is how traders are going to react to good, bad and in-line quarterly reports.
As most of you probably recall, the December E-Mini S&P 500 futures contract (Es) first broke beneath its 50-day simple moving average (SMA) back on Sept. 25. In addition to the 50-day SMA break, we also saw the Relative Strength Index (RSI) break beneath its 50-center line, and the five-day exponential moving average (EMA) cross beneath its 20-day exponential moving average on the same day. As we've been discussing for the past few weeks, those bearish breaks forced us to recognize that something unhealthy has unfolding. The market was telling us that it was becoming increasingly unhealthy on an intermediate timeframe.
E-Mini S&P 500 Futures -- Daily Chart
Source: eSignal
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Fast forward to Tuesday's auction, and we find a December Es contract that has become extraordinarily oversold in relation to its 50-day SMA. To put into perspective how oversold things have become, take a look at the chart below.
Percentage of S&P 500 Stocks Above 50-Day SMA
Source: StockCharts.com
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As you can see, with only 14% of S&P 500 stocks currently trading above their 50-day SMA, things are getting pretty stretched. What's not shown on the chart above is that the Es contract has closed beneath its lower Bollinger Band four of the past five sessions. For those unfamiliar with Bollinger Bands, closing multiple sessions in a row outside the top or bottom band is a sign of short-term excess/froth.
Referring again to the chart above, we see the number of S&P 500 stocks trading above their 150-day SMA at 33.6%, and the number of stocks above their 200-day SMA coming in just beneath 40%. Again, while lower readings were triggered during the mid-2010 and mid-2012 sell-offs, there's no denying that stocks have become stretched on the downside across multiple timeframes.
Moving forward, I continue to believe long-only, intermediate and higher timeframe traders should remain on the sidelines. While my analysis leads me to believe prices are over extended on the downside in the short term, there is simply nothing in my work that leads me to believe a sustained advance is likely to begin from current levels.
The current environment remains best suited toward aggressive and agile short-term traders. With that in mind, day and generally short-term traders will want to begin looking very carefully at the price action any time a prior session's low is challenged. In a nutshell, we're looking for an indication that lower prices are cutting off supply. A basic indication that supply is being successfully cut off would be when price breaks beneath a prior session's low, but 30-minute bars fail to close beneath the said low.
Another important observation will be value migration. Traders are unlikely to begin actively buying dips until value begins shifting higher. If we narrow our focus solely to this week's Es trading, we see value has declined steadily from 1894 on Monday, to 1874.75 on Tuesday and 1849 on Wednesday. Suffice it to say, this trend needs to be broken before higher timeframe participants will begin buying dips.
Additional Notes:
- Please check columnist conversation prior to Thursday's open for an updated E-Mini S&P 500 Futures (Es) volume profile and trade plan.
Any trading or volume profile related questions can be posted in the comments section below, emailed to me at parkcityyeti@gmail.com or posted to my twitter feed @ByrneRWS.
At the time of publication, Bob Byrne had no positions in any of the securities mentioned.