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A Bullish Continuation Pattern Developing In The Market?

|Includes:SDS, SPDR S&P 500 Trust ETF (SPY)

A strong gap-up Tuesday morning started a bullish yet concerning trend north that lasted the entire day.  Most market players looking at the charts today think this simply shows a strong bullish move north that means they need to start aggressively buying more long positions but, I see a reason to be concerned.

For a while now, we have known that High Frequency Trading (HFT) runs the market but, many don’t know how impactful they can be.  For those who have years of investing experience, they may notice something odd today.  We not only had a very strong gap-up to open but, we trended north the rest of the day without any volatility or a pullback.  Psychologically speaking, that is very complex for human traders to do from the entire open to close without taking some profits and waiting for a pullback to add more.   This leads me to believe we saw computerized trading completely controlling and dominating today’s market.  Why is this concern to us?

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What happens when they change their algorithms to sell?  What happens if they simply don’t show up someday soon?  These are the questions we must ask as the market is clearly inflated and has a long way to fall to the lows of the year.  When we are watching the bulls run-up, we must be skeptical of downside risk knowing how fragile our economy truly is.

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The 2009 rally was mainly attributed to liquidity being pumped into the market by the Fed but, we are not likely to see another QE of that magnitude with a growing deficit and high amount of debt already weighing on us.  When we are watching the bulls run-up and know that computers are doing most of the bulls work, we must be concerned when those algorithms will change to sell.  You do not want to get caught buying aggressively long in an overbought market with computers running the show.  However, you also do not want to fight the trend as the market.  This creates a risky environment.

This is why I have hedged my positions with inverse ETF’s such as ProShares UltraShort S&P 500 (NYSEARCA:SDS) and trading around a core position.  For example, Monday saw me sell SDS near the market lows only to buy back today near the market highs.  A new trend seems to be establishing in the market that I will look for confirmation of it to continue.

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A continuation pattern during an uptrend happens when the bulls make a significant move north in one day, like we saw on September 20th.  The next two to five days, the market downtrends towards the bottom of the candle of that large green day.  One key aspect is that the downtrend does not break below the bullish candle.  In this situation, the downtrend did break below September 20th’s bullish candle on the 23rd.  So, this cannot be considered a true continuation pattern, by definition.  However, the 24th saw the bulls make another move higher and the next day saw another downtrend.  This trend created a rare six-day continuation pattern before Tuesday’s large move up.

This pattern puts me on the lookout for another modified continuation pattern to take place starting Wednesday.  This would mean if the pattern holds true, you will want to press your index short positions and start slowly reducing shorts and accumulating longs near the lows of Tuesday’s candle around 1140 in the S&P 500 (SPX).  I will be using this trend as a guideline myself but as always, you must be flexible in case you notice a trend changing.  Arguing with the market is always a losing battle.  Prepare and react quickly rather than predict and you will almost always reduce your risk and still reap significant profits.  Leave the predictions for the ratings-hungry pundits.

As always, do your own homework to see if you agree.  Have a good night and I’ll see you in the morning.  Good luck out there.

Mike

At the time of publication, Kudrna was long SDS but positions may change at any time.




Disclosure: Long SDS but positions may change at any time
Stocks: SPY, SDS