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The SPX spiraling down?

May 31, 2011 12:28 PM ET
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Portfolio Strategy, Long/Short Equity, Special Situations

Seeking Alpha Analyst Since 2008

Dr. Kris has two degrees from MIT because one just wasn't enough. Her life goal was to figure out the universe and having done that (at least to her satisfaction), she decided to tackle something even more difficult—the stock market. Applying the scientific method along with an insatiably curious mind, she began trading stocks, futures, and options in order to find the holy grail to market success. She's discovered to her immense satisfaction that not only is there one way to succeed but many. Combining her love of cooking with the stock market, she's devised recipes for investment success designed to please the palate of most investors. Dr. Kris currently manages a private equity long/short portfolio and writes of her current research projects that appear on her website, StockMarketCookBook.com. Her most exciting project is applying market timing models to Modern Portfolio Theory to not only give greater returns but at substantially lower levels of risk. (See PortfolioPreserver.com for further information.)

The chart of the S&P 500 (SPX) has been trading in a channel with a decidely downward bias. [See chart below.] This is a bearish pattern and there are reasons to believe that the pattern will continue.

Why? For one, the topping tail on today’s mid-morning chart shows that the early morning buying pressure couldn’t be sustained, most likely due to negative housing and manufacturing reports.  Secondly, the market internals (as of this writing) are edging into the bears’ camp (rising VIX & Trin), but the weak VWAPs (a measure of institutional buying) is tepid at best on both sides, giving credence to the Sell in May and Go Away adage. (Or may be that traders just decided to spend an extra day or two in the Hamptons.)

So, how should one play this scenario?  If you haven’t bought portfolio protection, now is the time to do so.  More risk tolerant players may wish to purchase index puts on days where the SPX hits its channel high and shows signs of reversing course (like today). [Note: Set a mental stop/loss just above the upper channel level.] 

Support levels for the SPX are 1325 (minor), 1300 (major), 1280 (minor), and 1250 (major).

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