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S&P 500 reversal or further downtrend?

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

Yesterday S&P 500 (represented in my posts by SPY) broke through $126 support level on a high volume. It did exactly what I was expecting a few weeks ago when I was thinking it would go all the way down to this support level. I was wrong on a little bounce circa a week ago, but I am also learning trading with the trend.

Yesterday’s trading was spectacular on one thing. You may have been impressed by media, that all the downtrend was due to the US debt ceiling problems, but when the deal was reached, the market opened with a gap up, but closed deep below 126 level. That proves that it was the economy and not the debt ceiling issues which were more important. And data coming out weren’t really any positive at all.

However, we are once again in oversold territory. Take a look at the market and you will see a huge short term uptrend and immediate short term deep decline. We are due for a bounce, a rally relief.

If we are awaiting a rally relief, what actually does that mean?

Well, the market must correct itself. Nothing goes up or down indefinitely. After a long or strong uptrend, there are typically dips, after a strong downtrend, there are bounces. This time we will see a bounce. Today’s trading, when you take a look at candlestick chart, shows a hammer candle after long downtrend. A candle with a long wick (shadow). It shows, buyers were willing to step in and actually overrode sellers at the end of the day. This should be a typical exhaustion day.

But how long will this rally take?

I think we will go back to 130 level (or 50 day SMA). It may of course continue higher, but it may bounce from that resistance and continue down.

Why down?

Well, everything may happen, but take a look at the overall market. We are still in sideways pattern (since January 2011), but it is evident that we are slowly turning into bearish trend. We are completing head-and-shoulders pattern and creating new lower highs and lower lows. The $130 resistance level will be important. If we bounce down from it, it will be a confirmation that we are reversing in bear market. If we break up and continue to 135 - 136 level, we still may have chance to consider head-and-shoulder pattern as continuation pattern (if we break through 136-ish level) and we may see a new bull trend. But economic data are not that strong so far to have enough power to move the market that high. But everything can happen.

So what can we expect?

As I said, everything is possible, but my expectations are that we are now exhausted (long hammer candle on volume spike) and we will go probably up to 130 level. There we will probably stop and go down again. In the light of this expectation I am going to reverse my positions, sell put options and buy call options to ride this trend up. How long it will take I do not know as well as if it even reaches that level. Time will show. However, I may be wrong and therefore I am adding a stop loss order on my current put positions and I will be waiting for reversal confirmation before I buy calls.

Happy trading



Disclosure: I am short SPY.

Additional disclosure: short VIX