Where to Next? Technical Analysis of the SPY Chart

Last week provided the start of another leg down in what has been an unpredictable stock market, and the market now appears to be in the midst of forming another bear flag. Since rolling over and selling off strongly in late April, the market has demonstrated all sorts of conflicting formations that have confounded trend traders and investors.

That's why at Sabrient we prefer an absolute return long/short approach that is indifferent to market direction, relying upon our fundamentals-based quant models to create relative rankings among stocks for identifying the best longs and shorts for a given portfolio, no matter what direction the market takes. Nevertheless, for long-only traders or those who use our quant rankings to create watch lists for swing trades based on technical entries and exits, an indication of where the charts are indicating the overall stock market might be headed can be helpful.

So, as we enter the final week of summer, I'd like to review the various chart patterns that we've seen since the market peaked in mid-April, and take a stab at where the charts are telling us the market might go from here. I'll focus on the widely traded SPDR Trust exchange-traded fund (SPY), which tracks the broad S&P 500 Index.

No doubt, this summer has been eventful. Coming off the April peak, May gave us a waterfall decline, including two confirmed bear flags, with the SPY falling from near 122 all the way down to below 105 (-14%). Then, June gave us both a bullish double-bottom reversal with SPY climbing from 105 to 113, followed by a bearish reversal that sold off hard into month end. But July changed everything. SPY was strongly bullish, putting in a V-bottom reversal from 102 all the back up to 112, supported by two confirmed bull flags, the first of which pushed through the downtrend line that had held for nearly three months.

But August began with what appears to be the head of a head-and-shoulders topping pattern around 113, which was confirmed with the break of the extra-bearish down-sloping neckline last Tuesday (see the second chart below). Although bulls are trying hard to support the market before it reaches the head-and-shoulders price target near 102.5, it might only be the second of two bear flags after finding temporary support at the previous downtrend line near 105, which also coincides with the site of the June double-bottom bounce. Oh, and by the way, the SPY remains well below its 200- and 50-day moving averages.

Confused? That's a lot to absorb, I know. On balance, it is still mostly bearish, although the bear flag might climb a bit higher before testing the support line. Nevertheless, keep in mind that technical charts only reflect the past, and they can turn on a dime...and often do when things look bleakest. (That's why we rely more on Sabrient's fundamentals-based quant models for stock-basket strategies, and only use technicals for entries and exits on individual swing trades in our alert services.) The bear flag might not be validated if the market keeps on rising instead.

Also, there is just one more week of summer before Labor Day weekend and the return of the senior portfolio managers, which should usher in higher trading volume, and perhaps a wholesale change in market sentiment.