May 13 Market Wrap — Selling in May

Week's Market Stats
1234week stats

Friday's Market Stats
1234market stats

Oftentimes a common expectation becomes a self-fulfilling prophesy and the "sell in May and go away" is one of those common expectations. Many have argued that it's simply a self-fulfilling prophesy and in this day and age it could very well be. But it has agricultural roots and in a largely agrarian society, which we no longer are, it made sense as farmers borrowed and spent heavily at the start of the growing season and that usually meant pulling money out of investments and investing in their land instead. Come harvest time they paid back the loans and put profits (hopefully) back into markets. Today the explanation is that people become less interested in the markets during the summer months and don't come back to them until the kids are back in school. Whatever the reason, statistics show that the worst investing months are May-October (think September-October bottoms).

For the first two weeks of May, and in fact starting with the last week of April, as can be seen in the first table above, the stock market has sold off. The blue chips and Nasdaq are down about -1% (the big cap techs, NDX, are only down -0.3%) and the RUT is down -2.5%. Transports and banks have been hit hard, down -4.6% and -4.5%, resp., and biotechs have been hit even harder, down -5.4%. Oil service stocks have been taken out behind the wood shed and severely beaten about the head and shoulders, down -12.3%, which is interesting since oil is up +0.6% for the month so far. Utilities are up +1.5%, showing a defensive posture taken by investors, and the dollar is up +1.7%, which has hurt the metals (but again, not oil).

From a price-pattern perspective it's looking a little more bearish after this past week's selloff. The challenge in figuring out the intermediate- and longer-term pattern is that we've had a lot of corrective price action since the April high, and really since the May 2015 high. While I'm expecting lower prices in the short term I still can't rule out the possibility for a renewed rally that will take us to new highs. It's one reason why I've been focusing on the short-term pattern (even down to the 10-min charts) as a way to help identify when the bears or the bulls control the ball. This helps us with stop management, which for me is the most important aspect of trading right now. When the larger pattern becomes clearer I open up my stops and enjoy the ride but when we have a choppy corrective pattern I keep my stops tight and make my trades short term.

As an example of my trading (mentioned only to give you a sense of how I'm seeing the current trading environment), I currently use the weekly SPX options for bear call and bull put credit spreads (OTM below and above significant support and resistance levels). I try to make some money each week and not worry about making a killing. I'll combine the spreads with small directional option trades (usually with the money from the credit spreads) but only if the setup looks pretty good for a directional move in the coming week. The directional option trades get managed even tighter and that's why you'll see me mentioning lowering stops on short positions (at the moment that's the direction of least resistance), usually just above the most recent bounce high. Again, with the choppy price action I believe it's much more important to control your risk (stop) management rather than worrying about profits. Control your losses and the profits will accrue; it's really that simple (but so hard to do since no one likes taking a loss).

To the charts, I'll look at the Dow's 10-min, 60-min and daily charts to show how I think the price pattern will develop and then the SPX 60-min chart to show minor differences with the Dow. I think the downside has the least resistance (is the new trend) but I absolutely cannot rule out the potential for just an a-b-c pullback that will be followed by a strong rally. I'm trading the short side at the moment but I'm not married to this direction and will switch in an instant if the market tells me to.

INDU 10-min chart

The Dow's 10-min chart shows a parallel down-channel off last Tuesday's high, which is merely a guide to watch how price might react at the boundaries. These channels are often an excellent way to support or negate wave counts and at the moment it's looking like we should see at least another leg down on Monday (maybe after a quick pop up in the morning). For the bearish wave count, a new low on Monday should be followed by another bounce/consolidation before heading lower again into Tuesday where it would complete a 5-wave move down from last Tuesday. That would then set up a larger bounce/consolidation for a few days before again heading lower. But note the price projection at 17468 for two equal legs down from Tuesday. Assuming that level will be reached on Monday it will be a good time to protect profits on short trades from last week because the new low might complete an a-b-c pullback from Tuesday. If it plays out as depicted and a new low on Tuesday is followed by a choppy consolidation into Wednesday we would then have a good clue that the Dow will likely continue lower and give us a larger 5-wave move down from April 20th. If on the other hand we see a sharp rise back up and a breakout from the down-channel then we'll have a better clue that something more bullish has started. In this way we can better control risk while waiting for the market to tell us which direction is likely to have the least resistance.

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INDU 60-min chart

The 10-min chart above shows the leg down from last Tuesday while the 60-min chart below shows the decline starting from April 20th. The Tuesday-Friday decline is the last leg from the top of the wider down-channel to near the bottom. I show a little more downside to reach the bottom of the two down-channels (from April 20th and May 10th), near 17468 mid-morning on Monday, which is where the 17468 projection crosses. From there I show a relatively small bounce/consolidation and then another leg down into Wednesday, potentially down to the 17300 area (but price-level support at 17400 could provide a floor for at least a larger bounce). This depiction assumes we'll get a 5-wave move down from last Tuesday instead of just an a-b-c. But again, a drop to 17468, if it looks like it's going to hold as support, would be a good time to get very protective of short positions, just in case the bounce becomes something more bullish.

We'll need to let price lead the way before we'll know for sure but if the Dow makes it down to the 17300 area we'll once again have to be on guard for the completion of a 3-wave move down from April 20th and a reversal into a new rally leg. Only if the low is followed by a multi-day choppy bounce/consolidation will we again know that lower prices are likely coming. And then if we get the 5th wave down, likely the week after opex, we'll know to be ready for the completion of the leg down from April 20th and a larger bounce correction to follow. The lack of a clear impulsive move down from April 20th is what's making this difficult and why we'll have to play it one leg at a time, starting with the one on the 10-min chart and then moving to the 60-min chart as the pattern develops further. Keep risk management under control and short-term oriented as this plays out.

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INDU daily chart

Keeping the bigger picture in mind, the daily chart shows how very little has actually happened since the April 20th high. We're in a downtrend, as evidenced by the down-channels above, and importantly, the Dow broke below its 50-dma on Friday (for the important weekly close) after testing it on Thursday. Each bounce on the way down will have to be carefully watched to see if there's any impulsive move back up. If the bears are now in control we should see the Dow break support at 17400 and then maybe see that level act as resistance on a back-test (that would be a good trade setup for a short play) and then continue lower into the week after opex. From there a big bounce into June before a stronger decline into July. Interestingly, this pattern points to a probable large consolidation pattern in August (typically a dull month to trade) and then another move down into September to complete the 5th wave of the move down from April. That would set up a big bounce into year-end before the bottom falls out next year. So a bottom in September would again fit the "sell in May" pattern and then come back to play in September.

This is of course all speculative but it's based on what a typical wave pattern would look like (with typical time and price relationships between the waves). As I always say, these charts, starting with the 10-min, provide us a road map to follow. Importantly, it identifies when the market runs off the tracks and that's when we would get defensive (about the short side) and potentially look to get long instead.

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SPX 60-min chart

SPX has the same chart pattern as the Dow and its 60-min chart below shows the same down-channel from April 20th. But it's not quite as bearish in that the decline from last Tuesday has not yet broken its May 6th low like the Dow. It is testing price-level support at its previous low on May 6th, which was another test of its 2015 closing high at 2043.62 (SPX remains positive for 2016 as long as it closes above 2043.62). Before that it was tested multiple times in the first half of April. This level is important to traders and as long as it holds as support we could see higher prices. But a close below 2043 would likely usher in more selling (stops being hit) and a drop down to the bottom of the channel, currently near 2028, if not price-level S/R at 2023, and then lower if the larger impulsive wave count to the downside is correct. If we get a bounce Monday morning, watch for a back-test of its broken 50-dma (it broke on Friday like the Dow), near 2055. A bounce up to there and then another selloff below 2043 would likely be the one that breaks the camel's back (staying aware of course of a head-fake break and strong reversal -- we are entering opex week after all).

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Conclusion

As the decline from April 20th (April 27th for the RUT) has progressed I've been trying to point out how it should progress if the bears are back in control, which was the setup into the April 20th high. I've probably been sounding very cautious about the downside by constantly pointing out where to lower stops to, where the pattern turns bullish, etc. The reason is because we do not have a clear impulsive move down and if I was feeling bullish the market I would be looking at the decline as just an a-b-c pullback that should soon be bought. It's not hard to argue a bullish pattern here and while the larger pattern keeps me looking south I'm very nervous about this being just another pullback that simply needs a central bank or two to announce the next great QE program (such as buying stocks hand over fist to support the market, I mean economy through the "wealth effect" since it has worked so well so far, for the wealthy at least).

This market has rallied far beyond where it should have as it ignores all kinds of fundamental deterioration and technical deterioration as well (bearish divergences in an overbought market). And it could continue to do so far longer than we think possible. I think this market needs at least a bigger pullback before potentially heading higher and more than likely, imho, the market has tipped over into the next bear market. But this market has fooled me more than once in its ability to just keep marching higher and therefore I remain cautious and watching the pattern for more clues as to who's in control here. At the moment price has not yet told me to look at the long side and that keeps me in the bear's camp. I'm just watching the bears carefully to see if and when they get spooked again. That means tight stops on short plays since I'd rather be flat and watching than to have a position go big against me.

Have a good weekend and come Monday we'll see what message price gives us as we enter opex week (a time, when short, I feel like a cat in a room full of rocking chairs).

Monday's pivot table
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