The Problem Now Is The Overhead Supply
One of the questions I keep getting is at what point to we step in and "Buy the Dip". Readers of the blog and subscribers to our research have been warned for a while now that there has been no reason to be long the U.S. stock market averages. So it's no wonder that we're getting the follow up emails wondering, "Okay great, but now what?". Unfortunately it's not that simple. Just because we've wanted to sell and were fortunate enough to have gotten one right, doesn't mean that we can simply just pick a spot and say, "We want to buy there". The consequences of the recent breaks in trend that we've been hoping for is that now we're stuck with overhead supply on any bounces.
Technical Analysis 101 is a simple study of supply and demand dynamics. Support is a price level, or an area, where history has proven that demand exceeds supply. Whenever prices get to that level, there are more buyers than sellers, and that's why we get a rally. Resistance is a price level, or area, where history has proven that supply exceeds demand. Whenever we reach that "overhead supply", the sellers outweigh the buyers and that's why prices fall.
There is something that we refer to as the Polarity Principle. This is when former support (where demand previously exceeded supply) breaks down. The market is telling us showing us that at this price level, supply now exceeds demand. There are now more sellers than buyers at this price. Therefore, whenever prices rally back to that prior support level, it now becomes resistance, meaning there are now more sellers than buyers. This is what we call overhead supply. This is Polarity 101 and arguably the most important concept in technical analysis.
Polarity is now the problem with U.S. Equities. Support levels have been broken across the board and that former support is likely to become supply on any rally attempts. And by the way, this is assuming that we even get a rally. So the best case scenario, isn't so great at all. I think a good example of this is in the S&P500. This is the one that's getting all the attention anyway, so let's just use this one. We're looking at the SPDR S&P500 ETF $SPY breaking the support levels last week that had held in both March and July. After those support levels broke, turning them into overhead supply, the next levels near the December and early February lows broke as well:
These broken support levels (shaded in gray) now become overhead supply on any recovery attempts. The market has proven that there are now more sellers than buyers at these prices. This is the new problem that the market now has to deal with.
How do execute going forward? I don't think it's so much a question of "Where do we buy?", but actually "Where do we sell?". I would be a very aggressive seller of any strength back towards those December and February lows, which are near 198 on the $SPY. And even if prices are able to exceed this potential overhead supply, there is even more overhead supply near 204 that was support in March and July. Again, a problem.
Prices are trading below a downward sloping 200 day moving average which simply means we are not in an uptrend. To me, this is a sell rips sort of market, not a buy the dips. Remember, it's all a matter of defining your time horizon and risk tolerance. From an intermediate-term perspective looking out weeks and months (like I do), this is the environment that I believe we are in.
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Tags: $SPY $SPX $ES_F