Last week, the Federal Open Market Committee decided not to raise interest rates. Essentially, we got a pause.
In his statement, Fed Chair Jerome Powell said the central bank would consider the “cumulative” impact of rate increases in future meetings, and that they haven’t made a decision yet on what they’ll do at the July meeting.
Despite some questions about what the Fed will do next, the unstoppable June rally continued higher for a few more days before coming to an abrupt stop Friday and falling again today.
Last week was important for economists. This week is important for traders.
Now that the news has settled, investors and analysts are starting to weigh what’s coming down the pipe (Wednesday’s Fed testimony, Q2 earnings, questions about China’s economy) and whether it will be enough to stop this young rally in its tracks.
And while the bulls are confident this is just a minor bump in the road higher, the bears are betting that the rally may be close to stalling out.
Based on what I’m seeing in the charts, there are three important numbers every trader needs to be targeting right now.
Here’s the crazy part — it doesn’t matter if you’re bullish or bearish. The three numbers you need to know are exactly the same either way.
The 3 Numbers You Need to Know — Bull OR Bear
Alright, get ready to jot these down.
430
422 (up to 425)
416
All three of those numbers represent levels that could become significant technical support for the S&P 500.
Now, before I get into the two different trade setups, let’s talk a bit about what technical support is and why it’s important to both groups of traders.
The best way to think about support (and its counterpart, resistance) is with an image from an arcade game I used to play… Breakout.
As you can see, there are four walls. But for the purpose of discussing support and resistance, we’re only going to focus on the bottom and top walls.
Now let’s say that the stock is the ball — it can either bounce up or down. If it moves down, it hits the bottom wall. This would be considered the “support” level.
Support is the price level at which the stock consistently hits and tends to find support keeping it from going any lower… meaning, it’s a price level that attracts buyers, who push the price back up. If new buyers rush in every time the stock hits this price, it will have a hard time moving below this level.
Alternatively, when the ball bounces up, it hits the top wall. This would be considered the “resistance” level.
Resistance is the price level at which the stock consistently hits and tends to find resistance preventing it from going any higher. In other words, it’s the price level that attracts sellers. If people sell their shares every time the stock hits this price, it will have a hard time moving any higher.
When a stock finally musters up enough energy to break above resistance, that price becomes a new technical support level. The reverse is also true; broken support will then become a resistance line.
(Click here for more about these two technical levels — and why they’re key to profiting in any market condition.)
Now that we know the power of support and resistance, let’s look at those three numbers on the SPY chart.
Potential Support #1: 430. In early June, SPY spent a few days consolidating just below 430 before springing higher. A short-term pullback could bring SPY back to this level, which could become a new support level. A drop to this level would represent a 1.6% fall from Tuesday’s close.
Potential Support #2: 422 to 425. On June 2, SPY gapped up from 422 to 425. Should SPY break below the first potential support line, it could find support at 422, 425, or anywhere in between. A drop to this level would represent a 2.8% to 3.5% fall from Tuesday’s close.
Potential Support #3: 416. This level used to be a resistance line; SPY had a hard time breaking — and then staying — above this level until this latest rally kicked off at the end of May. Because it used to be a resistance line, it’s now a potential support line. A drop to this level would represent a 4.8% fall from Tuesday’s close.
So, how do we use these numbers in a trade? Remember, these are all levels that could become a potential floor for the market; in other words, it will take a significant amount of bearish conviction and momentum to break below each of these levels.
If you’re bearish and think the broader market is going to see a significant selloff, you could make a bearish option trade that uses any of these support levels as an exit target.
For example, you could buy a put option that goes up in value as SPY moves closer to these levels. Since we’re not expecting SPY to move below these potential support levels, you’d want to consider exiting at least some of your position before a rally potentially resumes.
Alternatively, if you’re bullish and think this selling is just some healthy profit taking before the larger bull rally resumes, you could use any of these support levels as an entry point to get long.
Because these are support lines, we would expect SPY to fall to one of these levels, but not lower. You could buy low at support and then sell high after the rally resumes.
Personally, I think the bull has returned, as technicians see the 20% bounce from last year’s bottom as a tell tale sign. Match that with the Fed’s pause in rate hikes, and it seems likely that we’re in a real bull market. But I suspect we will have to deal with lower-than-expected Q2 earnings, which companies will start reporting next month. Is it possible that “sell in May” will really become “sell in July”?
To learn more about my trading strategy, give Gabe and his VIP team a call at 855-509-6600. They’ll be happy to answer any questions you may have.
To your continued success,
Tom Gentile
America’s #1 Pattern Trader
