Spotting the Move

The Dow jones Industrial Average ended the session on Friday, June 10th down a mind-numbing 880 points from the previous close and all other major indexes were similarly maligned. As such no one would blame you for lamenting if you were not among those lucky enough to have either covered positions or gotten short at the top.

The great Yankees pitcher Lefty Gomez famously admitted "I'd rather be lucky than good" back in the 1930s. But a trader would rather be good than lucky any day of the week because it's the talent and ability that we cultivate that allows us to identify the right trades to make in any situation. In the long run, ability always triumphs over chance or simply being in the right place at the right time.

A vital component to developing the ability that leads to good trading is being able to both anticipate when the market is about to make a significant move and then find ways to trade with the market's direction. Friday's session long sell-off, which really began gaining momentum towards the end of the previous session, may have appeared just as suddenly as it was relentless. But there were five technical indications forming over the prior sessions that a chartist could have considered in recognizing a coming decline.

The chart for the SPY ETF, which tracks the S&P 500, gives us clear examples of the five indicators that signaled this most recent drop.

1. The "Heavy" Top

When you step outside on most days the clouds are light and wispy, with blue sky as far as the eye can see, and you know that there won't be any chance of rain. But on some days the clouds are dark, dense, and intimidating, and they dominate the sky. On these days you can be certain that it will storm and you're better off either staying inside or at least making sure you're dressed for the weather. On the 5-minute SPY chart above, we can see the formation of a "heavy" top, gathering like storm clouds. 

Going left to right, the top actually begins on this chart in the aftermarket session on Thursday, June 2nd with a high of 418.60. But notice the pronounced dips and rallies that followed. Despite reaching 418.60 in the June 2nd aftermarket, the SPY barely broke 416 several times in intraday trading in the sessions after that, followed each time by declines of at least $5, or more than 1%. These rather steep declines after failing to make a new high or even approach the aftermarket high it made earlier is what lends the top its weight, its heaviness so to speak, and they are a sign of coming weakness.

2. The Sudden Slip

While the Heavy Top can foretell an impending move down, it offers no guarantees in and of itself. Like any good formation, it relies on confirmation from other types of chart movements to gain strength. The chart above offers confirmation in the form of the Sudden Slip.

When examining charts, the prices during the intraday sessions are far and away more meaningful than the extended session prices. However, extended session prices in a market such as SPY can be reliable since it tracks an index that trades overnight, and therefore will have some volume and efficiency before and after regular trading. The premarket price action in SPY can tip us off to the market's intentions at least for that day, particularly SPY's prices right before the open.

Indicated with the red arrow and circled in the chart above, a Sudden slip occurred approaching the open on Thursday, June 9th. Moves like this typically take place around 8:30am when some piece of important economic data or a highly anticipated earnings report is released. In this case, it was continuing concerns about historic levels of inflation coupled with some retail data. In this example, SPY eroded more than 1%, from 414 to below 409 just as the open was approaching. A premarket sell-off into support is not uncommon in any type of market, but what made this particular sell-off indicative of weakness was the fact that it sold-off to below the previous day's range, or below the previous day's low. A heavy top weighing on the market and a sudden slip going into the open to below the previous day's low provided two solid clues that an overall decline was underway. 

3. Rally into Resistance

With abundant technical sell signals at hand, you can find yourself searching for the opportunity to either get short or liquidate a position in case the market begins to crash in earnest. Naturally you'll look for a rally to sell, and that rally came towards the middle of the session on June 9th.

In all honesty, this was a tough one to spot because you could have made the case that the SPY was holding a reasonable bottom at 408 and that it might in fact reverse to the upside. However, if you were now thinking down for the market rather than up, based in part on the indicators we just discussed, then the rally it made up to 411, as shown in the chart above, provided the last good opportunity to sell closer to the top. The 411 price point was the last high that SPY made on that day following its premarket sudden slip, so a rally to near there was a place to sell and if you were getting short, you had an easy cover right above the intraday high around 411.70.

4. Crashing Through Support

Trading momentum may seem unnatural and therefore difficult for many traders who base their technique on buying support and selling resistance. You can make the case that percentages diminish if you try and sell the further you get from the top, and you'd rather just patiently wait to buy support or for some other indication that a bottom is in.

However, when support doesn't hold, there is a lot of money to potentially be made as momentum carries the market down further. As shown above, once SPY broke 408 there was very little by way of further support to latch onto and you could have used that- through the day's low -as your place to sell coming down from the rally up to 411 that didn't carry.

5. The Bottom Falls Out

If you still harbored some bullish hopes, then you could have made your final stand at 407.25 on the SPY, as there was some corresponding support there as seen on the 5-minute chart we've been referring to. After breaking 408, the SPY offered a glimmer of stability at a bit above 407 and for a few glorious minutes you could have convinced yourself that by-golly the last gasp of support was going to hold.

But those hopes were soon dashed as SPY crashed through 407 and then embarked on a veritable Highway to Hell. Notice on our chart that there is absolutely no support whatsoever below 407 besides that fact that so much was already pushing the market down. Based on our reading of the chart, that is a clear command to either get short or get out of the way. Furthermore, if you happened to have been long from lower down you could have used this as your last chance to cover without risking either giving back a larger portion of profits or turning a winner into a loser.

Once the bottom falls out the market, there is no telling where it will stop. But with so many bearish technical indicators influencing the market, and with a market that had been rocked by inflation, supply chain issues, war, and other fundamental factors having a negative impact there was ample reason to believe that the decline would be severe. Be that what it may, the SPY dropped to 401.20 on June 9th, was sharply lower in the extended session, and continued its downward momentum on June 10th, closing at around 390. Even if the drop had not been so drastic, there's real money to be made in every move, so what would have been wrong with getting short through the lows at 407 and taking it back at 405, for example? 

It's not every day that we see a drop of more than 6% in the broader market over the course of several trading sessions. However, the five indicators discussed here could have tipped you off that at least some sort of significant sell-off was coming. This may seem like a good bit of Monday Morning Quarterbacking and 20/20 hindsight. But patterns repeat themselves and examining moves such as what just took place will prepare you for getting yourself on the right side of the market the next time a situation like this occurs.