Thoughts for Thursday, May 8...

The selloff that we saw on the S&P 500 presents us with what appears to be a classic reversal situation. We discussed previously the notion that we were in the third wave up of a rally from March 17. We also discussed the 1420 to 1425 area as a potential area of price proportionality and resistance. In addition to this, we have also considered the possibility of a divergence on the 10-day relative strength index. It appears to me that all of these issues have been relevant over the last few days.

If we look at the chart below, we can see what might be described as a narrowing trend channel . We typically see trend channels narrow as a price move nears completion. We can see that the S&P 500 closed at the upper limit of this trend channel on Tuesday, and then broke down below the lower range of this narrowing channel on Wednesday. This represents a potential completion of what I have been calling Wave C.

It is not insignificant that this price pattern completed around the area of proportionality and resistance that we have discussed previously. Among other things, this area represents the 50% retracement level of the decline from October to March. It also gives us a fair amount of proportionality between the initial wave up from March 17 to April 7 and the final wave up from April 14 to May 6. I would have preferred to see the S&P 500 close above the 1420 level, but what we have seen may be good enough.

The final issue of interest is the 10-day relative strength index (RSI). Last week, we discussed a possible divergence that was forming on the technical indicator of price momentum. We have seen this divergence continue to develop over the last week. The sell-off on Wednesday dropped the RSI below its previous lows. This was what Welles Wilder, the man from McLeansville, NC who developed many of our technical tools, called a failure swing. Failure swings are not always reliable predictors on their own, but they can prove helpful when coupled with other tools. I view the failure swing that completed on Wednesday as a bearish occurrence.

All of this lead me to believe that we may be due for a week or two of downward price movement. My initial primary targets are 1300 to 1325. We will see if this plays out.