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With the market struggling over the last few days and the volatility increasing over the last few weeks, I thought it might be helpful to take a look at one of the major index ETFs to see what is going on with the overall market. I selected the S&P 500 SPDRs (NYSE: SPY) as it represents the broad market the best of the three major indices.
What we see on the weekly SPY chart is similar to what we have seen from a number of individual stocks. The SPY has been in a clearly defined, upward-sloped trend channel for the past year and a quarter. We see how the lows over this period connect very neatly to form the lower rail.
Two other things jump out at me about the weekly SPY chart. First, look at how the 10-week RSI hasn’t dropped below the 50 level since December 2012. That shows you how strong of a rally we have had in the last 15 months or so. The second thing that stood out is how the slow stochastic readings are barely out of overbought territory during this recent pullback. This is concerning as over the last year, most of the dips have seen these readings reach the 50 level. In order for that to happen this time, we are going to have to see more selling in the coming weeks and that could cause the index to break below the lower rail of the channel.
To get a better look at the channel, I have taken the liberty of including the daily SPY chart for the last ten months. We can see now that the lower rail is just under the $179 mark at this point in time. We also see at the bottom of the chart that the SPY isn’t in oversold territory on a daily basis yet which suggests that we could see more selling over the next couple of days before we see a technical bounce.
Should the SPY break below the lower rail, the next layer of support is down at the $173 level which was the low of the downswing back in February. The 52-week moving average is moving up right now and could coincide with the $173 level here in the near future, giving the ETF two layers of support in the vicinity. The other thing to be watching for is a possible crossover of the 13-week and 52-week moving averages. If it reaches that point, you will want to lighten up on your equity holdings as it is a sign of much steeper pullback.
Here is how I would play it. If you are an options trader and we see the SPY reach the $179 level in the next few days, I would buy a straddle using the June 179 calls and puts. If the ETF hits this lower rail, it will likely produce a big move in one direction or the other. Either the support holds and the fund rallies back up to the $190 level over the next few months, or it breaks the support and we see it drop sharply over the coming weeks.
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