Trader's Daily Notebook: Get Some Perspective on the Market Decline

 | Apr 17, 2017 | 7:00 AM EDT
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Last week ended on a pretty sour note for both bulls and the major indices, but how serious is the current downturn, and when was the last time we saw a sustained bear trend take hold?

Before we answer those two questions, let's take look at weekly SPDR S&P 500 Trust (SPY) chart, and briefly review the market's corrections dating back to the March 2009 bottom.

SPDR S&P 500 Trust SPY -- Weekly

A few things stand out to me on the weekly chart above. First, nearly every correction that's occurred since the 2009 bottom has included either a test, or violation of the 40-week (or 200-day) simple moving average. The only corrections noted on the chart above that did not test the 40-week SMA were the 9.27% decline in January 2010 and the nearly 8% drop that occurred between late-May and late-June. Right away, longer-term traders and investors should recognize that while price breaking beneath the 40-week SMA is never a bullish development and generally leads to a notably more volatile trading environment, such a development does not guarantee the market is destined to roll over into a prolonged bear market.

Second, take a look at the percentage declines. If we average all the declines I've noted, except for our current, 3.25% decline, we find the SPY has dropped on average 11.35% during corrective phase. Even if we ignore the two deepest and two shallowest declines, the SPY has still dropped nearly 10.75% on average. Figures like these help to put our current decline into a better perspective.

Lastly, despite the numerous double-digit declines SPY bulls have suffered through since early-2009, we've yet to see price consolidate beneath the 40-week SMA and make a secondary break lower. Put another way, each break of, or consolidation beneath the 40-week SMA appears to have reset expectations and attracted new buyers to the auction.

In regards to the seriousness of the current downturn, I believe active traders should be moving quickly, looking for opportunities to take advantage of the increased volatility. But beyond that, I haven't a clue when the current, long-term bull market will come to an end.

Frankly, if we simply consider where price is trading in relation to the 40-week SMA, I don't believe we have anything close to sufficient evidence to say the multi-year bull market has come to an end. Heck, we'd need the current decline to more than triple just to reach the average decline depicted on the weekly chart above. And for those keeping track, an 11.35% drop from our recent high near $240 would have us testing roughly $212.75, or long-term support (was resistance) from late-2014 through mid-2016.

The unfortunate reality, when it comes to trading and investing, is we won't know the bull market has ended until long after the fact. That's why we utilize risk controls. So, whether you use moving averages, a volatility-based average true range (ATR) stop or some other method to control your risk isn't important. As long as you're controlling your risk in some manner that removes emotion from the process, the odds that you'll successfully sidestep a sustained and gripping bear market are in your favor.

And for those wondering about the last sustained bear trend we saw in the SPY, price began to break lower, on a weekly basis, in early 2008. And by that fall we were in all-out panic mode. But before the market really collapsed, we were well under the 40-week SMA, price had consolidated and begun making lower lows from beneath the 40-week SMA; price was more than 20% beneath the prior swing high. Again, for comparison purposes, the SPY is approximately 3.25% beneath the early-March swing high. So, for you longer-timeframe folks in the audience, let's not begin to panic quite yet.

Shifting our focus back to a shorter timeframe, we can clearly see how a downtrend is trying to take hold.

S&P 500 Futures -- Daily Volume Profile

For the first time since Nov. 7, 2016, the E-Mini S&P 500 futures (Es) are back beneath the 50-day exponential moving average (EMA). And to make matters worse, the contract is within a few handles of breaking beneath the year-to-date (YTD) volume weighted average price (VWAP). At this point, I believe we can all agree most traders are monitoring the contract for a break of the March 27 swing low. A close beneath that level would likely set traders up for a high volatility decline toward the low-2260s (the most actively traded area, value, for 2017) and the rising 200-day SMA (roughly 2223).

We'll enter Monday's auction with an initial focus on 2324 and 2334 to 2335. While all trading within that area is expected to be choppy, a generally bearish bias remains warranted. An open within that 11-handle zone that tests higher (toward the mid-2330s) and trades back down through its opening print and developing session's VWAP would be expected to collapse toward 2324.

Bearish continuation beneath 2324 has an immediate target of 2318, and a secondary target of 2309.75.

S&P 500 Futures -- 15-Min Volume Profile

A sustained trade above 2335 opens the door to continued buying toward 2340.25 and 2345 to 2345.50. For now, we'll look for sellers to remain committed to their positions until the contract is back above the mid-2340s.

Any trading or volume profile related questions can be posted in the comments section below, emailed to me at parkcityyeti@gmail.com or posted to my twitter feed @ByrneRWS.

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