The Easy Money Has Been Made

 | May 22, 2012 | 5:30 PM EDT
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Last week I highlighted the first big Fibonacci retracement level as a downside target in the S&P 500. I said that the bad news was the .382 Fibonacci retracement of the rally off the October lows coming in at 1289.60, and the odds are good that this level will be seen before the selloff is complete, which is still a long way down.

During Friday's expiration-related selloff it got a lot closer, as the S&P 500 bottomed at 1291.98, less than 2.5 points from that Fibonacci retracement level. From there, the market has shot back up in one of its sharpest two-day advances of 2012.

Was the bottoming of the S&P 500 just above its .382 level some weird coincidence? I don't think so. Maybe the coincidence is that so many traders got bearish as the market returned to that Fibonacci level. Of course, that helped set the stage for the sharp rebound that followed.

SPX: Bouncing off the .382 retracement
Source: optionsXpress

Now that the market has achieved (or almost achieved) this important downside objective, what can we look for? Obviously, a bounce was overdue as the market had become quite oversold on the drop into Friday's lows. The rebound has already carried 36 points in the S&P 500, back up to the 1328.49 level. That's almost a 3% move in just a couple of sessions. I'd have to say the easy money on the upside has already been made. That's not to say the rebound can't continue, because it obviously can. But I am using today's continued bounce to cut back a bit in my positions to a maximum of 60%-invested levels. I got the a.m. pricing at Rydex (now Guggenheim Investments) of 1326.73 in the S&P 500. I'm just cutting back a bit in my S&P 500 holdings. I have also been writing out of the money calls in the SPDR S&P 500 (SPY) after buying June $131 calls into last week's selloff.

If the rally continues, and I suspect it will (though not in the straight-up manner of the past couple of sessions), I have targets to look for as levels to sell into.

First is another Fibonacci retracement level. This one is the .382 retracement of the decline from the April highs to last week's multi-month lows. That decline was 130.40 points in the S&P 500. The .382 retracement of that decline comes in at 1341.79. So that's the next target for this rebound. If that level can be exceeded, a little higher is the next target -- the gap from last Monday, the May 14 gap at 1353.39.

SPX: The May 14 gap beckons above at 1353
Source: optionsXpress

Now that we have seen a stunning reversal off last Friday's multi-month lows, it's no surprise the market's oversold and under-loved condition, which marked last week's lows, has been largely relieved. Not that the market is as overbought and over-believed as it was at the recent top, but it's no longer at oversold extremes.

The McClellan Oscillator, which last Friday registered its most oversold reading since last August at -339, is headed for a reading closer to the neutral zone. Yesterday's reading of -176.76 was still quite oversold but no longer at extremes. Today, if the market closes anywhere near the morning highs, the oscillator should be back on the oversold side of neutral, no longer in oversold territory.

On the sentiment front, there is the latest contraction in the Volatility Index (VIX). On Friday, the VIX spiked to a new high for 2012 at 25.14. That provided a good buy signal. Monday of that week, the VIX gapped up from the close of the previous Friday, May 11, from 19.89. Today, the VIX is returning to fill that gap. The low has been just above the gap at 19.98. The market is still shy of May 11 closing levels, but the VIX has effectively returned to the level that marked the May 11 close. On this sentiment gauge, last week's shakeout has already been erased. I'm not thrilled to see that.

VIX: Pulling back into last Monday's gap
Source: optionsXpress

Grade me bullish, now up to 60% levels, but cutting back in positions as upside targets are reached.

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