Gaps Matter

 | Aug 23, 2011 | 3:25 PM EDT
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I am not sure what the financial media will pin this one on. Maybe they'll say it's a relief rally because former IMF chief Dominique Strauss-Kahn got off without so much as a fine. But that has nothing to do with the market. Nor does the latest speculation about Bernanke's upcoming speech and the prospects for QE3, which really are no different today than Monday, when the big opening rally completely faded and gave everything back. Nor, in the scheme of things, does the end of Gadhafi matter much to the market -- unless, of course, you happen to be living in Libya.

Do you want to know what matters? Gaps matter -- and this week, so far, not much else. Let's take a look.

On Aug. 10, the S&P 500 (SPX) closed at 1120.76. The next day, Aug. 11, it gapped up from there and kept going higher until it hit the recent recovery highs at 1208.47 on Aug. 17. Since then, the pullback has been a choppy one, but it has clearly had its focus on that Aug. 11 gap. Note that last Friday, the SPX pulled back late in the day to a lower low for the move at 1122.05. At first, I thought that might be close enough to the gap and so I did some buying into that selloff on Friday. Then, on Monday morning, I thought I was pretty smart when I saw the SPX popping 22 points at the opening after just about tagging that gap. I did some selling into that pop but, unfortunately, remained net long. This was unfortunate because that massive opening gap (massive in the futures where it was 24 points wide at the outset) got filled by the close -- and then some.

The midday swoon carried to 1121.68, which was less than a point above the gap and from there the SPX would recover more than half of the earlier gains (up about 13 points from that low). But then late in the day, it was back down again. And this was, again, no random selloff. It was a selloff with but one function, maybe two, to run the stops below the earlier lows and to get closer to the gap. Mission accomplished on both scores. The SPX bottomed at 1121.09 in the final minutes of trading and bounced a few points into the close.

Then, this morning, we saw another gap-up opening, though not on any grand scale (but it was looking pretty explosive last night in Globex). That opening gap in the S&P cash and futures was soon erased as the market pulled back into negative territory. But the S&P held above yesterday's lows and for that matter, never got closer to that gap. Monday's low of 1121.09, just one-third of a point above the gap, is as close as it would come for now. And, of course, now it's launching.

SPX -- Daily/Bottoming at the 8/11 gap
Source: optionsXpress

During the morning pop on Monday, I cut back a bit in my Dow positions, as they were having a good morning, but then, at the close I re-established some positions in the Emerging Markets Fund at Rydex (RYWVX), for the first time since March. That fund is leveraged 2:1, so it moves. In fact, I sold out my remaining positions in that fund on March 25 with the fund at $25.56. Yesterday, the fund closed at $17.31, which was a pretty good haircut, and I am holding it for now. I am now back to a maximum of 75% invested in mutual funds.

Within the bigger picture, some of the same numbers still apply. They don't have anything to do with the news either. Notably, I am still watching that Fibonacci .382 level at 1101.73, down to the recent lows at 1101.54. If it gives way, that's trouble -- maybe big trouble. But until then, I am buying selloffs into support. The latest of which was the Aug. 11 gap.

SPX long-term/Fibonacci .382 still holding
Source: optionsXpress

While the SPX was calling a bottom at its gap from Aug. 11, the Nasdaq 100 (^NDX) was doing its part by scoring a neat double bottom with its Aug. 9 low. It never broke that low but, boy, last Friday did it come close.

Note in the chart below that the low on Aug. 9 of 2034.92 was almost tagged last Friday. The low on Friday was just .38 above it at 2035.30. Again, about one-third of a point higher. But it held. That's the important part. And now it's 3.5% higher.

I didn't buy the NDX into the pullback to the lows, but I did add to my Apple (AAPL) positions yesterday (I bought the September 340 and 350 calls), as it sold off to the $356 level. After all, as goes AAPL, so goes the NDX. Today, I am hedging those positions as the stock pops back up (selling the 365 calls).

NDX -- Bouncing off the double bottom
Source: optionsXpress

The usual suspects were, of course, also present offering support to the near-term bullish case. The McClellan Oscillator settled on Friday at a fully oversold -130 and even on Monday, it was still pretty oversold at -118.52. That still qualifies as a buying opportunity in my book. And the Market Volatility Index (VIX), which had popped up to the 45.40 level last Friday, was still pretty elevated at yesterday's close at the 42 level. I've seen better numbers, but I'll take it for a bounce. And in this market, that's all I am playing for. I will no doubt be cutting back in some of my positions at today's close, assuming the S&P 500 closes near the 1150 level.

VIX -- Setting the stage for the rebound
Source: optionsXpress

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