A Play for This Fork in the Road

 | Dec 08, 2011 | 2:45 PM EST  | Comments
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Stock quotes in this article:

SDS

,

SSO

Last week the market saw a greater-than-7% surge in just two sessions, which served to basically wipe out the entire November loss. Again: In just two days, right at the end of the month, that entire loss was gone. In the week following that move, the S&P 500 has basically been in a consolidation phase, trading sideways with little further gain, nor much in the way of weakness.

The reason for the consolidation is in part due to a near-term overbought condition, created by the quick and broad strength at month-end. This is normal price action following such a move, and it's largely constructive. The other main reason for it is that the S&P 500 has now been carried back to what has been major overhead resistance. This 1270-to-1285 range has contained upside progress in the past, having become resistance when the broad decline began in earnest back in August. This whole sequence of events, therefore, has brought the S&P 500 and the other major indices to a major inflection point. 

The big question in front of is: Will the market gear up for a push through this resistance level, or will it once again fail and transition into another decline? Currently there is evidence to suggest this move may have more energy behind it than have previous attempts to break through, and that indicates we should be giving the benefit of the doubt to further upside attempts. The one obvious factor we see is simply the resiliency of the recent strength. Some negative news has hit the tape, and the market has reacted, but those reactions have been short-lived and shallow. Eventually, in fact, they were used by traders as buying opportunities.

The second factor we see as supportive of higher prices is our Self-Adjusting Relative Strength Indicator, or SARSI. This measure, over an intermediate-term basis, had reached an oversold reading as last the final few days of November had gotten underway. This had suggested the bulk of the selling had occurred and that the probability of a recovery rally was increasing. The SARSI has since recovered from the oversold reading, but it still has further room to rally before reaching overbought levels. It also tells us the market has further room to rally.

The negatives are pretty obvious at this point, as well. First, the 1270-to-1285 range in the S&P 500 has contained market strength to this point. Until that range is broken, it needs to be respected, it and could likely be a limiting factor once again. The other big negative is the overhang of the well-known European issues. The U.S. market has become captive to these headlines, and any disappointment from the upcoming European Union summit Friday could quickly remove trader optimism and create selling pressure once gain.

The current setup really provides the potential for two trades -- one long and one short. For our illustration, we will use the ProShares UltraShort S&P 500 (SDS) and ProShares Ultra S&P 500 (SSO) as our ETF vehicles to take advantage of the current situation. This is a relatively simple trade, as well.

 

ProShares Ultra S&P 500 (SSO) -- Daily
Source: MetaStock

 

Strength above the 1175-to-1185 range in the S&P 500 would indicate renewed buying interest and additional strength in the 1300-to-1320 range. This would translate into a move above $48 in the SSO. We would get long the SSO at that level, with an upside target of $52 to $54. Use a stop of $44, and look to tighten that stop as the trade develops.

 

ProShares UltraShort S&P 500 (SDS) -- Daily
Source: MetaStock

 

Weakness back under 1225 in the S&P 500, meanwhile, would signal increased selling pressure and indicate further downside risk. This would translate into strength in the SDS of a move back above the $20-to-$20.25 range. We would get long the SDS at this level with an upside target of $21.50 to $22. Use a stop of $18.90.

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