One Gap Begets Another

 | Dec 20, 2011 | 4:30 PM EST  | Comments
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In Thursday's column, I highlighted the island reversal in the S&P Futures at 1203, which marked the bottom Wednesday. I also noted that this level is now support, but below it is a remainder of the "orthodox gap" in the futures from Nov. 30, originally between 1196.50 and 1227.

Because that gap was based on the expiring December contract (with the gap in the March contract about six points lower near 1189), I said that I would be looking for the gap in-the-cash at 1195 to possibly mark a bottom. If so, I would add to positions as that gap approached. I said, "Color me increasingly bullish as the market pulls back into its Nov. 30 gap."

Amid all the hand-wringing about something or another Monday, where did the market sell off to? The bottom of its Nov. 30 gap in the futures on the continuation charts. The gap was at 1196.50, and Monday's low was one point below at 1195.50. So in the futures, the gap was completely filled. From there the futures have exploded back up to the 1235 level -- a pop of almost 40 points in just a few hours of trading. It's noteworthy that there is a big gap in roughly the same spot as the one that was just filled. It runs from 1199 up to this morning's low of 1217. As we often find, one gap begets another.

 

E-Mini S&P Futures -- The Tail That Wags the Dog One gap begets another
Source: RJ O'Brien Futures

 

As I noted above, the futures on the continuation charts filled its Nov. 30 gap, but the cash didn't. There, the gap at the 1195 level remains untouched. The point is that Monday's low was about the futures, not the cash. If you were waiting for the gap in the cash to be filled, you're still waiting.

 

S&P 500 (SPX) -- Not Quite Back to Fill Its Nov. 30 Gap
Source: optionsXpress

 

Fortunately, there were other things that suggested a low might be forming, so I wasn't focused solely on gaps in the S&P 500 (SPX) and the S&P Futures. For me, the big tipoff was the failure of the Russell 2000 (RUT) to confirm the new lows made by the SPX and everything else. The SPX and S&P Futures, Dow, Nasdaq-100 and Nasdaq Composite all made new lows late Monday. The lone holdout was the RUT, which held a couple of points above last week's lows. That little non-confirmation by the RUT gave me confidence to add to my mutual fund positions at the close. Did I know the Dow would be up more than 300 points today? Didn't have a clue. Neither did anyone else. The difference is that I had a reason to buy, while anyone listening to the usual noise (oops, I mean news) only had a reason to sell.

 

Russell 2000 -- Bullish Non-Confirmation
Source: optionsXpress

 

As the market explodes to the upside, however, I am taking some chips off the table -- at least in the SPX, which I added to at yesterday's close. Apparently, I jumped the gun as I got the morning pricing at Rydex at the 1234 level -- not bad after adding those positions at Monday's close of 1205.35. I'm still invested up to 40% in equities and 50% overall, including junk bond funds.

Another contributing factor in my decision to add to positions Monday was the likely oversold reading in the McClellan Oscillator. The oscillator settled Friday on the oversold side of neutral at -53, so it was already headed toward oversold. Monday's reading of -134 was an indication that another sharp rebound is likely around the corner. Then there is the strong seasonal pattern that we are in the midst of. It only gets stronger as we head into the new year, as the Santa Claus Rally gets underway this Friday.

Granted, I would have liked to see the Volatility Index (VIX) heat up a bit, but you can't have everything. I'll put it on my wish list for Santa. Happy Holidays!

 

Volatility Index (VIX) -- Not Much Help Here
Source: optionsXpress

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