It starts off with a word of caution because the first significant beginning of month tell is a fakeout. It looks like a bullish gap but it goes nowhere and that small rally fades. What an incredible signal however. Look closely at that rally off of the bottom. It started with a very strong white bar. Then there were gaps at the ends of the first and last peak. The market is ready to take off.
What we will soon observe however is that a gap at the top of a rally is often an indication that the rally is coming to an end.
Next we have the terrific bull market that came out of the flash crash. Note three waves begin with gaps on the first of the month. Now, I don't know what could be a stronger buy signal. If you ever see this formula then buy: gap up on the first of the month after a retracement.
(Note the gap that begins the second wave. See how the previous wave ended with a hammer, almost a gap.)
At the top of this market we start to see the tide changing. Now we're getting red bars on the first of the month. The market climbs higher but the warning bells are in.
Before the crash however we get another fakeout, an big white bar that was caused by technical traders covering stops over a technical point. This is a false rally ending in a dramatic island candle. Once again, a gap at the top of the rally indicates it is about to end.
Finally we got the big red bar on what should have been an up day, the day the debt deal was reached.
What can we expect on September 1st (this coming Thursday)? I don't know. Not every month has a significant day on the 1st. Tracking back before the flash crash this pattern doesn't hold up. I think a reasonable explanation is that this activity is caused by institutional trading. Perhaps fund managers but certainly traders with a long term focus. They seem to be a prescient lot.
My best guess right now is that the market edges it's way back to the 1200 range. Perhaps on Thursday then we see a red bar.
The alternative scenario is that the market dips back to 1100 and we get a white bar. This would be uncomfortable since I believe the market is heading further south but by my own logic (especially if there were a gap up) then this should be a buy signal. I believe in this case it would warrant a limited long position.
I believe the indicators and chart pattern are giving good evidence that the market will retest 1200 before dropping back:
If the dip after the automatic bounce does not make a deeper low then it is often followed by a secondary bounce which leads to the ultimate low. This is indicated by the pink circle. I believe that is where we are right now.
The reason I believe we're heading up to 1200 rather than making a lower high is because of the indicators. Note the stochastics are "running". Rarely do stochastics turn around midstream when they look like this. Possibly they could turn around at the green line as they did right after the flash crash but given the current market momentum and recent news (Buffet investment in BAC and strength from Bernanke's speech) I believe it's reasonable to project the market edging up a bit.
Finally, RSI often retraces back to 50 after a crash before the bear market continues. We saw this in the flash crash correction and I believe we're seeing it again. We're only at 42 so there's still room for the bulls to edge the market up a bit. We are seeing divergence on the composite RSI indicators so caution is still the word. Let's look at the small chart for the S&P:
The market's bounce off of the lower diagonal support line is clear evidence that technical traders are behind this latest rally. Possibly the market stalls at the red diagonal resistance line but I believe that the technical traders are more likely gunning for the 1200 horizontal line in the hopes that this will turn into a bullish triangle. I believe their hopes will be dashed at that level.
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