In my Sunday (Oct. 21) update, I shared this ominous observation: “The chart constellations suggest that the potential for a mini-crash are elevated if nearby support is broken. Although we are aware of, and monitor, some very bearish outcomes, odds suggest that a mini-crash (drop to 2,700-2,587 points on the S&P 500) would be a low-risk opportunity to go long either for a brief bounce or a year-end rally that will carry back toward 2,900.”
Two days later, my inbox was full with “How did you know?” emails. Here is a brief explanation, and — more importantly — what charts and indicators suggest is next.
Support levels worth watching
The most commonly watched support level is the 200-day simple moving average (SMA). I personally don’t care for the 200-day SMA, and haven’t even mentioned it in months because too many people are watching it. An indicator’s effectiveness decreases with its popularity. Look at any chart, and you’ll see the S&P 500 Index SPX, +1.86% criss-crossed the 200-day SMA in seven of the past 10 trading days.
A more effective — and less known — support level is the trend channel and 50-week SMA shown below.
The green arrows show how often the 50-week SMA has acted as support in recent years. Last week, when the S&P 500 bounced from it, the 50-week SMA coincided with the black trend channel, which increased its predictive potency. Once broken, investors got spooked.
Next support is around 2,640, 2,600 and 2,590.
Support levels for the Russell 2000 Index RUT, +2.16% Nasdaq Composite COMP, +2.95% and Dow Jones Industrial Average DJIA, +1.63% are also not far below current trade.
Elliott Wave theory
There are a number of Elliott Wave theory interpretations floating around.
A number of them are ultra-bearish, but the one shown — which I published in the Oct. 21 Profit Radar Report update along with the commentary below — seems to be the most likely scenario:
“Based on Elliott Wave theory, if we consider the drop from 2,941-2,711 to be wave a, and the bounce from 2,711 to 2,816 wave b, the ideal target for wave c would be either 2,675 (wave c = 61.8% wave a) or 2,587 (wave c = wave a).”
Investor sentiment
As the chart below shows, we are seeing a number of short-term sentiment extremes.
• VIX: Although the VIX VIX, +8.30% can still move higher, readings around 25 have marked prior lows.
• VIX/VIX3M ratio: The current reading of 1.15 means that investors are more concerned about 30-day volatility (VIX) than 90-day volatility (VIX3M). This usually happens near a low.
• CBOE equity put/call ratio: Currently at 0.71, which means that traders are buying 0.71 puts for every call option. While this is elevated, readings around 0.90 are more commonly seen at lows.
• VIX contango: Currently at 4.85%. That means that VIX futures (VIX price in the future) trade 4.85% above the spot (or current) price. This is elevated, but could still move higher.
Conclusion
The S&P 500 already met and exceeded the initial wave c downside target at 2,675. A number of sentiment gauges are at or near “bottom is in” territory.
Another leg lower to flush out ”weak hands” is still possible, but the weight of evidence suggests that another drop (if it happens) will be followed by a sizable rally.
A more detailed short-term outlook is available here: S&P 500: Crash or buy the dip?
Simon Maierhofer is the founder of iSPYETF and publisher of the Profit Radar Report. He has appeared on CNBC and Fox News, and has been published in The Wall Street Journal, Barron’s, Forbes, Investors Business Daily and USA Today.
