ES/SPY from here - 3 Likely Paths and How I Would Play Them

The ES/SPY futures chart has been trading in a bearish rising wedge and is once again threatening to fall below it near the wedge apex. I'm providing 3 likely paths the trend may take from here.

The most bearish prediction (red) is a steep correction. We saw a very similar pattern play out after new all-time highs were hit early this year. Rising wedge breakdowns are generally quick drops that occur near the apex of the wedge , but usually also involve some intense bullish retracements, especially due to the extremely strong bullish trend . Expect increased volatility and an expanding price range if the lows of today (9/26) are taken out overnight or tomorrow (9/27). How far and fast this could dip is difficult to predict. The daily 100 and/or 200 sma could be tested or even broken at some point before we see a new all-time high, but I anticipate buyers will be found at or just below the 50 day moving average resulting in a significant first rally, especially if it is tested on high-volume within the next week. I plan to exit a portion or all of my short position on a heavy-volume push below the 50 ma to take advantage of increased implied volatility . The weekly 10 ema would also be a reasonable 1st target. Buying calls anticipating some sort of bounce at or near the weekly 20 ema if it is reached is certainly worth a try (we haven't tested it since July), but I would exit a long position quickly for a profit if a lack of buyers is found when returning to test either the weekly or daily 10 ema . If a 2nd corrective wave follows the 1st rally, my downside targets will be the daily 100 and 200 sma's. I would review the pattern from February/March of this year to get an idea of what to expect (we saw a 50% retracement after the first drop in early Feb, followed by a 78.6% bullish retracement in March (measured from January highs to Feb lows).

The most bullish case (blue) involves squeezing back up through the bearish rising wedge , likely making a new all-time high as traders with short positions are forced to buy to cover. We saw this occur earlier this month when sellers were unable to close a daily candle below the wedge , so it could certainly happen again. Typically, this is followed by some type of a topping pattern ( double top , head and shoulders , etc) and a sudden "dump" at the very apex of the rising wedge . How this scenario plays out beyond this point, it's hard to say, but due to the strength of the trend, I would stay cautiously bullish , buying dips until the lows of the previous bullish wave are taken out (in which case we would get some sort of a corrective phase).

Finally, there's the neutral path (green), where sellers prevent price from holding inside the rising wedge , but enough buyers are found below it in order to develop into a new rising wedge pattern or something like a horizontal channel. At some point, we will see price range expand, either returning to making higher highs and higher lows beyond the wedge apex (see blue above), or beginning a drawn-out distribution phase, which appears on the chart as a slightly downward trending channel or long-range bull flag pattern. Distribution phases can go on for weeks to months and are generally difficult to trade until the range is clearly established. Fib retracements and previous points of support would be the most useful for estimating potential bounce points that can be bought either with a tight stop, selling rallies just below previous resistance, or "pyramid in," building a bullish position slowly as it trades lower if intending to hold throughout the phase. When the distribution phase ends, it generally happens suddenly (sometimes covering the entire range within a matter of days) and with increased buying volume .

Personally, I'm initially playing this pattern bearish with put options, simply because I see the risk:reward ratio as most advantageous. Even if the likelihood of a full trend reversal at this point is relatively low due to the strong bullish trend , the profit potential from a pullback of just 3-5% is high enough to give puts a try here. A daily candle close well inside the rising wedge would be enough evidence to exit the short position and wait for further signals, such as a topping pattern above the wedge apex to re-short. While I would prefer to see the red pattern play out and would see even a 10% correction here as healthy for the overall trend (as long as the 2018 lows hold), I fully expect the green pattern with a prolonged distribution channel to emerge eventually, either gradually within the next few weeks or following a more gentle 3-5% pullback.
Oct 08
Trade closed: target reached: Reached 1st bearish target and exited for a profit. Expecting a retracement/bounce of some kind, perhaps back-testing the rising wedge, then will re-evaluate. May play the bounce conservatively bullish depending on where we open tomorrow.
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