SPY Island Reversal Setup
Last week saw the largest decline in markets since the rally of the March low and in doing so created an Island Reversal Pattern which is a bearish type of chart pattern. Island Reversals form when price creates a gap up during an uptrend, holds above the gap level for a few days, and then reverses back to the downside while creating another gap on the move down thus creating an “island” consisting of a few price candles that are suspended above the bulk of recent trend. This Island Reversal occurred during a trend of yellow price candles which indicates that the market was experiencing bullish momentum volatility which can either be a signal of continuation or sign of a reversal. In general, after a period of bullish momentum volatility the trend will continue upward as long as price remains above the low of the first yellow candle(dashed yellow line) while a reversal tends to occur if price breaches below the first yellow candle. Price held just above the dashed yellow line on Thursday’s decline as well as on Friday’s attempted rally.
Going into the new week of trading there are two things we want to watch for as a signal of what to expect next:
1) Should price make a move below the dashed yellow line it will likely be an indication that the two-month rally off of the March low has ended and a new short-term bear trend is forming.
2) Should price hold above the dashed yellow line and move higher while filling the gap it will likely indicate that the recent uptrend is still in play while keeping momentum in favor of the bulls.
The Relative Strength Index(RSI) shows the green RSI has crossed below the purple signal line which indicates that the short-term momentum in price has shifted bearish. The green RSI is holding above the 50 level which is the midpoint of the total RSI range. In general, an RSI reading above the 50 level indicates overall bullish momentum behind price while a reading below 50 indicates overall bearish momentum behind price. Should the green RSI line cross below the 50 level it could be an indication that overall momentum is turning bearish, while a bounce up and off of the 50 level would indicate that overall momentum is remaining bullish.
The Price Percent Oscillator(PPO) shows the green PPO in a fresh cross below the purple signal line which indicates short-term bearish momentum in price. The PPO and signal line both remain above the 0 level though which indicates that overall price momentum remains bullish. In general, a PPO reading above 0 indicates intermediate-term bullish momentum while a reading below 0 indicates intermediate-term bearish momentum.
The Average Directional Movement Indicator(ADX) shows the green directional line(+DI) has crossed below the purple directional line(-DI) which indicates that the short-term trend in price is bearish. When the green +DI line is trending above the purple -DI line it indicates a bullish price trend, while the purple -DI line trending above the green +DI line indicates a bearish price trend. The histogram in the background shows trend strength and since we have the purple line above the green line it is showing us the strength of the bearish trend. When the histogram is rising it indicates a strong trend and when the histogram is declining it represents a weak trend, and for now the histogram is declining which indcicate that the current bearish trend is weak.
The Volume indicator shows a two-day spike in volume as price gapped down after a period of relatively low volume in April and May. The volume on Thursday and Friday was at its highest levels since the March selloff which indicates that more traders were active on the late-week selloff.
Overall the dominant trend in price remains bullish, but could turn bearish based on the island reversal setup as well as weakening lower trend and momentum indicators. Watch for support above the dashed yellow line as a signal that price may move higher; watch for a move below the dashed yellow line as a signal that the uptrend has ended. Current view is neutral, but I opened a short-trade on Friday due to the possibility that the island reversal pattern was a sign that the two-month rally has lost steam and is at risk of reversing to the downside.
Going into the new week of trading there are two things we want to watch for as a signal of what to expect next:
1) Should price make a move below the dashed yellow line it will likely be an indication that the two-month rally off of the March low has ended and a new short-term bear trend is forming.
2) Should price hold above the dashed yellow line and move higher while filling the gap it will likely indicate that the recent uptrend is still in play while keeping momentum in favor of the bulls.
The Relative Strength Index(RSI) shows the green RSI has crossed below the purple signal line which indicates that the short-term momentum in price has shifted bearish. The green RSI is holding above the 50 level which is the midpoint of the total RSI range. In general, an RSI reading above the 50 level indicates overall bullish momentum behind price while a reading below 50 indicates overall bearish momentum behind price. Should the green RSI line cross below the 50 level it could be an indication that overall momentum is turning bearish, while a bounce up and off of the 50 level would indicate that overall momentum is remaining bullish.
The Price Percent Oscillator(PPO) shows the green PPO in a fresh cross below the purple signal line which indicates short-term bearish momentum in price. The PPO and signal line both remain above the 0 level though which indicates that overall price momentum remains bullish. In general, a PPO reading above 0 indicates intermediate-term bullish momentum while a reading below 0 indicates intermediate-term bearish momentum.
The Average Directional Movement Indicator(ADX) shows the green directional line(+DI) has crossed below the purple directional line(-DI) which indicates that the short-term trend in price is bearish. When the green +DI line is trending above the purple -DI line it indicates a bullish price trend, while the purple -DI line trending above the green +DI line indicates a bearish price trend. The histogram in the background shows trend strength and since we have the purple line above the green line it is showing us the strength of the bearish trend. When the histogram is rising it indicates a strong trend and when the histogram is declining it represents a weak trend, and for now the histogram is declining which indcicate that the current bearish trend is weak.
The Volume indicator shows a two-day spike in volume as price gapped down after a period of relatively low volume in April and May. The volume on Thursday and Friday was at its highest levels since the March selloff which indicates that more traders were active on the late-week selloff.
Overall the dominant trend in price remains bullish, but could turn bearish based on the island reversal setup as well as weakening lower trend and momentum indicators. Watch for support above the dashed yellow line as a signal that price may move higher; watch for a move below the dashed yellow line as a signal that the uptrend has ended. Current view is neutral, but I opened a short-trade on Friday due to the possibility that the island reversal pattern was a sign that the two-month rally has lost steam and is at risk of reversing to the downside.
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