Bullish Breakout

Friday was a key day for equities, even though it was the half-day after Thanksgiving and volume was low. At the start of the day, the SPX faced a double trendline resistance in the 1400 area. SPX broke confidently above the resistance lines, and the 100 daily moving average in the 1407 area. It closed at 1409.

I would have expected resistance levels to hold if there was going to be much further downside before Christmas. I am now leaning bullish into the new year.

Here’s the SPX daily chart, showing the big rising wedge from the October 2011 low:

[click on charts to enlarge]

I am turning generally bullish for at least a few weeks or months, as the overall setup on equities suggests that a more significant top may not be far away. Let’s look at the rising wedge on SPX. That has broken back up over the broken rising wedge support trendline now, but that doesn’t mean that the pattern has failed, or that it has already played out. These patterns often see a significant move up after the first break downwards, and those moves up can often make new highs.

A good example of that is the rising wedge that formed on oil between June and September, shown below on the USO ETF.  After the initial break down in late August, USO went on to make a (2%) higher high in September to form the second top on a double or “M top.”

Only after that second high did the main decline begin, with the first decline having set up the valley low on that pattern indicating to a target at 33. Since then, a falling wedge (the bullish equivalent of a bearish rising wedge) has formed with a double-bottom formed at the low there. Advances or declines on these patterns often end with a second reversal pattern. If SPX goes on to establish a double-top then the second high would usually be within 3% of the first high.

Here are those setups shown below on the USO daily chart. On a break above 33, USO would have a double-bottom target in the 34.7 area, where it would hit an established resistance zone in the 34.6 to 35 range:

That brings me to this week’s trade setup on Vodafone (VOD). On the VOD chart below, a rising wedge has formed and broken down, and the overall setup for the chart is bearish. However there is a bounce opportunity here if we see a retracement early next week, which we would normally see at the start of the week after Thanksgiving.

My trade here will be to buy VOD at 25 or less on any retracement next week, with a stop at 24.25, under the established support zone at 24.5 which held the recent low. The RSI reached an oversold reading not seen in the last seven years there, and I’m looking for either a right shoulder on a head and shoulders pattern to form here, or the second top of a double-top. My first upside target is 26.5. If VOD hits 26.5, I plan to sell half and set the stop on the remaining half to break even. I will sell the remaining half if it reaches 29–in the area for a second top of a double-top, and under strong long term resistance in the 29.5 area. Here’s how that looks on the VOD daily chart:

There are several potential bad news events for equities between now and January, such as the failure to reach an agreement on the fiscal cliff. I am concerned about news derailing the market between here and Xmas, but am inclined to trust the technical setup rather than news or fundamentals as the technicals tend to perform better. If the market does get derailed the technicals should give some warning at least.

The seasonality at this time of year is strong, with a potential retracement next week and a strongly bullish lean from there into the new year. This technical analysis is line with Lee Alder’s observations on the money flow from the Federal Reserve to the Primary Dealers.

SPX has a strong resistance area to negotiate between 1420 and 1430, but as long as it can get past that, I’m looking for a test of the highs.

From Market Shadows Newsletter (11/25): From Fed, With Love.