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January 26, 2010

Creepy Crawly

For those getting caught up in intraday action, the market had lots of curves to throw. Stocks... particularly the NDX... rallied fervently enough in the early going to convince some traders that the correction was over. The rally failed. Silver swooned heavily in the AM, recovered most of its losses, then closed weak. Gold diverged from silver and threatened to regain the $1100 level, but also failed. All this was noise. The stock market is controlling this correction, and the bottom line is that the S&P 500 did nothing but continue to consolidate beneath its 65DMA. In fact, the action is beginning to suggest a crawl forming just under the moving average.

s&p 500 index daily chart

Now, allow me to dispel a popular misconception about such crawls. Traders generally believe that a crawl along a moving average leads to an imminent break of that MA. However, crawls are continuation patterns, not reversal patterns. Regardless of the side of the moving average on which the crawl occurs, price tends to extend in the same direction as which the MA was approached.

A classic example of a crawl forming post-break occurred on the US Dollar index back in the summer.

us dollar index trend line

Therefore, if a crawl is, indeed, forming here, we have another strong clue to more weakness in equities. In fact, when price crosses a moving average before forming its crawl, the extending move tends to be more powerful. After all, the moving average was unable to resist the price move in the first place, implying a particularly strong thrust. Combine all the clues... moving average break, trend line crawl, no buying-on-weakness, multiple NRCs, and the fact that we are due for a intermediate cycle bottom... and the odds are heavily in favor of stocks suffering another swoon in the next couple of days.

The caveat is that price did print a marginal new low for this correction (by the width of a hair), so there is a potential for a swing low should stocks move higher tomorrow. Even if a swing low were printed, I will be skeptical unless we see a close above the 65DMA. Printing above Friday's high would be even more encouraging. As noted, price only set a new low by a razor-thin margin, so its credibility for the purposes of a swing low is also razor-thin.

Speaking of crawls, we have an item of major concern for precious metals bulls on the DX chart:

us dollar index daily

I expected the DX to be rejected rather fervently by its 200DMA, but price is lingering. If this countertrend rally takes a classic A-B-C form, we could yet see an extension to about 80.75. The only good news in this scenario is that it should be over fairly quickly. The "A" leg lasted just over three weeks, so the "C" leg should only last another week and a half or so. Of course, those of us sitting on call options will be watching precious time melt away. For the record, I am considering buying DX futures as an additional hedge. Such a trade would be exited once the DX either 1) negated the crawl by dropping away from the 200DMA or 2) resolved the crawl with a break higher and then printed a new swing high.

Given the nature of this correction thus far, I expect it to end violently. We will likely see a panic day in which both gold and silver fall into the vicinity of a major pivot, perhaps $16 and change for silver and $1025 for gold. Historically, these panics occur early in a session and are almost entirely reversed by early afternoon. Such a day would signal the commencement of the next, powerful wave higher in precious metals and could also occur days before the dollar rolls over. Apart from toying with hedges, my trading plan will be to buy any morning panics in PMs... via silver futures... and close out the trade if the swoon is not substantially recovered by early afternoon. Honestly, though, I would just prefer if the market fooled us all and turned higher tomorrow!


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