I Think Another Market Rally Is About To Begin… Here’s Why

Last week was a volatile one in the stock market. That Monday, stocks opened sharply lower, and the selling continued throughout the first part of the day. At the low, SPDR S&P 500 ETF (NYSE: SPY) was more than 5% below its all-time high. The decline took just 11 trading days.

During the rest of the week, SPY rallied back and closed high enough on Friday to eke out a small gain for week.

As expected, the 50-day moving average (MA) was important to the price action.

SPY did break below the MA. But the decline stopped right at an important support level near 429.68, which I’ve added to the chart above. That line is based on the principle of symmetry, which can be applied to charts.

The 50-day MA shows the average trend in the stock market over the past 50 trading days, or almost three months. To capture the true trend over three months, we would want to use a 66-day MA since there are an average of 22 trading days in a month. But the 50-day MA is popular with traders and has been for decades. Because of its popularity, it’s worth paying attention to.

For the 50-day MA, or for any moving average, we tend to see prices move above it and below it. There is often a degree of symmetry in those moves. That means we often see prices move about the same distance above and below the MA.

One reason for the symmetry is the fact that the distance from the MA shows the degree of emotion in the market. Extremes in exuberance, shown as large rallies above the MA, are often followed by extremes in pessimism, which result in large declines below the MA.

Last week’s selloff ended almost precisely at the first target based on symmetry, and prices are now likely to move back to new highs.

Other Reasons For Optimism

Sentiment confirms my optimistic outlook.

Individual investors seem to be wary of the current rally. Bearish sentiment was essentially unchanged despite last week’s gains in major indexes, according to the American Association of Individual Investors survey.

Source: AAII

A large number of individuals turned bearish the previous week after a 3% drop in the S&P 500. They remained bearish. The shift in bullish sentiment came from a decline in the number of investors who have a neutral outlook for the next six months. As bears turn bullish, prices could rally substantially.

Now, for the short-term outlook, I want to look at my indicators. And on that front, I am cautious in the short run.

My ITV indicator remained bearish for SPY but is at a high level that’s consistent with short-term bottoms.

Its current position, with the indicator so far above the MA (blue line), means it is likely we should see a rally as ITV reverts to its average.

My Profit Amplifier Momentum (PAM) indicator offers additional support for my optimism. This indicator already reached its bearish extreme a few weeks back — shown by the bars in the bottom panel — and is now moving back toward a “buy” signal.

PAM is designed as a short-term indicator. So based on this, I’m optimistic that a rally is beginning.

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