As you know U.S. stock market bottommed in early June and staged a good rally from there. In early July the rally accelerated a bit, but then we saw a sharp decline last Friday. And it appears this rally may be over. That’s one of the main reasons I do not like to trade these oversold rallies – becase by their nature they start out of the blue and then end suddenly. Right now the daily chart is not very bearish yet, so we may see some choppy trading and another rally attempt later this week, but eventually I expect to see a resumption of the decline that started in early May. A decline below 2510 in Nasdaq 100 and 1310 in S&P500 will be a good sign that the bears have taken control again. You can see the daily chart of S&P500 for a clue about what I expect here:
Now, let me give you my reasoning why I do not expect to see an immediate decline below the key levels stated above. First, let me be clear, it is quite possible that the larger-degree downtrend has already resumed, but that’s not the most likely scenario. Why? – Because of the behaviour of the VIX index. If you take a look at VIX, you will be surprised to see that it actually declined on Friday despite the huge decline in the stock market (as you know, it is more natural to expect VIX to rise when stocks decline). That fact tells us two things: 1.) the market is likely not ready to tumble from here as usually the increased volatility preceeds the market decline and 2.) there is a huge complacency at the market, i.e. the sentiment is extremely one-sided as almost everyone is bullish. This second thing is a good reason why the next decline is likely to be deeper than the 1st one that we experienced in May.