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Good Morning, this is Capital Essence’s Market Outlook (the technical analysis of financial markets) for Wednesday September 2, 2015.

We’ve noted in the previous Market Outlook that: “based upon recent trading actions, an important near-term high has been established and the S&P is in a midst of a short-term overbought consolidation.”  As anticipated, market turmoil continued Tuesday as weak data out of China and decline in energy pushed all major U.S. indices down nearly 3 percent.  For the day, the Dow Jones industrial average closed down 469.68 points, or 2.84 percent, at 16,058.35.  The S&P 500 closed down 140.40 points, or 2.94 percent, at 4,636.10.  The Nasdaq closed down 58.33 points, or 2.96 percent, at 1,913.85.

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Notably, the CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, surged 10.45% to 31.40.  Often refers as investors fear gauge, VIX tends to move inverse to stocks and is used to determine the severity of futures moves in stocks.  General speaking, a reading above over 30 often associates with some sorts of selling panic while a move below 20 indicates complacency.  Below is an update look at a trade in VIX.

Chart 1.1 – CBOE Volatility Index. (daily)

Looking at the 4-year daily chart of VIX, we can see that the mid-August massive selloff had caused volatility to spike to the level that had not seen since 2011.  VIX had once again closed above the 30 threshold following Tuesday’s selloff.  When the VIX is this high it means there’s some panic out there and that from a contrarian point of view is positive because it’s suggested that the market is at or very close to a tradeable bottom.

Right now the most important thing to look for is trading actions around the 30-40 zone.  A failure to move above 40 follow by a close below 30 signals the wash-out is done and this bull market has further to go.

Of course, if VIX climbs above 40, it could be indicative of something more serious!

After all, high volatility gave way to lower stocks prices.  The S&P 500 ended in correction territory, down nearly 3 percent in their third-largest daily decline for 2015.

The graphic below is from our “U.S. Market ETF Trading Map”, show the near-term technical bias and trading ranges for the S&P 500 index.  As shown, the underlying is in a short-term bullish trend when the price bars are painted in green.  The underlying is in a short-term bearish trend when the price bars are painted in red.  The yellow bars identify period of neutral or sideways trading pattern.  Additionally, the light-blue shading represents the short-term trading range.  A move above or below that range is considered overbought (as represents by the red shading) or oversold (as represents by the dark-green shading).  Readings above or below the red and green shaded areas are considered extremely overbought or extremely oversold.

Chart 1.2 – S&P 500 index (daily)

As indicated in the above chart, our “U.S. Market ETF Trading Map” rates the S&P as a Sell.  Tuesday’s downside follow through served as a confirmation and extension to Monday’s bearish reversal signal.  Money Flow measure trended lower from below the zero line, indicating an increase in selling pressure.  This is bearish but let’s notice that with Tuesday’s decline, the S&P is less than 30 points to the bottom of its short-term trading range.   As it was the case of late, a traded below that area often marked short-term market bottom.  So, it seems to us that downside risk could be limited.

Over the next few days, traders should monitor trading behavior near 1885-1867.  Expect the index to draw in buyers in any pullback toward this area.

Of course, if the market fails to rebound, then we know that market’s internal strength has deteriorated and that the S&P will have to move to a much lower level to attract new buyers.

For now, the important sentiment 2000 mark represents key resistance.  Unless there is a close above that level, the path with least resistance remains lower.

In summary, our near-term work on momentum and price structure suggested that the stage is set for a re-test of the prior low near 1867 on the S&P.  Current trading environment is terrible from the perspective of volatility. Given that high volatility indicates that investors are more risk averse, lower stocks prices should be expected if the VIX is going to stay elevated.

(By:Michelle Mai for Capital Essence)

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