S&P Overbought But Downside Risk Limited

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Good Morning, this is Capital Essence’s Market Outlook (the technical analysis of financial markets) for Tuesday February 9, 2021.

We’ve noted in the previous Market Outlook that: “overbought conditions have returned on an intraday basis but momentum remains supportive so downside risk could be limited. It is possible that S&P could continue to drift higher as trading sentiment remains strong.  As for strategy, buying into short-term dips remains the most profitable strategy.”  As anticipated, S&P rallied to record highs on Monday, gained 0.7 percent to 3,915.59, led by value sectors like energy and financials on growing expectations for further stimulus at a time when Covid-19 infections in the U.S. continue to slow.  The Dow Jones Industrial Average rose 0.87 percent to 31,385.76.  The Nasdaq Composite advanced 1 percent to 13,987.64.  The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, rose about 2 percent to 21.24.

Energy led the gains in the broader market supported by a rise in oil major Exxon Mobil (XOM) on an upgrade from BNP Paris to neutral from underperforming, citing the company’s planned reduction on fossil fuel spending.  The move higher in energy sector was also supported by optimism that pick up in the pace of vaccinations will lead to a strong reopening and boost energy demand.  As such, the Energy Select Sector SPDR Fund (XLE) jumped 4.18 percent on the day and is up 17 percent YTD, outperformed the S&P.  Now the question is what’s next?  Below is an update look at a trade in XLE.

The graphics below are from our “U.S. Market Trading Map”, show the near-term technical bias and trading ranges.  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 1.1 – Energy Select Sector SPDR Fund (weekly)

Our “U.S. Market Trading Map” painted XLE bars in green (buy) – see area ‘A’ in the chart.   Over the past few weeks, XLE has been trending higher after the early January correction found support near the late 2020 rising trend line.  The overall technical backdrop remains supportive of further advance.  Right now the most important thing to watch is trading behavior as the 45 zone is tested as resistance.  A sustain advance above that level signifies a bullish breakout and trigger acceleration toward the 50-50 zone, or the 50% Fibonacci retracement.

XLE has support near 39.  Short-term traders could use that level as the logical level to measure risk against.

Chart 1.2 – S&P 500 index (daily)

Short-term technical outlook remains bullish (buy).  Last changed February 2, 2021 from bearish (sell) – (see area ‘A’ in the chart).

[Note: for more details analysis, please take a look at our “US Market ETF Trading Map”]

Key technical development in Monday session was a clear break above the important sentiment 3900 mark.  This is a positive development but let’s notice that with Monday gains, the S&P is traded above the lower boundary of the red band, or extreme overbought zone.  As mentioned, the normal behavior for the S&P has been to consolidate and retreated almost every time it traded above that level so there is a high probability that a significant consolidation pattern will again develop in this area.  While seemingly vulnerable to some short-term setback the overall technical backdrop remains positive so pullback should be short-lived.

Short-term trading range: 3870 to 3970.  S&P has support around 3900-3870.  A failure to hold above that level has measured move to around 3820.  Resistance is around 3970.  A sustain advance above that level has measured move to 4000.

Long-term trading range: 3300 to 4300.  S&P has support near 3600.  A failure to hold above that level has measured move to 3300.  The index has resistance near 4000.  A close above that level has measured move to 4300.

In summary, while overbought conditions might put a cap on the upside the overall technical backdrop remains supportive so downside risk could be limited.  As for strategy, traders should look to increase exposure into short-term market dips rather than chasing breakouts.


Thanks and happy trading.

(By:Michelle Mai for Capital Essence)

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