Conditions are ripening for a rally

After last week’s drubbing the S&P 500 has fallen to an area of confluence from which a bounce seems quite likely at some point over the coming days:

Click to enlarge

While a 30-50 point rally in the S&P could certainly materialize over the next couple of days, the damage inflicted across global markets is quite significant. The S&P 500 breached its 200-day moving average for the first time in 475 trading sessions and the Russell 2000 and DAX both completed major chart pattern tops:

S&P 500 breaks under its 200-day SMA for the first time in 475 trading sessions

A simple yet important indication that the trend is changing and a reminder that there is ample open space below….

Russell 2000 (IWM) completes 11-month top

The measured move target on this top are the summer 2013 lows (12-13% below current levels)

German DAX Composite completes head & shoulders top 

Measured move target 12% lower

A typical scenario given the magnitude of these completed chart patterns would be for some further downside today and/or tomorrow resulting in a climax in bearish sentiment which in turn offers ripe conditions for a bear trap. The bear trap (short squeeze) rally will typically last 2-3 trading sessions before the primary trend (lower) reasserts itself and new lows are made.

A couple of things to watch for today. On Friday the equity put/call ratio spiked to .87 which is one of the first indications of retail investor fear we have seen during this pullback – a move above 1.00 would offer a high probability contrarian long signal for equities

The NYSE McClellan Oscillator (ratio adjusted) ended Friday at -61, historically this indicator has offered a good long signal for equities when it has fallen below -75 (-100 is an indication of an extremely oversold condition which we haven’t seen since June 2013)