Ever since the December FOMC (which was largely a “more of the same” experience in terms of what information Powell offered to the market, except for one implication about the future of quantitative easing), the S&P 500 has been nosediving. Is it really because of narratives like this?
“The soft-landing narrative is in trouble, and that’s making stocks look expensive.”
Answer: No, probably not.
Finance news outlets love to assign an arbitrary reason to the day-to-day movements of the stock market. You’ve seen it before. You’ll open up your favorite website for up-to-the-minute finance news in the premarket, and you’ll see something like,
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“Market trading lower as recessionary fears mount.”
…And then the market will turn, and start rallying, and that headline will flip to something like,
“Market trading higher as investors cheer slowing economy as a sign of inflation easing.”
It’s tiring, it’s nonsense, and it’s not what we at Market Rebellion do.
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Usually, when you see short-term stock movement, it’s more clearly attributable to charting and trade dynamics than some ethereal representation of “investors” collectively agreeing that some event is universally “bad” or “good” for the market.
Enter: The S&P 500 Chart Gap — The More Likely Reason for This Week’s >7% Peak-to-Trough Decline
We’ve talked about gaps plenty of times in the past. If you’d like to read more about gap fills and how a licensed CMT trades them, check out this article featuring a clip from Market Rebellion’s Lead Technical Analyst, AJ Monte.
If not, we’ll sum it up. A gap looks like this:
It’s the empty void created from a “gap-up” or a “gap-down” opening. It’s measured from wick to wick, shadow to shadow — not from the body. And it’s considered to be “filled” when another candle’s wick or shadow trades fully into that range. That is what we call “filling” or “closing” the gap.
Trading the gap is one of AJ Monte’s favorite technical trading set ups because it’s widely recognized, easy to spot, and as such, technical traders can turn these gap fills into a self-fulfilling prophecy. That’s why gaps fill 80% of the time — and why one just filled today.
Between November 9th and November 10th, the SPY “gapped-up”, creating a hole — an empty void — a gap between $381.14 and $385.64. With momentum drilling stocks to the downside, this became a reasonable, nearby target for bearish traders to short into, and bullish traders to steer clear from.
But what happens when a gap fills?
Gap Fills Frequently Lead to Reversals
As we said above, gap fills can act as a sort of “short-term price target” for traders and algorithms funneling into a trade. The money they shovel in goes a long way in moving stocks in their direction, and that creates momentum. But once the target is reached, what happens?
Typically, they exit the trade. It’s time to move on to the next one. Likewise, when a gap fills, it can represent the vanquishing of a threat for traders looking to get in on the opposite end of the trade.
In the above case, a bullish SPY trader may have waited as the ETF approached the gap, knowing that with the gap in striking distance, it was likely going to be filled. That trader (or algorithm, more likely) knew that if they waited to buy, they could probably get a better price. However, with the gap filled, it can look a lot more appealing.
Add in that in this particular situation, the SPY has traded in the red for four days:
- -0.64% on December 14th
- -2.45% on December 15th
- -2.03% on December 16th (at the time of writing)
A popular trading theory states that after the third consecutive day of same-direction price action, the odds of a short-term reversal become greater with each passing day. That’s a fancy way of saying,
“Stocks can’t move in one direction forever.”
The bottom line: The SPY gap is closed. Now, as short traders claim victory, taking profit on their position — and long traders look to establish positions heading into the end of the year, a gap fill reversal (even on a one day basis) could create a solid opportunity for a bounce.