The SPDR S&P 500 Trust — SPY. The most actively traded ETF on the market, with an options market to match, is widely considered to be a benchmark for the overall U.S. stock market.
Since the first month of 2022, the SPY ETF has been in a well-defined downtrend.
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How Is a Stock Market Downtrend Defined?
A downtrend in the stock market is defined by a series of lower lows and lower highs in the price of a stock or a stock index. In other words, a downtrend is characterized by a persistent decline in the value of a stock or index over a period of time.
During a downtrend, the market will often experience a series of bearish technical indicators and patterns. Patterns like lower highs and lower lows, or a bearish crossover in moving averages.
Additionally, the overall market sentiment may also be negative, with many investors and traders becoming more cautious and less optimistic about the future prospects of a stock or the market as a whole.
It’s worth noting that a downtrend does not necessarily mean a bear market, which is a broader and more severe decline in stock market values. A bear market is generally defined as a decline of 20% or more from recent highs, while a downtrend is a persistent decline in stock prices but may not reach the 20% threshold.
That said, in 2022 the SPY ETF experienced all three.
Source: TradingView, Market Rebellion
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But this is not the chart that the market can’t stop talking about.
Traders all over FinTwit are looking at this chart:
Source: TradingView, Market Rebellion
This is a weekly chart of the SPY throughout 2022. As it stands, we’re (for the fifth time) bumping up against the trendline. A look at the prior chart depicts a possible glimmer of hope: A peak above the 200 day moving average.
Everyone has a different idea of what it means for the SPY.
Some people see a reverse head and shoulders bottom.
Others see signs that we’ll bump against the trendline as we have four other times this year, fail, and take another leg lower.
Others are simply watching and waiting before making their next move.
Our own AJ Monte has even given his own take, which is that the major indices are overbought and likely to take a breather. According to AJ, the CCI, the stochastics, and the drop in volume all point to a bearish divergence in SPY. Want more of AJ Monte’s real-time market opinions? Subscribe to the Weekly Market Report for free weekly takes from Market Rebellion’s Lead Technical Analyst.
Still, with so many conflicting viewpoints, who’s right? And how can you trade the next move in the SPY?
How to Trade SPY: Wait for the Candle
As we always say, the most important trading trait is discipline. In this case, that means waiting for the close of the next weekly candle. With the SPY ETF (and the market as a whole) in a well-defined downtrend, a close that lands confidently above that downtrend line could be a powerful sign of a trend reversal.
This would coincide with a break in the $400-level (a difficult battleground for the SPY throughout the past year), an SPY that remains above its moving averages, and an end to the “lower highs” of the prior year.
In other words, a close above the downtrend line would likely become a self-fulfilling prophecy that many traders, funds, and algorithms would likely jump on. According to a January 17th Bank of America survey, hedge funds and fund managers are the most underweight that they’ve been to U.S. stocks since 2005.
The significance of being more underweight now than they were during the Great Financial Crisis is key, because if bullish signals continue to line up, fund managers will have plenty of catching up to do in order to even get back to equal weight. This is a phenomenon that Fundstrat’s Tom Lee has been pointing out for roughly a year.
So then, why wait for the candle at all?
Because another failure to break through the downtrend line will almost certainly be viewed as a continuation of the previously established downtrend. Despite how far stocks have rallied in January, stopping here would still be another “lower high” — that wouldn’t be good for bulls.
The Bottom Line
Before you act on this precarious SPY trade set-up, wait until you get confirmation of the trade direction. If the SPY weekly candle closes confidently above the downtrend line, that’s likely very bullish for SPY and the market as a whole. If SPY fails to close above the line, it could spell trouble for bulls — and create a bearish trade set-up heading into earnings season.