With only a few days left until the end of the year’s first half, the stock market bounced from the lows. But, sure enough, the bounce looks timid at this point, especially considering that the -20% threshold has only been reached recently.
A -20% decline from the highs marks the start of a bear market. Rallies during a bear market are known to be aggressive, giving the impression that the bear market ended.
This is precisely what happened in the last few days.
Stocks are off their lows, as reflected by the S&P 500 index. It bounced back above 3,900 points in an almost vertical move, despite the Federal Reserve being hawkish and the market expecting more rate hikes at every Fed meeting left in 2022.
So is it time to buy the S&P 500 index? Or is this the time to fade the rally and establish a short position? After all, this is a bear market. So what should it be?
It has all been a massive bullish divergence
2022 began with the S&P 500 at record-high levels. Since then, it corrected more than -20%.
However, the Relative Strength Index (RSI) has diverged from the price action all this time. The RSI is perhaps the most popular oscillator in the financial community.
Traders use oscillators to filter false breakouts in the market. More precisely, if the market makes two consecutive lower lows, but the oscillator fails to do so, then a bullish divergence appears.
The oscillator is more reliable when making a trading decision based on the two. This is because it considers multiple periods (usually 14) before plotting a value, unlike the price action that is based on the open candlestick.
Based on this information, the RSI shows a huge bullish divergence, followed by another one of smaller amplitude. It does not mean that a reversal is a certainty, however.
In fact, the series of lower lows and lower highs may easily continue, and the market keeps diverging from the RSI.
But it does show resilience. And it tells short-sellers that the risk of a reversal increases by the day.
Another bullish pattern formed in the first half of the trading year. More exactly, a falling wedge pattern.
The market still moves between the two edges, but a daily close above 4,000 and the upper trendline implies that the pattern has ended. After a falling wedge, the price action typically retraces at least half of the entire decline, so a move above 4,250 should not be discounted.
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