Doji candlestick could signal market bottom

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“… There have been some technical developments that are encouraging for bulls. The first is where the SPX bottomed earlier this month, which was around 20% below the SPX’s all-time closing high and year-end 2021 close. Note that this low was also near 3,852, the close of the SPX when President Joe Biden took office in January 2021…you don’t have to look further than March 2020 when the SPX was in the 2,270 area where the Index was down, trading bottomed when Biden’s predecessor, Donald Trump, took office in January 2017. A key difference between now and then is that in 2020 we were on the cusp of major fiscal and monetary stimulus, while the Fed is now raising rates and not buying bonds, and fiscal stimulus is a thing of the past

-Outlook Monday morning, May 29, 2022

As May ended last Tuesday, long-term bulls added another piece to a difficult puzzle, with the S&P 500 Index (SPX -4,108.54) closing above its 24-month moving average and recovering from a multi-pronged area of ​​support – as above discussed in excerpt – earlier this month. Notably, the index ended the month above its 24-month moving average, giving new life to bulls that were on life support just weeks earlier.

While the May close doesn’t definitely mark a bottom like I hinted at last week, it could give some of you a reason to tiptoe back in the water, or if you have the urge to do more than tiptoe, take advantage the three-week drop in volatility as measured by the Cboe Market Volatility Index (VIX -24.79) to hedge long positions.

As a quick side note on this drop in the VIX, the 3-month daily chart below has bounced back and forth between the levels since returning above the level coinciding with its 50% year-to-date gain on April 22nd hovering which coincide at 50% and 100% above the 2021 close at 5:22 p.m. Call buying on VIX futures is still relatively small compared to put buying, suggesting that the VIX could decline further in the coming weeks and break the current pattern.

There was another interesting aspect to the May close as the monthly candle was a doji. In other words, the May open (4130.61) and close (4132.15) were about the same.

Such doji candles on a monthly chart are not that common. And with doji candlestick patterns being used as a signal for the possible end of an ongoing trend, this doji candle piqued my interest as it occurred in a month testing the 24-month moving average. As such, I referenced a monthly chart of the SPX to look for other events where the SPX experienced a monthly doji in the midst of a correction or bear market.

I’ve found eight incidents since 1990. All but one (August 2002) signaled a major bottom. In August 2002, the SPX did not bottom until six months later, which ironically was also a doji month.

In the case of October 1992, months of sideways movement were followed by a strong rally. While there is a possibility that this is August 2002 and the May 2022 monthly doji on the SPX is not signaling an end to the trend, bulls can rest on this story for now. Per my comments in parentheses, there is some commonality in the May doji occurring at its two-year moving average, although most instances saw bottoms at the SPX 12-month or one-year moving average.

SPX dojis

SPX Doji Months 90-99

SPX Doji Months 2000-2010

SPX Doji Months 2010-2023

But if you’re set on equities, you might want to consider easing as there’s still major potential resistance from 4,170, the March closing low, and 4,375 above that. How the market performs around these levels when tested can give us another clue as to whether this is a short-term rally in a bear market or a longer-term rally. For example, if the SPX fails to scale both of these levels and subsequently moves back below its 24-month moving average, the chances of breaching the recent lows increase. But a move above these resistance levels would increase the likelihood that a longer-term rally is on the horizon.”

-Outlook Monday morning, May 31, 2022

While longer-term charts look encouraging for bulls, that doesn’t mean the all clear sign is flashing, especially in the context of mixed sentiment indicators – some showing negative extremes, like call options on the SPX and Nasdaq -100 Index (NDX—12,548.03 ) components. At the same time, we have seen inflows into leveraged technology exchange-traded funds (ETFs) and outflows from broader market ETFs.

The bounce off the May lows has been impressive, but as the excerpt above shows, there are resistance levels immediately overhead to take as confirmation that last month’s low is having persistence.

For example, my Twitter comment on Thursday, June 2 proved premature as the SPX close barely recovered above its June 2021 and March 2022 closing lows in the 4165-4170 range and was quickly hit by sellers in Friday trading became.

This could indicate that if you are using this level to come back into the market with extra dollars, it is better to wait for a weekly close above this level or for at least two daily candles where the SPX high, low and close are above it lie area of ​​resistance. Also, I find it interesting that Thursday’s close was roughly the same as May 3’s close of 4175, the night before the Fed’s last rate hike.

There are other resistance levels to keep an eye on, whether that be the October 2021 and January 2022 lows at 4,300 or the trendline connecting lower March-April highs that starts the week at 4,280 and ends at 4,250.

Finally, the 4,375 level should not be forgotten as this is the level from which the SPX saw a short lived breakout above a trendline connecting lower highs in January and February, with the breakout back below this level on April 22nd strong selling led late last month.

In summary, a monthly candlestick chart of the SPX 24-month moving average is encouraging for bulls as there is a lot of history on their side. But with the Fed raising interest rates and an unclear path as to how far it will go to fight inflation, the jury is out on whether multiple levels of resistance will prove impenetrable.

If you remain patient to put more dollars in and let the SPX price action guide you, you have little risk if sellers show up at those resistance areas that I have pointed out to you. However, if the SPX moves convincingly above each of these levels, you can steadily increase your dollar allocation to stocks if the last month proves to be a significant bottom.

SPX Daily Leg In

Todd Salamone is senior vice president of research at Schaeffer’s

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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