Look for stock markets to reverse after Friday’s news-driven rally. Traders should expect large rallies like that to be at least partly reversed in the short-term. Friday’s move pushed the S&P 500 into overbought territory when looking at the one-month relative strength (RS). Over this time frame, high RS is best used to spot short trade candidates. RS measured over periods of three months to a year should be used to find long trades.
SPDR S&P 500 (SPY) has reached this overbought level 50 times since 2001. The result? A week later SPY closed lower 94% of the time. SPY was lower on the day following this signal, which will be Monday, 100% of the time. Barring more major news, we have a very high probability short trade in SPY this week. That makes ProShares Short S&P500 (SH) a buy and aggressive traders should consider ProShares UltraShort S&P500 (SDS), an ETF designed to move twice as much as the underlying index on any day.
For SPY, the critical levels to watch this week are shown in the chart below. A close above $136.45 negates the short trade. Support is at $132.99, and a break below that level could see prices retest the recent low near $127. Based on market history, SPY should break the initial support this week.
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