The S&P 500 is Approaching New Highs. Double Top or New Breakout?
In the world of technical analysis a double top is a bearish reversal pattern, that sets up when a stock reaches a high twice but reverses on the second occasion below a support level created between the two highs.
On Nov 22nd the S&P 500 reached 4743 (Top 1). The index reversed reaching 4,500 on Dec 3rd but has rallied since. Today the futures show the index at 4,731 (Top 2). So now that we have just about reached the previous high set on November 22nd the question is whether or not this is a double top or is the index ready to breakout again?
If the index breaks above the previous highs of Nov 22nd then we are in un-chartered territory. However, if the index meets resistance here and pulls back below 4,500 then the double top will be confirmed and a bearish setup will be in play.
The stochastics indicator has just crossed into overbought territory. This does not mean that a correction will happen and it can stay overbought for quite some time. But it is important to watch a crossover below the 80% signal line.
The Federal Reserve:
The Federal Reserve will make their policy decision on Wednesday at 2 pm EST. Jerome Powell (The Fed chair) has already indicated that they will consider speeding up the ‘tapering’ process on asset purchases. He also removed the word ‘transitory’ from their description of inflation.
Currently, there are two rate hikes priced in for the second half of 2022. Any indication of a more aggressive policy stance by the Federal Reserve could cause a market selloff. In Dec 2018 when the Federal Reserve raised rates by 0.25% the stock market fell 17% in the following days!
On the flip side should the Federal Reserve keep a ‘wait and see’ approach as per their last meeting the index could rally to new highs.
Only time will tell whether or not this is a double top or getting ready to breakout to new highs!
Cheap Insurance:
It might be wise to buy some cheap insurance via Bear Put Spreads on the overall market just in case the Federal Reserve policy announcement causes a selloff. Currently you can buy a Bear Put on SPY ( ETF that tracks the S&P 500) that expires Dec 23rd for $50 which would pay you $950 per contract if the index fell 6.5% from current levels.
Possible Outcomes:
- Stock Market Rises: Whilst you risk losing $50 per contract if the index goes to new highs, the gains in your portfolio will more than likely offset this loss. For example, let’s assume you had stocks worth $10,000 in your portfolio and they rise with the overall market 1%. Your stock portfolio would be up $100. This gain in your stock positions will cover the cost of the cheap insurance policy at $50.
- Stock Market Falls: On the flip side if the market starts to slide you will be delighted to have this policy in place to offset losses in your stock portfolio. For example let’s assume you had stocks worth $10,000 and they fall with the overall market 6.5%. Your portfolio would be down $650. But you bought the cheap insurance policy with a gain of $950. This gain will offset the loss in your stock portfolio and still make you an overall profit of $300!
Summary
In summary, the S&P 500 is approaching new highs. There is a significant news event on Wednesday with the Federal Reserve that could move the market in either direction. At his moment in time we have no clue what will happen. A cheap insurance policy as outlined above allows you to stay in the market and cover some if not all downside risk at the same time. Might be a wise thing to do!
Happy Investing
Stephen