European Woes Weighing on Markets, Futures Drop Hard in Last Hour

US markets looked poised for a significantly higher open this morning until the last hour when futures sold off sharply. In a 30-minute stretch this morning the SPY dropped nearly 3 points, demonstrating that the extreme volatility is not limited to market hours. American markets have struggled over the past couple days while European markets are open due to mounting concerns over sovereign debt.

Massive swings give institutions liquidity to sell equities. Huge plunges typically lead to more downside as margin calls are triggered and some institutions are forced to liquidate. These are patterns that I’ve experienced before in my 14+ years of trading. The first pattern to Identify was the Head and Shoulders top.

This gave everyone enough time to sell some longs and perhaps get ready for the neckline break to get short (1250-1265). In the words of CNBC’s Patti Domm “Scary ‘Head and Shoulders’ Pattern Emerges in S&P Chart.

At this point the market is trying to pause here and build a new lower pivot. The question is, will it hold and start a new fledgling rally? The formula is fairly straighforward: Day 1- no violation of that day 1 move, then a follow thru within day 4-7 , then a follow-through day of 1.5% on heavy volume.

Yesterday’s quick action to the downside violated all my retracement rules. This took the quick follow through momentum trade off the table. We now have a new lower range to trade against, assuming we don’t open below it this morning (which is looking like a big IF).

But that doesn’t mean you have to trade. This is a tough tape. The only strategy that is working is buying extreme down moves for a trade, or shorting bounces and breakdowns. Buying the high beta stocks at key points for a cash flow trade and then taking profits.

Micro resistance is 1137 and then 1146. Medium resistance is 1160 then 1171. Macro Resistance is 1220-122.

Lower end support is 1118-1122, then the recent low of 1101. A 30/60 minute close or a daily close below this level will then give you a Re-test of 1077 longer term support 1040. Then major-major support is 1010 from 7/01/10. These levels might not come into play for a few weeks.

Futures are opening up 10 handles or so and we are still drastically oversold. Let’s see if this gap up can hold, for a push into the upper end of the micro range. Or do they sell them off? We still can try and make cash flow in this range. Before it either resolves to the upside or downside. But I would only put “small macro” money to work if you are trying to put longer term money to work. Break it up into three tiers. One in this lower pivot, then add if we get more clarity and resolve to the upside. Or add in the 1010-1040 range if we continue if break lower and try and bottom at bigger support. I put a 70% chance that the low of the year is not in.

The reason why many of us navigated 2008 so well is because we traded levels vs. levels and did not get emotional or use opinions We watched to see what didn’t bounce when the market tried to relieve oversold conditions. We let the market do the talking.

By the way, back in 2008 the VIX was over 40 for 125 plus days, so huge swings were normal. After the flash crash, the VIX was over 40 for 10+ days.

We’ve only been over 40 for three days or so. I am already exhausted, so be prepared that this can last for awhile and it’s not all the machines. We had the same type of action in 2008. Everyone needs a villain. Right now they are saying it’s the machines, I say it has to do more with Washington and the slow economy.

Disclosure: No positions

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