Good day! The index futures continued to tease last month's highs on Tuesday after the announcement that Bush-era tax cuts would be extended for another two years. Additionally, unemployment benefits will be extended for thirteen months and the payroll tax will be lowered by 2% for a year.
The price action remained range bound following Monday's close, but broke higher out of the 3:00 a.m. ET correction period as activity picked up overseas. The momentum soared over the course of the next two hours, but the pace began to fade following 5:00 a.m. ET.
An attempt to extend the rally ahead of the open was met with cautious buying and the indices crept to slightly higher highs on the 5 minute time frame. This created a reversal pattern in the Dow Jones Ind. Average and S&P 500 that I refer to as a 2TTM. It's a type of double top in which the second high takes place on slower momentum and serves to trap bulls that attempt to buy new highs. At the same time, it flushes out the bears that came on board following the first high. The result is typically a rapid reversal to the downside.
Dow Jones Industrial Average (Figure 1)
The selling of the premarket reversal pattern kicked in immediately out of the opening bell. Larger-than-average gaps in the indices do have a strong tendency to close when they take place after several days within an up or downtrend, so this technical bias helped as well. Heading into this week, I was already on the lookout for this type of price action. In fact, it's the action I wrote about over a week ago that I wanted to see before the market offered any type of larger daily correction. The pace of the buying, however, was stronger than I had wanted to see in order to form a rapid daily reversal.
The price action heading into the day was favorable for stronger pullback action on the shorter term time frames intraday. A continuation of the momentum shift took place mid-day. Slower downside into noon was followed by a very gradual uptrend as the indices hugged their 15 minute 20 period moving averages from 12:15 ET into 14:45 ET.
By hugging the moving average with a decline in volume, the indices were pointing towards a breakdown bias. This particular type of AvalancheTM is one I call a "Shallow Avalanche"TM because the initial pullback into the 20 sma is still not extreme. This type of setup will often lead to a breakdown that is stronger than the initial drop off highs. This bias held and the indices dropped sharply once the moving average gave way around 14:45 ET. The selloff continued into afterhours trade and the index futures eventually found support at Monday evening's lows in the Dow and S&P and Monday's closing price level in the Nasdaq.
S&P 500 (Figure 2)