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Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Thursday, August 06, 2020 Headlines

1. S&P 500 closes above level of pandemic influence

2. What the inverse correlation tells investors

3. Tactics for trading: ascending triangle

Market Moves

Stock indexes rose high enough to reach an important milestone. The S&P 500 index (SPX) closed higher than it did on the last day before the pandemic panic took hold (Friday, February 21st). The weekly chart below details how the historically unprecedented collapse and remarkable recovery of the index has lifted prices above the initial resistance level. This effectively puts the market in the position of predicting that the effects of the pandemic have been rendered economically inconsequential.

Of course no individual investors would say that COVID-19 hasn't had a profound impact on their life. However, in the two-dimensional world of chart analysis, the broad market index averages the voices of millions of investors. Today it speaks out unequivocally. Collectively, investors think everything done by companies, consumers, governments, and of course, the Fed, has effectively counterbalanced the pandemic. Unless the market sees significant selling in the next two sessions, this is the interpretation that chart watchers can conclude.

While this may not prove to be true, the point is that investors are behaving as if it is, and that they are optimistic about the future. While many believe they shouldn't be, experienced chart watchers know that it is important to let prices tell their own story. Strange as it might sound to many, the markets seem to be headed for a happy ending to this turbulent chapter.

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What the Inverse Correlation Tells Investors

An interesting phenomenon has been occurring in price comparisons lately. The chart below displays the steadily accelerating trend in an inverse correlation between stock prices and the U.S. Dollar index (DXY). The red indicator below the chart shows how one year ago, there was a generally positive correlation between the two.

Since the beginning of 2020 and throughout the pandemic period this correlation has turned increasingly more negative. That means if the dollar falls, stocks are likely to go higher. Mathematically that makes sense because stocks are bought with dollars. However, markets don't always move this way, and they rarely move so strongly this way. The cause of this inverse correlation is certainly no mystery. It is related to the monetary policy of the Fed. However, this will be an important comparison for chart watchers to review. If it changes, it may mean an end to the rapid rise in stock prices over the past several weeks.

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Tactics for Trading: Ascending Triangle

If the dollar is going to continue falling, it is appropriate to look for stock setups that can help traders initiate positions. The chart below demonstrates a well-known price pattern developing in real time. The ascending triangle pattern forming now on Amazon (AMZN) share prices is worthwhile for pattern enthusiasts to observe.

Simple tactics for trading such a pattern include the following. First, there is a statistical advantage to waiting for an entry above the resistance (red line). Second, setting your stop below the green line allows you to be patient if the stock retraces the pattern again. Third, measuring the distance of the initial surge (solid arrow) can give you an idea of a short-term price target (dashed arrow). Some studies show that trading ascending triangles in this way has better than a 60% probability of seeing stock prices rise after purchase.

The Bottom Line

Stocks rose above the last close before pandemic fears set into the market in earnest. This is a major milestone. It is tantamount to the market predicting that the economic impact of COVID-19 will soon be nullified. It appears that a falling dollar facilitates that prediction. Amazon is currently showing a price pattern that could benefit from the continuation of this trend.