Many traders and investors speculated about a potential market bottom or at least a meaningful rally could be around the corner as S&P 500 rallied from the oversold condition below 3900 to almost 4100 just within 4 days.
The rally was expected to be short-lived as explained in the video at the bottom of the post using multiple scenarios focusing on the characteristics of the price action in order to differentiate a bull trap from a market bottom. This was further supported by the bearish reversal off the resistance at 4100 on 18 May 2022 for S&P 500.
Capitulation Is Needed For Stock Market Bottom
In order to call for a stock market bottom, capitulation from both institutions and retailers is needed. Before market capitulation happens, leadership in sector, industry group and stock is likely to disappear together with market rotation as the smart money is rotated out from the market.
As the current market price structure is eerily similar to the global financial crisis in 2008 as explained in my video about the stock market crash déjà vu, take a look at how the consumer staple sector ETF XLP behaved before a market capitulation happened in 2008, as shown below.
Since January until September 2008 XLP outperformed S&P 500 as XLP attempted to breakout to a new high on 19 September 2008 (annotated as 1), S&P 500 formed lower high and lower low while tested the support-turned-resistance at 1260.
A few days before the failure of the breakout in XLP, increasing of selling was observed as shown in the volume pane (annotated with a blue arrow), which served as a red flag of the breakout attempt. After a break down below the immediate support (annotated as 2) with increasing volume, XLP struggled to rally up and eventually led to a capitulation together with S&P 500.
The magnitude of the drop after the swing low formed (annotated as 2) was 25% in S&P 500 with steep, wide price spread and climatic movement to the downside. The volume increased sharply on the way down. The characteristics of both the price and the volume pointed to a market capitulation. Subsequently, a meaningful rally off the oversold condition marked the selling climax and bottoming process was unfolding, which lasted for 5 months.
As shown in the chart above in 2022, XLP experienced heavy selloff suggested rotation out from the consumer staple sector. This is significant as traditionally XLP is the defensive sector, which is usually the last to get rotated out by the smart money.
Since late April 2022, XLP experienced increasing of selling as shown in the volume followed by a failure bar broke below the support at 78 (annotated as 1). Continuation of excessive selling was observed after the failure, better known as upthrust after distribution, which is a classical event where smart money unloads their long positions or even initiate short positions.
On 18 May 2022, XLP broke below the support at 76 with the biggest bearish bar (annotated as 2) since the Covid-19’s low with increasing of volume, suggested urgent institutions selling. As the unfolding sequence is similar to what happened in 2008, we could anticipate a potential stock market capitulation might begin soon just like in 2008. This type of analogue comparison could be effective like how I anticipated the selloff started on 9 May 2022 before it happened as explained in the video about the bear market leading indicator.
Anticipate A Bull Trap Using Wyckoff Method
As mentioned earlier, watch the video below to find out how to recognize a bull trap and not to be confused by a market bottom.
This is to be used in conjunction with the analogue comparison as mentioned above to better interpret the messages from the market. As presence of demand was observed on last Thursday and Friday, a rally attempt is expected. Should the rally fail to commit above 4100, capitulation of the stock market is likely to start soon. Visit TradePrecise.com to get more stock market insights in email for free.
This article was originally posted on FX Empire