Thursday, March 15, 2007

Hammer Time

This is a candlestick chart of the S&P 500. Today's action shows that after a strong sell off this morning, the market recovered nicely and closed very near the high of the day. This is shown in as candlestick with a long stem and a white body. This type of candlestick is referred to as a Hammer. It is usually a bullish pattern. What it shows is that the selling pressure that took place during the day was overwhelmed at some level and buyers took over. The buyers could be shorts covering their positions or new money coming into the market, the chart doesn't tell us that. All it tells us is that for the short term, the selling was met at some level by more buyers than sellers, and the market reversed.

A Hammer pattern is a great pattern to look for. Once a Hammer is formed, there is usually continuation, at least for the short term. If you were short the market, and the Dow was down 130 points you would be feeling pretty good. As the market selling slowed you might still be comfortable in your position. You start to become nervous when the market approaches the opening price for the day, and then continues to finish at the high. This is a short squeeze. When a market is oversold in short term, it becomes a likely candidate for some sort of short squeeze situation. The intensity and duration all depends on many factors.

At what level does it stop? Well, markets usually rally further than most people think are appropriate and sell off past levels that seem rational. What is the good news that caused the buying? Is the bad news that caused the selling gone? Well sometimes it doesn't always take good news to cause a rally. The next place to identify is where is the next level to look to short or sell long positions.

In the bottom pane of the chart is two lines that represent 2 pivot points. The red line is the daily pivot. This is calculated by adding the High+Low+Close, and then dividing by 3. So the pivot number for today's action is 1379.75. The blue line is the three day pivot. This is calculated by adding the Highest High in the past 3 days+Lowest low for the past three days+the close, then dividing by three. The three day pivot is 1386.83. With the S&P500 currently at 1387.17, I would not re-short the market or sell current long positions, until the market falls below the three day pivot. The S&P futures are currently up 1.40 in the overnight market, so there is a little cushion there, but that can change fast. Watch the pivot numbers...the floor traders do. More on how to use pivots next time..

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