After Tuesday’s massive intraday upside reversal traders yesterday were encouraged enough to step in with some follow-through buying. That has brought a number of the major U.S. and European equity indices into initial resistance areas in the near-term. 

On the S&P 500 hourly chart in specific we note that the 4% rally since Monday’s close has brought the index into an area of resistance between the 50% and 61.8% Fibonacci retracement level.  While this is far from a major resistance area it is a level to watch for some short-term profit taking.  Alternatively, should the index be able to climb above 1150 on a daily closing basis it would potentially give way up to 1180 and beyond.  In theory that sort of move could then lead to performance chasing by funds as most of them are underwater for the year and desperately need performance.  The result could be a big rally into year-end.      

 

Let’s have a closer look at the important support level reached by the Russell 2000 small cap index on Tuesday.  The area between 590 and 650 served as solid support back in 2010.  On Tuesday the index briefly fell down to 600 and then snapped back up quickly, leaving behind a big outside day on the daily chart and a long bullish hammer thus far on the weekly chart.  Additionally the stochastics oscillators are showing divergence between price, where the index made a new low for 2011 but the oscillator did not. 

 

Thanks to the big two day rally volatility has come down in a meaningful way.  After breaking out of what was a bear flag formation on the S&P 500 implied volatility index (VIX), the index has again fallen into this formation and below the 40 level.  The 30 area remains the level to watch.  As long as the index can remain above there equities should continue to trade in wild swings.  Medium to longer term (3-6 months out) I still think the VIX could rally into the 70s for what it’s worth.

 

The price action in broader equity indices as well as key individual stocks such as Cisco Systems (NASDAQ:CSCO) and even some financials such as Morgan Stanley (NYSE:MS) has been constructive the past two days and sentiment readings are negative enough that this countertrend bear market rally could continue as we head into earnings season.

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