After Panic Selling, Which Way Will Gold Go?

Gold charts are forming two patterns: a bull flag and a mini head-and-shoulders. Gold is a 50/50 trade that could go either way.
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By Chris Vermeulen of TheGoldAndOilGuy.com

Did you close out any long positions Wednesday? Well if not then you are one of a few!

Wednesday the market gapped down 1.5% at the opening bell, which set a very negative tone for the session. Volume was screaming as protective stops triggered and traders closed out positions before prices fell much further. This gap seemed to have caught several traders off guard, but those of you who follow my newsletter knew something big was brewing and to keep positions very small.

Just before the close on Tuesday, I had a buy signal for the

S&P 500

, which was generated from the extreme readings on the market internals. After watching the market chop around and get squeezed into the apex of the rising wedge the past three weeks, I knew something big was about to happen and I did not want to get everyone involved, because I felt a large gap was about to happen and the odds were 50/50. Instead we passed on the technical buy signal and waited to see what would happen Wednesday.

Below are a few charts showing one of my extreme reading indicators I use, which helps me to identify possible short-term bottoms.

S&P 500 -- SPY Exchange-Traded Fund

This daily chart of the

SPY

(SPY) - Get Report

ETF clearly shows that we saw panic selling in the NYSE; I consider 15+ sell orders to each buy order to be PANIC SELLING. This is shown using the purple indicator at the bottom of the chart. Wednesday there was an average of 37 sell orders to every buy order, which tells me the majority of traders are closing out all their long positions.

In an uptrend, this indicator works very well and can help time a bottom within 1-4 days. As you can see on the chart below, we just had a huge selloff and everyone seemed to be exiting their positions. This panic selling tends to carry over for a couple of sessions until the majority of traders around the globe are finished selling.

The problem with this indicator is that in a downtrend, we tend to get these panic selling spikes regularly, which means this time it may not work out because of the trend line break Wednesday, which I think has officially changed the trend from up to down. Because of this possible down trend starting, I feel it's best to wait and see if it's a dead cat bounce or if there are real buyers behind it, then we will take action to go long or short the market.

Market Internals: Put/Call Ratio, NYSE A/D Line

Here are two charts that are currently at extreme levels. This typically means a bounce should occur the following day or a gap higher. If you did not know there was a strong trend line breakdown Wednesday, you most likely would have taken a small long position into the close.

The Put/Call ratio, when above 1.00 means, more people are buying put options, meaning they are leveraging themselves to make money if the market drops. As a contrarian indicator, if everyone is buying leverage to the down side, then they should have sold their long positions already. That would mean most of the selling has already taken place in the market, thus it should have some upward bias in the near term.

On the other side, you can see the NYSE A/D line which shows how many stocks on the NYSE are advancing and how many have declined. When this indicator is below -1750, we know the market is oversold on a short-term basis and there should be some upward bias in the near future.

Now Let's Take a Look at Gold

Gold was left on the side of the road today as traders and investors focused on the equities market. I was actually a little surprised that it didn't make a big move Wednesday because the U.S. dollar rocketed higher for the entire session. Anyone who has been watching gold closely already knows that gold is doing its own thing now. Some days it moves with the dollar, other days it does not. It's become much more random than it used to be.

Anyway, it looks to be forming two patterns. The first one is a bull flag. If a breakout to the upside occurs, that would send gold to the $1,230-$1,240 level.

The second pattern is a mini head-and-shoulders pattern, which would send gold down to the $1,180 area if the neck line is violated. It is a very tough call for gold.

Mid-Week Technical Traders Update

In short, it's going to take a day or two before we get a feel for the S&P 500 as we wait to see if it bounces with volume behind it. I personally would like a bounce so we can short it. It is unfortunate how the market broke down yesterday. We were so close to getting a really good setup in either direction, but the FOMC meeting shook things up and caused the large gap, which in turn made a large group of traders miss that beautiful drop. It's frustrating when you wait for something only to have a piece of news mess things up. That's just part of trading though.

As for gold, I feel it's a 50/50 trade and could go either way so I am not going to take a position right now. I'm just going to wait for the market to tip its hand a little more before I jump.

I hope you found this information useful. If you would like to receive these trading reports, updates and ETF alerts be sure to visit my service at:

www.TheGoldAndOilGuy.com

Chris Vermeulen is founder of the popular trading sites www.thegoldandoilguy.com and www.ActiveTradingPartners.com. There he shares his highly successful, low-risk trading method. Since 2001, Chris has been a leader in teaching others to skillfully trade in gold, silver, oil and stocks in both bull and bear markets.