Will prices of the best-known companies and stock index futures have fallen to zero? Will equity markets have disappeared? Will the futures markets that depend on the cash equity indices evaporate in tandem?
No. But that's what the current pace of decline -- the panic -- in the
September S&P futures
(SPU2:CME) implies. And that pace of descent is unsustainable.
Here's what I mean. The September S&Ps have tanked 28 points on average in each of the past three sessions. Measured from Monday's closing price of 819.80, if the S&Ps were to continue tanking at that pace, they would trade to zero in just 29 sessions.
By Sept. 2, the first trading day of the month, the S&Ps would be trading at zero. The capital markets as we know them, and all of the value tied up in them, would be gone.
Of course, markets don't go straight in one direction forever. But the pace of the recent decline is providing an example of
downside momentum. It is extremely unlikely that the financial world as we know it will have vanished by trading to zero by the beginning of September.
Trading Unsustainable Momentum
When the rubber band gets stretched too far in one direction, experience tells us, it snaps back. So how far is too far? Although it's difficult and dangerous to step in front of a freight train, trading is about risk-taking, and some of the best reward-to-risk trades come from extremely oversold (or overbought) conditions. By identifying exact levels after a spate of unsustainable downside (or upside) momentum, you can -- with defined risk -- test the theory that the S&Ps will snap back.
Lewis Borsellino, one of the bigger S&P local traders, who has more than 20 years of pit trading experience, put it to me like this: "The 60-day moving average
is a big average for us in the S&Ps. When the price gets extended 20% from the 60-day, that's when we get a snapback."
While this situation is very rare, it did occur Monday, with the low occurring almost exactly 20% below its 60-day moving average.
The S&P 500 cash index is useful and required for keeping your sights trained on the larger time-frame picture when declines or advances reach multiyear lows or highs. The 808.53 level in the following chart closely coincides with Monday's 811.00 low in the S&P futures, the 20% rubber band stretch down from the 60-day moving average. Notice in the chart how Monday's low coincides with the S&P cash 200-
moving average, as well as with its 78.6% retracement of the July 1996 swing low.
If the 811 area (or the 808 area in the S&P cash), does not hold, Fibonacci extensions from the 60-minute chart suggest the futures will test down to 785 to 788, as shown in the next chart.
The dollar's bounce overnight Monday will be a positive for stocks but a negative for gold, since bullion is largely a dollar-denominated transaction, making the metal relatively more expensive. Notice how
(GCQ2:COMEX) has been capped the past two sessions at the 78.6% retracement of the contract high to the most recent swing low.
The gold set-up is similar to the one I pointed out in
(HGU2:COMEX) back on
July 2. Notice the two-week tweezers tops (two bars next to each other with the same high) in both gold and copper.
Look what has happened to copper since:
Should the S&Ps and dollar advance, look for a similar 10% decline in gold.
Marc Dupee is an independent trader and co-author of the book
The Best: Conversations With Top Traders
. Dupee was formerly markets analyst and futures editor for TradingMarkets Financial Group. At time of publication, he held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he invites you to send your feedback to
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