After sinking to start the session stocks managed tread water and finish well off of their lows for the session. The VIX hasn’t managed to close above 20 since 1/18 and another attempt to do so today was rejected. After initially moving higher by nearly 10% to 20.33 shortly after the open, the VIX rolled over and finished with a 5% gain, its best since rising 6% on 1/17. The low volatility has led to dips getting bought, much like we saw today.
After rallying to new highs last week, most traders were probably looking for a pullback and that is what we are seeing now. Some will likely be anxious about buying dips, for fear of catching the falling knife that proved to be the pullback from the late October high and early September highs. However there is a major contrast between this rally to new highs and those rallies: we are seeing price congestion.
Price congestion is the term we use for a multiple days worth of trading that occurs in a clearly defined range. Price congestion is important to recognize because it represents an equilibrium of supply/demand being construed. Equilibrium’s in supply/demand is what causes prices to eventually move higher for once an equilibrium is obtained an influx of supply or demand then moves prices lower or higher.
When analyzing the price action in late October one can notice that price congestion was non-existent near the top end of the range. This is evidenced by the S&P500 only spending 2 days closing (10/27 & 10/28) above 1,280. Compare that with the most recent foray to new highs and our point is clear. Since closing above 1,300 on 1/18, SPX has failed to relinquish this threshold. Today the index actually bounced perfectly off of the 1,300 level.
This price congestion is exactly what the bulls want to see after a monster rally as it means that the supply one would expect to come out after this rally is being absorbed by new demand. If the supply continues to be absorbed by demand above 1,300 only a little bit of new demand will be required to retest the 1,333 high from last week. Furthermore, we would expect there to be significant demand in the 1,250-1,285 range as that range acted as resistance prior to this breakout and we now believe it will provide support.
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