Mean reversion strategies kicking in
Last week's three-day decline in the S&P 500 ETF (SPY) was the steepest 3-day decline since March, Despite two long red candlesticks and this 3.9% decline, I still consider the medium-term trend up. As long as the medium-term trend remains up, declines are viewed as corrections or pullbacks within a bigger uptrend. Perhaps more importantly, the ETF is already trading in a support zone from the prior consolidation (yellow area). Friday's close is pretty much in the middle of this consolidation.
10-period RSI became oversold for the first time since late October. At this point, many short-term mean-reversion systems are turning bullish. In an uptrend, mean reversion systems view short-term oversold situations as bullish. With the bigger trend up, the theory is that prices will revert to the mean after becoming oversold. 5-period RSI was oversold in early September, early October and late October. After the long red candlesticks and oversold conditions, SPY formed indecisive candlesticks to signal a short-term bottom. Note that the indecisive candlestick in late October occurred three days after the RSI became oversold.
The 60-minute chart is skewed after last week's sharp decline. The only item to take from this chart is broken support around 113.2 turning into resistance. Frankly, I would not be surprised to see short-term resistance a little lower - perhaps around 112.
