Over the weekend and into this morning, we saw some very large down draughts in the markets. The euphoria of last week, when we saw large rallies, has somehow been dissipated. Maybe somebody said something.
But regardless of the political twists and turns surrounding the euro debt crisis, I prefer to let my charts guide my trading.
On Friday, I noted that the Dow had reached a significant resistance level at the confluence of a Fibonacci retrace level and a short-term tramline.
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I suggested that this doubly-strong resistance level should be formidable, and so it appears this morning.
I made the case that Friday's high would likely be the top of the rally, and to expect at least a decent dip. I also said that I would likely be shorting the Dow near this high.
And because the gold and the Dow are trading more or less in lock-step, I was last week also expecting to short gold in anticipation of at least a decent pull-back.
A top in the Dow would likely occur at around the same time as a top in gold.
This morning, gold is down $30. Now let's take a look at the near-term hourly chart (which is my favourite short-term scale, incidentally).
(Click on the chart for a larger version)
The market did push above the Fibonacci 50% retrace, where I believed we would see resistance emerge.
Trader tip: This is a good example of a Fibonacci level being exceeded. If you wish to trade these levels, you can set your sell orders right at the retrace.
In most instances, the market will move back down off this level, giving you an opportunity to swing in the break-even rule.
If the market moves back up, as here, you will exit with no loss, and then have the opportunity to search for another entry. That strategy would have worked well here.
But look at the way the market made a high on Friday, and then over the weekend it moved down below the chart support (marked by purple bar).
Also note the weakening momentum readings as the market rallied late last week, producing a negative momentum divergence, as marked by the green arrows.
With the move down through the purple bar, it confirmed my scenario is the correct one.
Incidentally, this is one of my favourite entry methods entering on a sell-stop placed just below the purple bar which is placed at the minor low made on Friday.
However, I would be very surprised if many of my readers were watching their screens over the weekend! We all have better things to do then, I'm sure.
The ideal strategy is to enter resting orders late on Friday before the close of play in anticipation of a fill while asleep.
Alternatively you could anticipate the sell-off and just enter short trades on Friday. This is strictly what's called an 'off the books' trade, and I would not recommend it for most traders, as it is easy to be caught out.
But sometimes, you get a strong feeling. I confess that is what I did.
Markets could soon be heading sharply down
OK, back to the chart. I have drawn my trio of tramlines, which have terrific touch-points. I especially like the set between the yellow arrows. These touch-points anchor the tramlines and confirm their validity as solid support-resistance lines.
Note how Friday's rally above the 50% level took the market right to the central tramline kissed it, and then had a scalded cat bounce.
So, as of this morning, the market is testing the lower tramline, where I expect a small bounce. But if the market can convincingly break this tramline, it should be the start of a much larger move down, first to the $1,680 level, which is a 50% retrace of the rally off the 20 October low.
Many traders will now be looking to sell into this bounce, if it occurs. If there is no bounce today, the down-move will be severe.
Markets appear poised for very large down-moves, and I shall be trading now from the short side.
If you're a new reader, or need a reminder about some of the methods I refer to in my trades, then do have a look at my introductory videos:
The essentials of tramline trading
An introduction to Elliott wave theory
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