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Kathy Garber, Danny Riley

Guest post by MrTopStep contributor Kathy Garber of StructuralTrading.com


ESU13 has completed a bearish harmonic pattern. A bearish pattern during formation behaves in a bullish move until the completion. It is at this completion point that the pattern becomes bearish.

Strong harmonic patterns typically will retrace more than 61.8%, and ideal harmonic patterns retrace over 100%.

How much a harmonic pattern retraces tells a story. Typically the ideal minimum retracement is 38.2%. When price cannot get to a 38.2% retracement or fails to go lower than a 38.2% retracement, the story is typically a retest of the PRZ. PRZ is the abbreviation for Potential Reversal Zone, a short way of saying the "completion target for a harmonic pattern that consists of confluence levels." Another interpretation of the story is that the bullish move continues, tests the top of the upward move again, and goes past it to reach a further target.

In ESU13, a Bearish Garfly has completed and the PRZ was from 1661.5 to 1675 (yes, this is a big zone, but it was a big pattern). So far there was an attempt to hold above the PRZ (to hold above 1661.5), but price has since fallen back inside the zone. This implies a test of the lower portion of the zone at 1661.5.

If price does not hold above this level, the initial target on the downside is 1649 (yes, there is a harmonic reason for that price). Below 1649, the ideal minimum retracement target is at the 38.2% Fibonacci ratio.

So let's see what story unfolds ... does price stall sideways inside the PRZ? Does price break back above the PRZ and seek the 1708.25 target? Does price break down the PRZ to shift into retracement mode?

There's no guarantee of which scenario plays out first, but due to the harmonics we have clues, and the clues state that a hold above 1675 increases the probability of upside continuation, and that if price breaks down below 1661.5, the probability increases that the bias is downside to initial targets of 1649 and 1631.25.

Reminder ... targets are places to take profits, protect a winning position or exit the trade. Always trade with a plan, especially an exit strategy.

The S&P futures have closed higher 10 out of the last 11 days, up 61.5 handles.

Monday, July 1 +7.4
Tuesday, July 2 +.50
Wednesday, July 3 +1.9
Friday, July 5 +18.2
Monday, July 8 +8.2
Tuesday, July 9 +10.1
Wednesday, July 10 +3.0
Thursday, July 11 + 21.5
Friday, July 12 +.20
Monday, July 15 +7.2
Tuesday, July 16 -6.3

Our view (Danny Riley): The Asian markets closed mostly higher and Europe is trading modestly higher too. Well, we got the down day we were looking for, but overall volume was still very low. When you take out the 150,000 ESUs traded in Globex, just over 1mil ESU traded in the day session. Today is the first day of Bernanke’s two-day testimony in Washington. It’s important to remember that while the Fed may have backtracked on tapering right now, that doesn't mean they won't backtrack again. Do we think the S&P is on track for 1700? Yes, we do, but we also understand that once the bus gets too full it moves the other way.

According to the Ned Davis S&P cash study, the Wednesday before the July expiration has been up 16 / down 13 of the last 29 occasions. Our view is there is probably more room on the downside for at least the first part of the day. As we said last Friday and Monday, there will be at least one down day this week. With that in mind and the fact that the S&P tends to be up a day / down a day during the expiration, we lean to selling the early rally, then buying weakness. The buying the weakness part didn't work yesterday, but don't be surprised if it does today.

Lastly, before yesterday’s lower close the S&P futures had been up 13 out of the last 14 sessions; as of this morning the S&P has been up 9 out of the last 10 sessions. As always, have an exit strategy before you enter, keep an eye on the 10-handle rule, and please use stops when trading futures.

  • It’s 8 a.m. and the ESU is trading 1671.50, up 1 tick; crude is up 2 cents at 106.02; and the euro is down 29 pips at 1.3134.    
  • In Asia, 7 out of 11 markets closed higher (Shanghai Comp -1.01%, Hang Seng +0.28%, Nikkei +0.11%).
  • In Europe, 7 out of 12 markets are trading higher (DAX +0.27%, FTSE unchanged).
  • Today’s headline: “Bank of England surprise hits shares, dollar steady ahead of Fed”
  • Total volume: (LOW) 1,171k ESU and 8.9k SPU
  • Economic calendar: MBA purchase applications, housing starts, Federal Reserve Chairman Ben Bernanke to testify before the House Financial Services Committee in Washington, EIA Petroleum Status Report and the Beige Book.
  • Fair value: S&P 1670.66, +0.09; NASDAQ 3070.77, +3.23
  • Ned Davis Expiration Study for July - https://mr-topstep.com/index.php/equities/3687-expiration-study-for-july

Danny Riley is a 34-year veteran of the trading floor. He has helped run one of the largest S&P desks on the floor of the CME Group since 1985.
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DISCLAIMER: The information and data in the above report were obtained from sources considered reliable. Opinions, market data, and recommendations are subject to change at any time. Their accuracy or completeness is not guaranteed and the giving of the same is not to be deemed as an offer or solicitation on our part with respect to the sale or purchase of any commodities or securities.