Crucial Week for S&P500 – Bearish Divergence Spells Troubles

Summary:

The S&P500 index formed a bearish divergence ahead of important earnings to be released this week. Bears have an opportunity to go short.

The S&P500 index bounced sharply since the March lows. While it did not make a new all-time high, as Nasdaq 100 did, it regained the $3000 level. However, ahead of August and with the earnings season in full swing, S&P500 formed a dangerous pattern – a bearish divergence.

The meteoric rise of the US stock market is viewed as strange. In the times of the coronavirus crisis, unemployment and bankruptcies surged, while the number of permanent business closers outpaces the number of temporary business closures. In other words, nothing to cheer about.

Yet, the stocks are at highs for a simple reason – more buyers than sellers. Over three million new trading accounts were opened by the retail traders in the last few months since the COVID-19 pandemic, and they do not show below only to US residents. While the majority of the new traders are from the United States, foreign capital pours into the US stock market, to take advantage of the big tech companies leading the prices higher.

Speaking of the big tech companies, the days ahead are full of earnings reports from giants like Google, Facebook, or Amazon, guaranteeing big swings and high volatility levels.

Bearish Divergence on the S&P500

A bearish divergence is defined by two higher-highs on the market coupled with a lower high on the oscillator. In this case, the oscillator is the RSI(14).

What is interesting is that a similar bearish divergence formed right before the S&P500 meltdown at the start of the pandemic. Will this time be the same?

If yes, here is a plan on how to trade the S&P500 bearish divergence. First, wait for the price to break the lowest point in the bearish divergence. That is the $3000 level. Next, place a stop-loss order to limit the losses at the highest point in the divergence. Finally, measure the distance from the entry to the stop-loss and project it twice or three times to the downside, to build a 1:2 or 1:3 risk-reward ratio.