Trading The SPY? Use This Simple Momentum Trick

RSI relative strength index
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Market momentum is Red. Cash remains your best option… as I’ll explain…

Today, the markets took another nosedive after attempting to adjust to the Federal Reserve’s 75-point rate hike for June. The markets have already largely priced in another 75-point hike for July. However, speculation now exists that the Fed might only cut in July by 50 basis points due to concerns about a slowdown in the U.S. economy. 

Consumers are cutting back on spending. Businesses are laying off workers. And the Atlanta Fed Bank cut its GDP forecast for the second quarter to 0.0%. We are likely in a “technical” recession, and the odds of a deeper dive into 2023 are increasing by the day. 

I don’t think the Fed can control inflation without the help of Congress or the White House. However, we are not prioritizing supply-side solutions like business tax cuts or slashing regulations (particularly on the environmental side) to streamline more oil-and-gas production and more refinery capacity. 

The Fed will go it alone. And it will deliver a sledgehammer to the markets in the process because of inflationary spending by the government. 

The Biden administration has planned a $5 trillion budget on top of $3.5 trillion in taxes in 2023. That spending gap of $1.5 trillion is inflationary by default, and the Fed must combat that pressure. 

With all this in mind, I remind you that the stock market is not the economy… And the economy is not the stock market. So, while all this bad economic news continues, the market might pop in the coming days for a few reasons. Here’s what I want you to watch.

Overbought and Oversold

Today was one of the worst days I’ve seen for the market in a long time. The reason: Not only was momentum negative, but buying pressure was also effectively non-existent. 

The S&P 500 had zero companies jumping by 5% or more. Yet 142 companies – or roughly 28% of the entire index – fell more than 5% on the day. 

Meanwhile, in the broad market of 6,150 stocks – just three hit 52-week highs. Exactly 1,516 hit new 52-week lows. This truly is the great deflation of the equity bubble of the last three years. While this selloff continues, I want you to watch one key number. 

The Relative Strength Index (RSI)

This momentum indicator is a simple tool to define overbought and oversold levels based on price. While I also use the Money Flow Index (MFI) and the MACD 12, 26, and 9 as momentum tools, the RSI is a good starting place for people learning how to trade on momentum.

The RSI is defined by a range of 0 to 100. 

When a stock, exchange-traded fund (ETF), or other index-based asset’s RSI goes above 70, the stock is considered “overbought.” At this time, many traders might look to short the asset or take profits off the table.

If the RSI is under 30, that asset is considered “oversold.” At that point, short-sellers may look to buy back the stock, put options traders close positions, and investors might look to buy the stock on “the dip.” 

For the S&P 500, I think you should watch the RSI of the SPDR S&P 500 ETF Trust (SPY) from a volume and price momentum level. Typically, when the RSI of the SPY dances around the 30 level, it precedes a short-term pop. This can be a combination of short-covering and people buying the dip. 

The SPY’s reading is sitting at 31.2, just shy of oversold territory. If, by chance, we see a rally start on Friday, don’t be afraid to day trade for a move higher. 

With that in mind, remember that momentum is negative, and the lack of buying should concern investors and traders alike. It will take time for momentum to get back into the green. Of course, today’s lack of buying signals that the markets don’t believe that the Fed can just raise interest rates without causing problems elsewhere. 

As I’ve noted, the Fed hasn’t aggressively raised rates in the past without helping to fuel a crisis somewhere else on the planet (or here in the United States). So at this moment, cash remains in a stable position. 

In Conclusion

There are multiple momentum tools that you can use to help best identify exit and entry points. In addition, you should learn more about the best ways to trade in a bear market and negative momentum. I’ll be discussing both issues at length in the weeks ahead. 

For now, continue to exercise caution, and remember that you can build positions for the long haul. So many fortunes were made in a bear market. It’s time to build yours.

Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.
Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.

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