[Click on the picture to discover how a professional trader analyses market forces to build a trading strategy.]
We have been following the progress of the S&P 500 closely over the past few months and I have mapped out for you the areas of support and resistance using my methodology.
With the S&P 500 starting to weaken, I thought it would be a good opportunity to give you a recap of the zones I showed you many weeks ago and compare it to the subsequent price action.
By understanding how waves develop and where they often see reversals, you can start to build a trading strategy that aims to capitalise on this process. As I have described for you many times, the best approach I have found is to work your way into a cheap straddle by buying out of the money puts (if you are expecting a correction) with a strike price at the expected targets.
When prices reach the target you take profit on half of the puts and buy calls with the profits and end up with a straddle or strangle (if you buy out of the money calls). From that point on your work is done and you can relax.
The targets are based on the same theory that found the areas of support and resistance. The midpoint and buy and sell zones of waves are where prices often change course, so it makes sense that your targets should respect this fact. By looking at the most recent wave you can map out where prices could get to.
When looking at the current situation in the S&P 500 the most recent wave is the big up-wave since the end of December last year. If we are going to see a correction in prices then the midpoint and buy zone of that wave (75–87.5% retracement) is where we should expect prices to get to.
By buying puts with a strike at the midpoint and buy zone of the wave, you can prepare yourself to take advantage of the correction and ultimately have a position that will make money whether the market rallies or falls.
Another handy hint that I point out in the video is that you can also refer to the one and two standard deviation Bollinger Bands above and below the 20-week simple moving average (SMA). When a market is trending up for example, the one and two standard deviation Bollinger Bands below the 20 week SMA become support and if the market is trending down the Bollinger Bands above the 20 week SMA become resistance.
Right now the S&P 500 is seeing resistance from the major sell zone of the wave down from the high and is also being rejected from the one to two standard deviation Bollinger Bands above the 20 week SMA. It is an explosive spot that should ultimately see some serious selling pressure and we may have seen the first signs of that over the past week.
Editor, Alpha Wave Trader