Dow to Head Higher Through Mid-September

It sure seems like everything in the news has been full of alarm bells lately due to Greece, China and falling oil prices in one form or another. Frankly, China’s impact on the US equity markets may be just the buying opportunity we’re looking for as several factors combine to point towards strength through the expiration of the September Dow Jones futures contract on September 18th.

The two strongest pieces of evidence for the rally are the commercial traders’ position and the peculiar but, consistent market behavior of the equity markets beginning 20-30 prior to expiration. Finally, we’ll identify one of our favorite equity index futures technical setups and a key piece of seasonality to further facilitate a rising market through expiration.

The commercial traders in the Dow Jones futures as tracked by the weekly Commitments of Traders Report, maintain a very consistent relationship that we track via the MACD of their net position. We want to trade in the same direction as the commercial traders’ momentum. Commercial traders are value players and act proportionally upon the markets as their specific market is becoming cheap or, dear. We also track the commercial traders’ net position on a nominal basis, which happens to be their most bullish since July of 2010. This is the kind of strength we want to buy into using a technical setup we’ll identify shortly.

The bearish divergence buying opportunity appears to be fully supported by the most bullish commercial trader net position since July of 2010.

The bearish divergence buying opportunity appears to be fully supported by the most bullish commercial trader net position since July of 2010.

160x600The stock index futures have a fairly peculiar but, repeatable expiration pattern. The cycle plays out with commercial traders pressing the market lower about 20-30 days prior to expiration. This decline accomplishes several tasks. First of all, it washes out the weak small speculative long position. Second, it’s far enough to force index sellers to lay off part of their portfolio. Finally, its far enough for the commercial traders to cover their direct short hedges as well as allowing them to get futures bought against their short call option positions at a discount. Their late buying has been enough to run the market straight back up to the highs and create a new churning pattern of consolidation at the highs leading into expiration. The full piece is, “Stock Index Futures Expiration Tendencies.”

Moving back to the technical side, you can see that we’ve highlighted the beginnings of a bullish divergence bottom. Wednesday’s flush sent the market more than 140 points below the low made on Friday, August 7th. In spite of the move lower, our proprietary short-term momentum indicator will register a much higher bottom, indicating greater strength than meets the eye. Furthermore, open interest has declined by more than 13% during this mini sell off. The technical representation of a bullish divergence bottom is strengthened as the market is losing interested participants at lower prices as indicated by declining open interest.

Finally, the strength that I’ve noted through the expiration cycle has also been picked up by seasonal analysis. While I find its impact less useful in financial markets, many have noted the coincidental rise in the stock index futures through the expiration of the September contract. As always, a protective sell stop will be placed at the recent swing low, 17079 in the case of the September Dow futures.

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