Back On The Three Day Rule Again

Last week I was talking about a likely modest rally coming, which we have seen, and then a low retest, which we have not yet seen but I’m expecting to see this week.

After that I’m thinking we may well see a much larger rally on SPX, and one thing I was waiting to see before that rally was decent positive divergence on the weekly RSI 5, which we now have.

If we do see that larger rally, then I’d be looking for a test, and perhaps a break, of main downtrend resistance, which is at the weekly middle band, now at 4209.

SPX weekly chart:

I was looking for two things before that larger rally on the daily chart and both are now in place. The first was positive divergence, and a weak RSI 5 buy signal fixed yesterday. If we see another low retest then a full size daily buy signal should start brewing.

The second thing was a daily high volume spike, often seen near significant highs and lows, and we saw that on Friday.  Does it matter that this spike was likely more about opex than exhaustion? Historically not particularly, though a high volume spike on a really strong down day would have been better.

SPX daily chart:

Yesterday SPX closed back over the SPX 5dma, now at 3726, and that puts SPX back on the Three Day Rule. If there is a clear close (3-5 handles minimum) below the 5dma in the next two days, then there should be a retest of the retracement low before a retest of the all time high, though that is of course a long way above right now. This rule has fixed eight times so far in 2022 and has delivered eight times so far. On this basis of calculation (after a rule tweak in 2019) this hasn’t failed to deliver as far back as I have looked, to the start of 2007.

SPX daily 5dma chart:

Now I know the all time highs are a long long way above at the moment, but I work hard to draw my charts with an objective eye, and what I’m seeing on the US index charts, as well as many stocks and ETFs, from the all time highs are bull flags, which have generally been improving in quality as the markets have gone lower.

SPX historically has a very strong track record of retesting highs and lows while making significant tops and bottoms. A few years ago I went back through the full history of the SPX back into the 1920s and found that this happened about 70% of the time, forming double tops or bottoms at those retests. Now that is a significant distance from 100%, and bull and bear flags do break against expectation 20% to 30% of the time, but as long as those bull flag setups are there, then there is some chart support for a possible retest of the all time highs.

On the NDX chart a daily RSI 5 buy signal fixed yesterday and the bull flag setup is pretty decent.

NDX daily chart:

On INDU another weak RSI 5 buy signal fixed yesterday, but I’m showing the hourly chart below to demonstrate how some of the bull flag setups have been improving as markets have dropped lower. On the Dow hourly chart below you can see how the first bull flag trendline broke slightly to establish a better trendline.

INDU 60min chart:

The historical stats for the rest of this week are neutral to slightly bearish except for Friday which leans 71.4% bearish. If we are to see that low retest then the odds of seeing it happen this week are decent.

I find myself having to defend even suggesting that an all time high retest here might be possible, and obviously the economic backdrop isn’t promising, but the charts say it is possible and I prefer to take my lead from those. There is also the reality that the news background tends to look bleakest at lows, and best at highs. When I wrote a post on August 6th last year talking about a possible backtest of 3800 SPX coming, the response was mainly polite incredulity, yet here we are. We’ll see.

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Written by:

Richard Chappell

Jack is a 20 year retail trading veteran and co-founder of The Art Of Chart. He started his blog at channelsandpatterns.net in 2010 and since has published tens of thousands of charts looking at hundreds of trading instruments across most tradeable markets, doing original work mainly in the areas of trendlines, patterns and divergences. At The Art Of Chart Jack has taught trading skills, technical analysis, and the discipline and trader psychology that allow those to be used effectively in trading.

22nd Jun 2022

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