The VIX has formed an inverse head and shoulders pattern. The pattern does not come into play however unless the neckline is penetrated. If the neckline is penetrated the target of the VIX is 27-28. This would correspond to the S&P 500 dropping to about the 1250-1275 area. The question is does it look like the neckline is going to be penetrated.
We can see that the VIX hit resistance at it’s 200 day EMA of 21.64. This also corresponds to the neckline of the pattern. There are negative divergences forming which indicate that the VIX should drop. The VIX hit a higher high between April and May but the MACD and stochastics hit a lower high. The MACD momentum bars were much stronger in the initial run up that started in April but the bars in the current cycle are much weaker. The RSI is also decreasing.
This would indicate that the VIX is going to pull back. It could pull back to it’s uptrend line and then create another right shoulder or it could drop through the uptrend line and negate the pattern. In any event the market should move up from here. If the VIX were to negate the pattern the S&P 500 and other market indices would in all likelihood resume their uptrends.
The SPY daily chart confirms the VIX chart as there are positive divergences indicating the SPY should head higher. The SPY hit a lower low between April and May but the MACD negative momentum bars are weaker in the current cycle indicating that negative momentum is waning. The RSI is at the same level that it was in April when the market rallied and the stochastics are oversold.
The SPY weekly chart still looks bullish. The SPY has pulled back to it’s 20 day EMA where it has found support. This level orresponds to the 2011 market top which is also acting as support. The RSI and stochastics are still above 50. The MACD has given a sell signal but if the rally continues that should quickly reverse. As long as the RSI and stochastics turn around above 50 the rally should continue.
There are numerous wildcards in play that could influence the market direction.
1) Good or bad news out of Europe and China.
2) The announcement of QE3 by the Fed or ECB.
3) Natural or man made disasters.
Conclusion: The technical indicators are pointing to higher market prices at least in the near term. It remains to be seen if the market can break out of the trading range it is in namely S&P 1340-1400. A VIX surge past 21.64 however would be an indication to at least hedge any long positions or go outright short.