Use February Price Action to Trade October Market

The October sell-off is showing similarities to February's steep decline, suggesting that market players can uncover hidden trading signals through fractal analysis. This poorly understood technique relies on the market's tendency to repeat past behaviors – whether through mathematical retracements, the number of trading days, or total points from highs to lows and vice versa.

Let's start by looking at the fractal behavior of the SPDR S&P 500 ETF (SPY) between July 2015 and April 2016. The market topped out above $210 in February 2015 and entered a narrow range pattern that broke to the downside in August. Committed buyers returned near $190, triggering a V-shaped bounce, followed by a second decline that tested the prior low. Support held, generating a second V-shaped pattern that completed a double bottom reversal, marking the end of the intermediate correction.

The first selling wave lasted 26 days and carried 31 points. The fund doubled the daily count for a nearly equal number of points when completing the first V-shaped recovery pattern. This double-day total perfectly predicted the length of the subsequent downturn, which posted 31 points just like the first decline. Remarkably, the rally into April 2016 matched point totals for the fourth time but took 64 days, which nearly equals a 1.27 Fibonacci time extension.

This symmetry is common in market structure, especially during periods of higher-than-normal volatility, but mathematics rarely play out the same way twice. That's the primary challenge in analyzing S&P 500 price action in September and October compared with the first quarter. Fortunately, other math-sensitive market phenomena like parallel channels frequently offer clues about how these patterns will look in hindsight.

The sell-off into February in the SPDR S&P 500 ETF carried 34 points (a Fibonacci number) in 11 days. The subsequent recovery wave doubled the daily total, just like the 2015 incarnation, but stalled after 27 points at the .786 retracement level instead of completing a V-shaped pattern. It took four more months for the bounce to mount that level, reaching the January high on Aug. 24, slightly more than six months after the February low.

A rising highs trendline places a parallel channel at $261, marking a potential downside target. Perfect time symmetry doesn't look actionable right now, telling observant market players to consider octaves of total days, like the 11,22 and 26,52 patterns. Technicians also need to choose between the absolute high on Sept. 20 or Oct. 3, which marked the decline's inception point. The second price bar, which looks more reliable, has now carried 10 days and 23 points.

The S&P 500 fund could just head back to the high here, but a more potent buying opportunity may come at a lower price when fractal elements align directly, or through Fibonacci ratios. For example, a down leg that reaches channel support around the 22nd (or even 33rd) day would set off major buying signals, matching the point count of the first quarter decline while doubling or tripling the day count.

Observant traders may fail to identify the exact bottom before the market turns higher, but the first quarter fractal predicts a bounce into the .786 retracement level, offering actionable information about where the buying wave might end. Relative strength analysis can also be used to pinpoint tradable lows, with daily and weekly stochastics crossing into buy cycles in sync with fractal readings.

Fractal analysis could allow market technicians to identify a fourth quarter bottom and a buying opportunity well before their competition.  

<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>