10:15 am EDT:  Market liquidity, as measured by proxy through the ES via a proprietary measure, had improved over the last few weeks, but just deteriorated significantly.  The last time it approached these levels from the downside (greater to less liquidity) was May 6.  This doesn’t mean there will necessarily be another flash crash, but that it is very easy to push prices around on low volume.  Caution is warranted with all positions.

11:41 am EDT:  The 30 Year yield has now broken below its consolidating wedge as shown below, and a close below would confirm bond strength and weigh on equities short term.   Also, while the Euro remains relatively strong against the US Dollar, it has dropped precipitously against the Swiss Franc as the SNB issued some hawkish statements early this morning.  The decline started yesterday, however, and could be indicative of capital flight from the Euro to the Franc, which has been concurrent with short term equities weakness in the last month.  Accordingly, we would expect to see 1108-09 act as resistance if the ES is to head lower.  If it accepts above, the early weakness would seem to be just a shakeout.

12:36 pm EDT:  Though we have a new nominal high in the ES at 1113.50, the leaders are not confirming, in particular the EuroYen, which sits in the middle of today’s range.  Accordingly, caution with day trade longs is warranted at these levels.

Two quick things:

1) A reader correctly points out that the critical support area that includes the 20 day moving average for the ES mentioned in the morning report should be 1078-79, not 1178-79.

2) Day-session-only R1 (also the half gap) at 1091.50 held to the tick for the first 30 minutes, which suggests the possibility of a trend up day.  If that level is broken, we would expect at least a test of the lower end of the projected range at 1084.25 to 1085.50.

The ES opened above the upper end of the projected range and is testing yesterday’s high.  Our general rule is that if the daily R1′s at 1071.75 hold in the first 30 minutes, there is strong possibility of up trend day.  A failure should send the ES for a test of the half gap at 1064.00.

11:21 am EDT:  The key level we were watching was yesterday’s low of 1047.00 which was materially breached (low 1041.25).  While this now gives us a short term bearish bias, it is with some skepticism as the leaders did not confirm the down move.  Both the EuroYen and 30 Year T-Bond futures remain inside the prior day’s range, with the US Dollar Index largely flat.  Accordingly, it could be that we were too stingy with the 1047.00 price level.  If the ES accepts above 1050.00, it warns of a possible bear trap.  On the other hand, if the ES continues to accept below 1050, it sets the stage for a  down move to the 1016-1018 target area.

12:01 pm EDT:  The US Dollar Index broke through resistance, making it more likely that there will be upside follow through next week, correspondingly weighing on equities.  The ES was able to rally early, but was unable to capitalize on bullish seasonality, having now given up its gains and testing the support area containing the overnight low and weekly pivot, from 1076.50 to 1077.25.  While it is currently holding such support, upside potential looks limited absent surprise favorable news.

1:07 pm EDT:  It took a while to get started, but sellers took hold again at about 10:00 am, taking the ES down to the daily S3′s, after which there was a relief rally up to VWAP.  The ES is now making new lows and the 1056 to 1060 major support level is in sight.  We have been anticipating a short covering rally at some point, and will repost one way in which it could get started.  From Gaming the Market:

PPT Day Characteristics

These moves typically occur after 2:30pm Eastern while the market is near a new low or breaking point, with a relatively high VIX.  Another characteristic is a large NYSE Adv/Decl negative ratio.  One that is negative 10:1 going into lunchtime typically assures a weak close.  Ratios of 3:1 negative aren’t what you want. They are easier to manipulate by weak bulls. You want a big scary ratio. It is these negative internals that can clue you into the probability of a PPT push.  A big push on a big negative internal is the tell. To instantaneously swing the market around on these days takes a massive amount of concerted capital.

If you watched the market every day last year you know what this looks like.  Using 5min candles on your favorite index you will see an immediate and massive full body candle, sometimes eclipsing the entire day’s range in minutes.  There is no mistaking this move. 

If the ES gets down to critical support in the next few hours, today would fit the above criteria.  It’s important not to front-run this setup as further downside is possible.  Just something to be on alert for.

Update 2:39 pm EDT: It looks like this selloff is in response to a half baked scheme to ban short selling in Germany with just a few hours notice.  The news could have major repercussions in the markets over the next few days.

2:24 pm EDT:  To continue the Market Profile-based discussion from the morning report, the ES failed just as it was entering the next higher value area and did not respect the 1126.00 high volume level after heading lower.  Accordingly, the ES will likely need to base more in the (purple) value area before heading higher.  Once it accepts above today’s high of 1147.50 in the next higher value area, it has a good shot at another up leg.  A break of yesterday’s low of 1112.75 should lead to a test of at least ~1098 support.

The signs of instability and illiquidity were mounting, but we would not have believed it ourselves had we not had a front seat (again).  The markets have indeed returned to crisis mode not seen since the collapse of Lehman, and day trading with small stops in heavily leveraged instruments is quixotic.  We will, however, publish the report tomorrow on schedule.  Unless you are very experienced, it would be wise to lower leverage or stand aside until the markets calm.