Three Different Resistance Measures

The S&P 500 has stalled around its 50-day moving average, as was true the other day (see the previous post). Now that a few more days have passed since then, we saw a couple of spinning tops, which indicate indecision, then a large down day (yesterday) followed by a significant up day (today). Today's bullish candlestick was not as large as yesterday's bearish candle, and today the market opened from a higher level than yesterday's close. In OHLC charting, this is referred to as an inside day. Overall, I think it is safe to say that there is no definitive direction for future price change at this time. As I stated in class, at times like this, it is advisable to consult the economic calendar for the remainder of this week and next week, identify the "biggie" releases that will occur, then attempt to determine what each of these will do and how the market will react. Nobody can know this with certainty, so don't be intimidated. Actually, if you listen to the "talking heads" on the financial stations and keep track of what they predict, you'll probably be surprised by how inaccurate these persons are. So, don't be afraid to venture out and try this, you probably won't do any worse than the "talking heads."

Look at the following charts and analyze the most recent candlesticks and think about what they indicate about the battle between bulls and bears. Using these, I will now present three different ways to measure resistance.

#1: Fibonacci Retracement: If we apply a Fibonacci Retracement to the most recent high and low of the daily S&P 500 (see chart, click to enlarge), we see something quite interesting: the recent rally stalled at the 61.8% retracement point. The use of Fibonacci Retracement suggests that after a decline, the first possible point of resistance in a rally is when 38.2% of that rally has been erased (retraced). The next possible resistance point is at 50%, while the last occurs at 61.8% retracement.

#2: 50-day Moving Average: The next charts (click to enlarge) shows that the 50-day moving average acted as support for the S&P 500 since last fall, then became resistance in late January of this year. It is fairly common for prior support to become resistance (and vice versa). Note how the most recent rally failed just at the 50-day moving average. At this point, based on the most recent candlesticks, the direction of future price is still a toss up. A definitive move above the 50-day moving average, especially for a major market index, would be very bullish, and we might have a shot at returning to the previous high. If that were to occur, then the market falls below that level, what technical formation do we have? A double top, which is a reversal pattern. More about establishing a down target later this semester if this possibility occurs.

#3: RSI(9) < 60. In this same chart, look at the RSI in the upper portion. Note how the most recent high coincided with the RSI falling below 60 and remaining there. Just as the S&P is now testing its 50-day moving average, so too is it testing the RSI at 60.Often, an RSI value of 60 is used as resistance for a downtrend, while 40 is used to designate support for an uptrend.

So, what will happen from here? As I stated above, look at the economic calendar, identify the "biggie" numbers that can potentially move the market, and attempt to predict what each of these will do. In doing this, you are actually using economic theory, which states (for our purposes at this point):

      Stock Prices = f(interest rates, expected future profit)

In analyzing the future releases, focus primarily on the macroeconomic implications for profit expectations, since Fed Chair Bernanke indicated again today that the fed funds rate will remain low "for the foreseeable future." That reassurance was a fundamental driver of today's rally which erased most of yesterday's losses.