S&P 500 Index: Time to Take a Breather?

09/21/2009 10:35 am EST

Focus: STRATEGIES

Up nearly 60% from the early March 2009 lows, the S&P 500 index has put in a remarkable performance in the past six months. However, even the strongest trend moves need to take time to pause, rest, or even correct somewhat. Let’s analyze a long-term chart of this large-cap index and see what technical clues its monthly chart make available to us.


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Graphics credit: Metastock / WB: Detrend RT EOD from ProfitTrader for Metastock

While at first glance, there does appear to be conflicting forces at work on this monthly chart, a brief examination of each technical aspect will help us to put it all in perspective so as to determine the most probable outcome in the near term. First off, the index has already cleared and is well above its 12-month simple moving average (SMA) (red line). The SMA hasn’t begun to turn higher yet, but is likely to do so shortly—a very bullish sign, longer term. At the same time, the NYSE composite tape indicator (bottom panel on chart) has just completed a bullish zero-line crossover, indicating that money flow and internal momentum (based on the ratio of new highs/new lows, up volume/down volume, advance/decline ratio) is still getting stronger.

Those are the two long-term bullish technical aspects, now let’s focus on the near-term realities that the detrend oscillator (top panel of chart) and Fibonacci resistance levels are warning about. If you look at the detrend oscillator (which helps locate the true cyclical component in any trend move), you’ll note that its at the highest level since July 1997 and is even higher than in July 1999 and June 2003. While an overextended detrend doesn’t necessarily mean a major correction is at hand, it normally does a good job of warning that a period of pause or consolidation is very likely to occur in the wake of an extremely high reading. That’s exactly what happened after the July 1997 and June 2003 extremes, while a more substantial corrective move occurred in the aftermath of the July 1999 extreme.

While it’s impossible to know whether we’ll get a simple sideways consolidation or a multi-month corrective move lower in the wake of this current detrend extreme, the odds seem to favor a modest pullback, and here’s why: The S&P 500 index has just run up against strong Fibonacci resistance at 1060-1066 (right near the current price) and the index is also due to make a weeklycycle top within the next week. Additionally, the Russell 200 index is also due to make a weekly cycle top within a week at a price somewhere near 620-625.

Finally, look at how steep the angle of attack of the recent monthly swing has become. If you compare it with all of the other bullish upswings on this S&P 500 monthly chart, the only other swing that has similar amplitude, duration, and angle of ascent is the mammoth bull run from October 2008 through July 1999, a powerful trend move that was followed by a significant three-month correction back to the primary uptrend moving average (the 12-month SMA). Powerful Fibonacci support levels reside in the range of 1027-1012 and then a little below that, near 1000-989, and these Fib support confluence levels should act as noticeable support on any pullbacks in the index. Additionally, once the 12-month SMA turns up (virtually guaranteed now), it too will likely act as a powerful support level on a correction move.

The message the chart is projecting seems to be clear—those holding long stock positions should prepare to tighten stops and/or lock in some gains while they can, particularly if not long-term investors. The S&P 500 is anticipated to make a weekly cycle low by mid- to late- November 2009, so it might pay to be very conservative on the long side for the next seven to nine weeks. Aggressive traders might consider selling out of the money .SPX call options once confirmation the a weekly cycle high is firmly in place, being advised that this is not a strategy for the fainthearted. Modestly bearish traders might also consider selling near-term option credit spreads (Again, waiting for confirmation of the weekly cycle top being in place) in the .SPX or in the stocks most closely correlated to this index. Most traders and investors should simply be patient and wait and see what the “Big Car” (Chicago pit trader slang for the S&P 500 index) does over the next few weeks. It should be very interesting to watch, no matter what happens.

By Donald W. Pendergast Jr. of ChartW59.com

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