Let's back up and look at the big picture, placing current price action into historical context, and make reasoned judgments about market direction in the next few months. This useful exercise will lower the noise levels considerably and quiet the drumbeat of talking heads, emotional calls and self-serving opinion that can undermine carefully planned investment and trading strategies.
While weekly charts offer great perspective on price development going back three to five years, monthly charts take things one step further, offering a detailed view on an entire decade of uptrends, downtrends and sideways markets. Just think how much money you might have saved in 2008 just keeping one eye on these historical patterns while Mr. Market gyrated through the worst financial crisis in eighty years.
Of course, market history is fascinating, but the real value in monthly charts lies in the focalization of deep support and resistance levels that have the power to impact price action ten to fifteen years after they're first printed. Sub-divisions of these major levels, carved out through Fibonacci retracements, work equally well in exposing action levels that require your full attention.
I'll start with the
index, which peaked near 1,550 in early 2000 and sold off to 768 during the tech-driven bear market. It returned to the high in September 2007 and reversed violently, leaving behind a massive double top (red lines) that's still in play nearly four years later. Although 2002 support broke for two months in early 2009, the new uptrend reestablished 775 to 800 as a major price floor.
The recovery stalled right at the 62% retracement level (red circle) in April 2010, giving way to an intermediate correction that found support near the 38% retracement (blue circle) in the late summer. The rally since that time pushed above April resistance in December and then fizzled out in February of this year, about 40 points below the 78.6% retracement.
An uptrend that exceeds the 62% retracement level will typically push into the 78.6% retracement level. This increases the odds for a final rally to 1,385 (blue rectangle), which is just 38 points above Tuesday's close. That places the reward-risk ratio firmly against new long-term positions, even though the S&P 500 has recently gone vertical, pushing above February resistance.
peaked over 5,000 at the height of the tech bubble and then plunged to 1,100 by the end of the bear market. The mid-decade recovery lifted price into the 38% selloff retracement (red circle), where the index topped out in 2007. A test of the 2002 low held in early 2009, with price turning higher about 150 points above long-term support.
The subsequent uptrend carved out a V-shaped recovery that completed a 100% retracement in February of this year, with price returning to 2007 resistance. This is a typical ending point for a secular rally and a starting point for an intermediate correction that retraces 38% to 50% of the prior buying impulse. This math predicts a downside target between 2,050 and 2,250.
A decline toward that price zone would do no technical damage to the monthly pattern, unless it undercuts the 2010 low near 2,060. I doubt that will happen. Expect support to kick in at above the 50-month moving average, currently at 2,280. More important, a rally starting near that level could complete a massive breakout pattern, with an upside target above 3,000, at the 50% retracement of the 2000-02 bear market.
Like the Nasdaq Composite, the Nasdaq 100, Russell 2000 and DJ Transportation Average have all completed 100% retracements of their bear market declines. This uniformity predicts that big tech, small caps and the transports may struggle through the summer, while the S&P 500 outperforms in an effort to complete its journey into the 1,380 to 1,400 resistance zone.
Finally, let's examine
long-term chart to gain insight following the company's first-quarter earnings report yesterday. We'll use Fibonacci extensions instead of retracements to predict upside targets because the stock is trading near an all-time high. This is a less precise form of technical analysis, but still extremely useful for decision-making.
The stock topped out at $113 in early 2000 and sold off to $5.53 after the tech bubble burst. It returned to the high in October 2009, completing a 100% retracement, and then broke out in a powerful uptrend that stalled near $140 a few months later. Price pulled back to test new support in the summer of 2010 and then zoomed to a new high earlier this year.
Note how the most recent rally ended right at the 1.618 Fibonacci extension. This is a typical upside target following a major breakout to a new high; however, the stock has been acting well at this level, grinding sideways for the last six months and trading near the top end of the range. A breakout will be significant, with the next target (blue square) at the 2.0 extension, all the way up at $220.
At the time of publication, Farley had no positions in any of the stocks mentioned, although holdings can change at any time.
Alan Farley is a private trader and publisher of
Hard Right Edge
, a comprehensive resource for trader education, technical analysis, and short-term trading techniques. He is also the author of
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, due out in April. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.
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