The continued advance of the S&P 500 has been frustrated by resistance in the 1120-1125 area for about a month.
There are a number fundamental conditions, as well as, technical divergences in place that would suggest the rally should see a temporary pause and a pullback. At this point, many market participants would consider it healthy and constructive.
If it does occur, however, will it be a welcome respite or something more serious? The best assumption can be made by looking at a period with close correlation.
The basing period that occurred in late 2002/early 2003 is one that might not have fundamental similarities with the current period but it does have very important technical similarities.
In May 2003 price broke through a resistance line that capped an important 10 month basing/consolidation period. A powerful trend developed and continued for approximately 10 months culminating with a 47% rise off the March 2003 low.
March 2004 saw price consolidate, fail to penetrate the 50% retracement level of the 2000 high/ 2002 low and then break down. What followed was eight months of weakness that took the index down about 8% to the first Fibonacci retracement level off the low. A key reversal occurred in November 2004, sparking a powerful multi-year market rally.
In the comparable 2008/2009 period there was a consolidation base similar to 2003-2004 that, also, lasted about 10 months.
The neckline was penetrated in July 2009 and price has risen, overall, about 64% to current levels, taking us to the 50% retracement level of the October 2007 high/ March 2009 low. If we fail to move through this 1120-1125 area and pull back 8%, like in the 2004 period, we would, also, retest our first Fibonacci retracement level at 1015. The next significant area of support would be the neckline of the base consolidation period at 950.
Most market participants could live with a replication of the 2004 scenario and an eight-month 8% retracement from current levels and then a multi-year rally. The likelihood, however, of close correlation continuing diminishes the longer it lasts.
An alternative outcome is that price breaks up through the 1120-1125 area and the 50% retracement resistance becomes important support and the base for a new leg up in the rally. A second possibility is that we pull back more than 8% and the first Fibonacci level fails. This would incur significant technical damage that would take much longer than eight months to repair .
The comparison between the two periods is interesting and traders should be aware of the many similarities. It is, however, along with speculation on future price movement, more a technical exercise than the basis for a trading strategy.
Robert Moreno is a former member of the New York Cotton Exchange and the New York Board of Trade. He has traded for his own account for over 25 years. An experienced market technician and student of the art since the days of paper charts and manual computation, he authored a daily technical analysis information sheet popular with brokers and traders in the "pits." Currently, he is a General Partner at Wyckoff Investment Partners, LLC, which provides technical and fundamental research and analysis to traders and investors.