Signs of Strength
What a week! As I write this Monday morning the markets are moving higher in an attempt to regain some stability after last week's roller coaster ride. The big question on everyone's mind is are we at a market bottom? Sorry to say, I don't have the answer. If I did, I'd be on some Caribbean Island I'd own and you'd never hear from me again! But as a smart trader, I know that I can watch the market for clues as to the direction and magnitude of the next move.
I gave a presentation last week on Hour with the Pros on Fibonacci retracements and projections. By looking at the markets' actions and using these important numbers, we may be able to predict with reasonable accuracy, the direction of the next thrust of the major indicies.
My first look is to the broad S & P 500 index. We can see by looking at a large daily view of the S&P 500 index that we have only retraced 38.2% of the large bull-run which began in July 2006.
A retracement of 38.2% is weak and only serves to reinforce the strength of the bull market. A closer look at that retracement line shows that it was violated but the index could not close below it. When an index or any security for that matter pierces a support or resistance line, it is testing that line to see what lies beyond it. Last week, when the S&P broke below the 38.2% line, it did not find a mass of selling pressure. That in itself is a bullish sign. Looking left from August's price action, we confirm that the 38.2% retracement line was also a previous support and resistance line (highlighted in yellow). This adds strength to the price as a support level. We have a similar picture if we look to the Dow Jones Industrial Index as well.
Looking closer at the S&P 500, we see a retracement of the downward move of 61.8%.
This is a bigger retracement than we saw of the bull move. A large retracement of the bear move indicated an underlying bullish sentiment. You may notice that I do not always anchor my Fibonacci retracements from extreme highs and lows. I have found that by using openings and closes or areas of price congestion, I will have greater success with the retracement levels. I also have confirmation of those lines from levels of previous support and resistance, (highlighted in yellow).
The interesting thing about the strength in the broad market is that it is being led by the small cap stocks. Looking to the Russell 2000, an index of smaller cap stocks, we see a similar chart to the S&P. This is indicative of a healthy move.
This week will be a major test for the market. The Russell 2000 has not closed above the 50% retracement of the recent downward move. This has also been a previous support and resistance line.
If it should, we can expect the market to continue higher and retest last month's highs. If not, look for a slide that may take out last week lows. Using the Fibonacci retracements can give us an indication of the technical health of the markets. Fundamentally, we are receiving confirmation as well. Even with the doom and gloom portrayed by the media about the subprime markets, the Fed sees that an overreaction of cutting rates is not necessary at this time and inflation is still the main culprit. Recent cash infusions by the European Central Bank and the Fed seem to be a band-aid for a minor boo boo rather than unnecessary surgery on a economy with underlying strength. Stay tuned!
Until next time, happy trading!
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As a former stockbroker, brokerage trader, and hedge fund trader, Brandon brings various market views and insight to his classes. A wealth of knowledge, he has held NASD securities series 7 and 63 licenses. An Online Trading Academy graduate himself in 1998, Brandon has been trading his own account since. Brandon taught for Online Trading Academy in 1999 to 2001 before becoming a Realtor and Mortgage broker holding licenses in 15 states. Returning to the Online Trading Academy family late 2005, he now balances trading, teaching and a real estate career.