The S&P 500 Index declined -2.1% for the week. We've now retraced -5.2% from the most recent high reached on 27 July (intra-day). The good news is we're still 25% above the bear market bottom of 3,491.58 back in 13 October 2022. So far, this is just a routine market breather that we get in most market recoveries. Only when we retrace more than -10% should we start to be concerned.
Here is a "busy" marked up chart of the S&P 500 index. There's a lot to talk about.
You can see our down leg which blew right below a potential support level near 4,455. It also blew below the 50-Day SMA with ease. The 50-Day SMA is usually a short-level line of support in a rising market. We continued to decline until when we rebounded intra-day near another potential support line at 4,325. We'll see next week if we can stay above this level. If not, then our next potential support line is near the 4,195 level (or 4,200 to make it a round number, this is not a precise science). Below that, we start talking about testing the all important 200-Day SMA and things become serious.
It's important everyone understands that every peak and trough is a potential support line in a down leg. A down leg continues until enough buyers perceive value and step in to arrest the selling pressure. It's either willing buyers step in or willing sellers start to exhaust.
When we first break through a line of resistance in an up leg, buying pressure has overcome the supply of shares from willing sellers. In a strong bullish market, the price will march higher and not look back. However, you will often see the number of willing buyers start to exhaust at higher levels. Sellers start to re-exert pressure to push down the market until we approach the former resistance level. At this level, more willing buyers might step in to buy the dip and we bounce off that resistance level.
Resistance has now become support (change of polarity). This is now the level where buyers stepped in to move the market higher. The theory behind technical analysis is that we tend to anchor on prices (or levels) to the point where it drives our behaviour. In this case, we're expecting buyers to step back in if we revisit this support line (formerly resistance) because it's where enough buyers were previously happy to step in and move the market higher.
Let's have a look at our first potential line of support at 4,455 when this current down leg began:
When the market drifted down, we wondered if the trend was strong enough for our former line of resistance to now become support. Unfortunately the market blew right past this level and also blew past the next potential line of support at the 4,400 level (next trough). Now chartists are staring at the 4,325 level to see if this line of support will hold. You can see this is another trough where buyers previously stepped in to move the market higher.
There is also another coincidental reason to keep an eye near the 4,325 level:
You can see the market rebounded off the -23.6% Fibonacci retracement level. This level almost coincides with our key support level of 4,325. When you see convergence between two different technical indicators, the level/zone becomes more significant. The next Fibonacci level is the 38.2% retracement which almost coincides with our new potential line of support at 4,195.
I hope everyone reading this can understand how support and resistance lines work and how we get a change in polarity. It's surprising how hard it is to explain, but once you get the concept, it really sticks. You just naturally see it in every price chart you look at.
What's the point of this analysis if you're a fundamental investor? The benefit of technical analysis is that it mentally prepares you with the scenarios that might happen. If we breach a potential support level, we look to the next lower potential support level to see where buyers might step back in to arrest the decline. If they did it previously, they may do it again at that level. We can game plan our future actions based on our different scenarios. If the market happens to head higher from here, we can look at potential resistance lines where the market might experience some friction, or difficulty in advancing further. Again, we can game plan our actions.