In December we highlighted an interesting pattern of eveningstar reversal formations on the S&P 500 daily chart.
We noted that, in both October and November eveningstar patterns had formed on the chart. They had marked important lower highs
An eveningstar is a bearish three-day reversal formation, often seen at market tops. It consists of a large up-day, a narrow opening and closing doji-day, and is completed by a large down-day. It represents a transition from bullishness to bearishness.
When we posted the December article it looked like a third eveningstar was forming on the chart. Two days later a doji candle formed and the following day a another rudimentary eveningstar was completed, right at the declining 50 day moving average. It marked the December high and was followed by the dramatic December drop.
This week on Tuesday a large white up-day candle formed and it was followed on Wednesday by another doji candle. Wednesday’s doji high formed just as previous candles have at the still declining 50 day moving average.
The takeaway then is to be very cautious of any real weakness in today’s session because it would be a replica of several previous patterns that marked highs in the broader market.
We have been watching the wide levels on the weekly index charts, levels which had been support early in the year. They reverted to resistance following the December drop. Last week the NASDAQ Composite closed above its resistance area, while the other major market indices were just below or testing those levels.
The rebound in the indices off the December low was a sharp V-shaped move that recovered about half of the December decline. These recovery levels develop because long term investors realize they have recouped half their losses from the December high and are willing to sell, and short term traders who were able to jump on the rebound low are booking a quick profit.
There are economic and psychological reasons that technical levels develop on stock charts. They are real-time reflections of investor sentiment. It is important when interpruting candlesticks and patterns to understand the dynamic underlying the price action.
We tweeted out last week that Bollnger band width and average true range on the S&P 500 chart had contracted to a level that, in the past, had been followed by sharp moves in the index. There was no way at the time to know in which the direction the index might be headed, only that the move would be volatile.
This morning the broader market opened sharply lower and this may be the start of several days of downside action. It also reaffirms that the weekly areas of prior support remain difficult resistance.
In December the major market indices dropped sharply and broke below areas of former support on their weekly charts. These zones had provided strong support in February and April last year, and later in November.
As we know when a support level fails and price breaks down, the support level reverses roles and becomes resistance.
The market was able to halt the decline in the last weeks of trading of 2018 and book two solid weeks of upside action. But now the indices are approaching their former support-turned-resistance levels. What was once solid support is now formidable resistance. How the market handles these first tests could be critical in determining their intermediate-to-long term direction.
The nature of market participants suggests there is likely to be selling into these areas. Some long term investors will be happy to recover nearly half their losses since the October highs. Likewise, traders quick enough to have jumped on board this reversal move, will be just as quick to take their profits.
But just as solid resistance can repel, sometimes V-shaped bounces gather momentum and can pierce through tough resistance areas. The broader market’s long term directional trajectory will depend on the integrity of the zone.
The financials are one of the most beaten down sectors of the market. The Financial Select Sector SPDR Fund (XLF) is down 21% from its 2018 high and was down over 25% at its low last week.
Last week’s low touched the 50% Fibonacci retracement level of the fund’s 2015 low and its 2018 high. So far this week, the 50% retracement level in the $22 area has continued to act as support, and the 38% retracement level in the $24 area has acted as resistance.
These horizontal 50% and 38% retracement levels should be monitored for their ability to provide support and resistance over the short term. But there is another set of Fibonacci lines that should also be watched for their technical support and resistance potential going forward.
The blue lines that originate at the 2015 low and extend up through the retracement points of the 2015 low and 2018 high are called Fibonacci fan lines. They can also be used to define support and resistance, but unlike horizontal Fibonacci retracement lines which are static, the fan lines are dynamic, meaning they extend upward.
The XLF has a lot of work to do in order to reverse the trajectory of its downtrend. An initial step would be to move above the static horizontal 38% retracement level. The next step would be to begin trading above the rising 50% retracement level fan line.
The SPDR Gold Shares (GLD) have spent the last four years trading under resistance in the $130 area. This level has been retested multiple times and held firm. But it looks like another test is in the offing.
The low on the GLD monthly chart was made in December 2015, a higher low was made on December 2016, and a second higher low in October this year. This is positive technical action. In addition, the December monthly candle is a white marubozu, that is, a candle with no lower or upper shadow. An candle open at the low and close near the high is bullish price action.
On the weekly time frame, the Gold Shares ETF has broken out of a cup and handle formation with rim line resistance in the $117.50 area. The move took shares through the 40 week (~200 day) moving average, and the pattern projects an upside measured move to the $124.50 area.
The bullish higher lows on the monthly chart combined with positive price momentum readings on the weekly MacD and relative strength indicators, as well as a Chaikin money flow reading well into positive territory, suggest that the GLD could be headed even higher than the projected target price.
It is likely another test of the monthly $130 level resistance is underway. So, what if that level is broken? A breakout from the long term base foundation projects a minimum move of about $20, which would takes the GLD to the $150 level.
This is pure speculation but if it were to occur, it would represent a more than 20% advance from the current price of the Gold Shares ETF, and would probably be derived from some deeper undercurrent in the broader market. Not sure what that undercurrent would be but the implication is that it might not be a good thing.
The S&P 500 index was down nearly 13% for the year on December 24. We were officially in “bear market” territory with a 20% peak to trough decline in 2018.
But the sharp low-volume rally over the last four trading days of the year recovered half the 2018 loss and lifted us out of bear market territory. We are safely back into correction mode.
Happy New Year, Algos!