S&P 500 Index – What Gaps Can Tell Us About Where The Market Is Headed

By | September 16, 2019

The S&P 500 index spent most of the month of August consolidating in a 4% wide channel between 2940 and 2820. This month it broke above resistance and traded up to the area of the July highs.

A closer look at the S&P 500 daily chart shows new resistance in the 3030 to 3020 area. Support is the gap between 2960 and 2940 created earlier this month. Last week a strong looking hammer candle formed on Tuesday, followed by strength on Wednesday. That momentum petered out in the final two sessions as the index approached resistance.

The more sensitive momentum indicators like the Stochastic oscillator suggest the market is overbought. Less sensitive momentum indicators like the RSI do not and, along with the money flow indicators, continue trending higher.

Historically, the allure of new highs has a powerful magnetic effect on stock prices and, conversely in this case, everyone knows that gaps like to be filled. But the primary market motivators more recently have not been technical. They have been news driven and interest rates will be the driver this week.

On Wednesday and Thursday the Federal Reserve Board meets and will make a determination on interest rates. The pundits seem to think that a quarter point cut is baked into the market. So, if we only get a quarter point cut the market will likely be disappointed and head lower. The President will try to counter the downside action with a tweet storm railing against Chairman Powell. It will not help and a pullback into the end of the week could see the support gap between 2840 and 2820 filled in short order. The potential for a breakdown would be high.

On the other hand, a half point rate cut would be considered bullish and the market should power through resistance to new highs. It is hard to say how sustainable any rally would be. The necessity to lower rates at this point is not a ringing endorsement of the current condition of the economy. But the bond proxy stocks will jump and the risky high yield bond funds will benefit. The 3030 and 3020 gap now become support.

An upside target for a breakout move is difficult to project, unless we see another bullish “gap” up in price, for example, a jump above 3030. Then we would take particular notice.

Gaps sometimes come in threes. The first in the sequence is the “breakaway” gap. It usually occurs after an important consolidation period. The 2960 to 2940 gap earlier this month might be considered a breakaway gap. Let’s assume it is. If we were to then get a second gap (potentially triggered by a half point rate cut) that takes the S&P above the 3030 level, and it might be considered a measuring gap.

A measuring gap usually occurs around the hallway point in a trend. In this case, the trend would have started with the move off the August low. There has been a 7% move higher off the August low. If that is the halfway point then another 7% move would follow. At that point the textbook says to expect the third gap. The third and final gap is called an “exhaustion” gap. It usually marks a blow-off top and an end to the trend. This second 7% measuring gap rally into an exhaustion move takes the S&P index up to the 3150 area. At this point, the book says that the rally off the August lows would come to an end.

This thesis is, of course, technical speculation, but this kind of exercise helps to maintain a flexible perspective on the market. And it is a “noisy” market but the news and the tweets have helped to create the trend lines and the price gaps. So, trade around them and remember preserving capital is job one.

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