The S&P 500 Index bounced up 20% from its Monday low to its Thursday closing high. It seemed primed for the bounce and in Tuesday’s article where we pointed out a bullish morningstar reversal pattern. But we also mentioned that a V-shaped recovery was not what many technicians wanted to see. Volatility is extreme and a volatile rebound is not likely to be sustainable over the intermediate term. What would be optimal is for base building that would act like a platform for an extended stair-step advance. Measured moves of higher highs and higher lows over time give investors confidence that the move is sustainable. We may be in the early stages of building a base but unfortunately it requires a pullback.
The bounce in the S&P has taken the index up to the 38% Fibonacci retracement level of its February/March range. This level is intersecting with a downtrend line. It seems like a logical resistance level and a point for a pause in the rally. What we want to see now is some sideways action. This lateral movement could retest the lower level but should not make a new low. In a perfect technical world an extended W-pattern would form inside this week’s high/low range. This is just one possibility, of course, and there are numerous ways bases are made. Simple steady action over time instills confidence and confidence in the stability of the market produces higher prices.
It should be noted that this week’s upside action has turned the technical indicators up and out of their negative zones. Alternatively, the 50 day moving average is preparing to cross under the 200 day moving average, the classic “death cross.” The problem is that both the technical indicators and the moving averages are lagging indicators. Market or price action is the primary thing to watch.
The market needs a foundation to build on and construct a new all time high.
There was a powerful wave of buying that swept through the market on Tuesday. The major market indices were up over 10% in the session, closing on their highs. It was a relief to investors after a month of what seemed like indefatigable selling. In addition to the the positive price and money flow momentum on Tuesday there was another positive development on the charts. A three day morningstar candle pattern formed signaling a possible reversal in the down trend.
The daily charts of the major market indices illustrate their over 30% declines over the last several weeks. Highlighted in the green boxes are the three-day bullish reversal morningstar formations. The pattern consists of a large down-day candle, followed by a narrow opening and closing range “doji” candle, and completed by a large up-day candle. It represents a transition in investor sentiment, from bearishness to bullishness, and is considered by many technicians to be a reliable pattern. Here is a more in depth look at the morningstar formation from Investopedia.
The morningstar pattern like all technical chart patterns is created by the tension between buyers and sellers. It would normally reflect selling exhaustion and a sharp pivot to buying interest, often followed by a V-like reversal. But it is not likely that selling of the magnitude and velocity of the last four weeks would end so dramatically. More likely is that the low range would be drawn out over an extended period of base building. In fact, many market participants would probably prefer a more stable reversal bottom. Also, notice the price action in the indices back in the last two days of February and the first day of March. Rudimentary morningstar patterns formed on the Dow and the NASDAQ charts. This reinforces the need for confirmation when trading any technical pattern.
The bottom line is that the markets are under tremendous stress. Time will be required to properly repair the damage. The best medicine then is a slow but steady recovery reflected in a stair-step pattern of higher highs and higher lows. Hopefully, this morningstar pattern reflects a low on which we can build a solid foundation.
Jim Cramer featured the technical work of RightView Trading on the “Off The Charts” segment of Mad Money exactly one month ago. Here is a recap of the piece from a follow-up article on TheStreet.com that day.
It was another in a series of “Off the Charts” analyses that we did on the long term direction of the broader market. In this episode we looked at the bearish divergence between the S&P 500 Index, which is heavily weighted with technology stocks, and the Equal-Weighted S&P 500 Index, which gives equal weighting to every stock in the index.
At the time, the S&P Index was breaking above the resistance line of a horizontal channel pattern, while the equal-weighted Index was not. We suggested this was a bearish divergence. That the two indices would have to realign at some point. The higher probability scenario was that the technology stocks were distorting the performance of the S&P 500 index. This would mean that the breakout on the S&P 500 chart was a false breakout and that it would have to revert back in the direction of the equal-weighted chart.
Since then the broad market as represented by any of the index charts has fallen dramatically on both the health issues and economic issues of the coronavirus. All our technical analysis did was point out the fragility of the S&P 500 Index relative to its equal-weighted counterpart at that time. Many other technicians had observed similar technical bearish indications. The fundamental event triggered the drop and has continued to power it lower.
So where is the market headed? As it turns out another chart that we highlighted on “Off The Charts” last year shows that we are at or near another inflection point. The S&P 500 logarithmic chart has returned to a long term rising support line on its monthly time frame. A log chart measures price movement as percentage moves. This support line has been in place for nearly a decade and has been successfully retested multiple times. It is an important level from a technical perspective.
The integrity of this support represents the future of the intermediate term to long term direction of the broader market. If it is broken to the downside a channel pattern price target in the 2038 area would intersect with the 50% Fibonacci retracement level of the 2009 low and the 2020 high. But the 38% retracement level in the 2362 area intersects with the 2018 low. If this level is first tested it should provide substantial support of its own.
The opposite scenario is that if channel support holds then the upper range of the channel would be the technical target. This would represent new highs for the markets. At this point in time that would require some very positive fundamental news. Let’s hope for the best.
This is a big picture long term analysis and should be used as context for shorter term analysis. Also, remember the predictive power of technical analysis comes under stress in volatile fundamentally driven markets.