Wednesday, July 28, 2010

S&P500 Support and Resistance

Support Resistance
The overall concept of support and resistance levels applies universally in the technical analysis world.


On a regular basis, folks want to discuss the interesting topic of why support and resistance levels seem to work. Two philosophical ends of the spectrum support the concept:

1. Underlying pattern or foundation of the markets.

Adherents to this school of thought would describe the market as following a set of rules that are much like “the laws of nature.” Many students of Elliott Wave theory and Gann theory would fall into camp. This type of analysis tends to be predictive and very adaptive or fluid. If the markets don’t fit the current model points, the model has built-in adjustments that allow updates (that wasn’t really wave 3, this is now wave 3).

2. Self-fulfilling prophesy.

From this perspective, those that see support and resistance levels believe in the “many eyeballs” theory—if enough people are watching a level or an indicator (and more importantly take action there), then the market has a good chance of turning or reacting at that point.

Personally, I don’t really care which reason is more “true” as long as using the idea of support/resistance provides an edge. I fall more in the self-fulfilling prophesy camp, even while I think some market philosophies have more than a grain of truth to them!

Why discuss this? Last week, I published an S&P 500 Index chart (created on Monday 7/12) that showed an area with a confluence of support and resistance indicators that had a high probability of containing the up move that was underway.

SP500

If we look at that same exact chart, six market days later, we see that the area inside the light blue ellipse actually held the price activity.

SP500

The trend line remains intact, the 50-day moving average held, and the index tested but did not breach the 0.382 Fibonacci retracement in a definitive way—more on the concept of precision later. In addition, the market failed to pierce the psychologically important whole number of 1100.

In the bigger picture, this small victory for the technical analysis (and the bears) has no earth-shattering significance and the bulls will test this area daily. Regardless, the bears indeed are winning as long as these levels hold and the downtrend that started in late April remains intact with lower highs and lower lows.

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