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Trader's Corner

Determining Resistance Levels

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OIN SUBSCRIBER QUESTION
Where do you see resistance in the stock indexes currently and what criteria do you use to figure resistance?

RESPONSE:
Before I show charts and note where I would calculate potential resistance levels currently, some background information on 'criteria' on resistance or support areas.

1.) PRIOR HIGHS/LOWS
The first thing to check, or the first criteria in figuring current support and resistance levels is to look at any prior highs or lows that are at or near the current price. If a prior high is some distant, this is of course also a potential topping out point, but it's just going perhaps to be an 'ultimate' resistance point.

There is an assumption being made that buyers will AGAIN have buying interest at a prior (down) swing low. And that sellers will again come out when a prior high is reached. There is nothing more simple than this criteria and is based on actual prior buying or selling.

Where it gets more tricky is when there is either no prior high or low that is close to current levels OR prices of a stock or index have exceeded a prior high or fallen below a prior low.
Of course, in the present circumstances there is always going to be a prior rally peak to reference, given that the market still has a long long way to go to equal or exceed the 2000 top.

And, since we are quite far off the 2002-2003 bottom, there is a long way to go before any index at least would go to a new all-time low.

2.) TREND CHANNEL LINES
When there is NO prior high or low that is close to current levels, the next thing I look at is to see if prices are near the top or bottom line of the two parallel lines that make up a trend channel.

3.) A PREVIOUSLY BROKEN TRENDLINE
Sometimes there is a prior support trendline that was broken in the past and that prices have now come back to. This is a third possibility for finding potential resistance. Let me emphasize that finding potential 'support' or 'resistance', with the EXCEPTION of a prior top or bottom, is always a bit of an educated guess.

Moreover, resistance levels are somewhat approximate where any (channel, etc.) trendlines are being used, as an index can top slightly under, right at, or slightly above such trendlines. Or, of course, the index or stock can bust out above or below such lines or just follow the trendline up, 'hugging' the line. It's the most common thing to see happen in fact and VERY useful for option holders.

For example, someone long calls will generally achieve the lion's share of a gain once a resistance trendline is reached. After it is reached the rally often slows considerably and further gains may not exceed the erosion of the option premium.

4.) RETRACEMENT LEVELS
The so-called 'Fibonacci' retracements of 38, 50 and 62 percent, as well as 1/3 (33%) or 2/3rds (66%), are levels where resistance, or support, are often found.

5.) MOVING AVERAGES
Certain moving averages may end up 'defining', more or less, where buying or selling may cause a deflection from resistance, or a rebound from support.

S&P 500 (SPX)
The S&P 500 broke out to a new high, relative to the past several months. Therefore, it will be necessary to also look at charts of SPX's current daily chart trend channel as well as a weekly chart to see the prior peak (before this recent new high), in order to figure a next upside objective and possible resistance.

A couple of points before moving on: the 21-day moving average 'acted as' support or resistance in a couple of prior instances, as noted by the red down arrow for resistance and the green up arrow for support on the daily chart below.

The most recent low occurred after SPX reached its up trendline; this was the most telling sign for the end point of the last pullback. The 50-day moving average, although pierced some intraday (not on a closing basis), was also associated with the last bottom.

How do you tell if a moving average will be significant? By seeing if the index resists rising or falling above/below key moving averages; e.g., 21, 50, 200-day averages. If the trendline is pierced, it's important to determine if this is only temporary, lasting solely for day or two.

The next chart below, also an S&P daily, shows the current uptrend price channel that has tended to define the various highs and lows for the current uptrend in SPX. Based on the upper channel line, near resistance (at the red down arrow) is implied at around 1240.

Because of the tendency for a trend to slow down once it hits the upper end of an uptrend channel like this, holders of long calls might do well to take at least partial profits on long calls held from lower levels.

Note that the prior closing high at 1225 was the approximate support on the last consolidation before today's surge. There was ONE close under the prior high, but this was reversed the following day; TWO consecutive days' closes above or below a 'line' of support or resistance is more definitive. A prior high, once exceeded, tends to 'become' future support.

Now that the prior (March) high was pierced , a look at the SPX weekly chart is needed to see where the rally peak was before March 2005; we have to go all the way back to 2001 to see where that was. This suggests that major resistance can be assumed for the 1300 area, until/unless proven otherwise by market action.

By the way, those lows seen in the daily chart above back in April and May, when seen on the weekly chart below, form a very clear cut up trendline. Support over several weeks was found at this trendline, as noted by the green up arrow.

I have connected the early 2003 weekly lows above by bisecting or cutting through some of the lowest lows; this is an 'internal' or 'best fit' trendline. The most effective use of trendlines in my experience, is as a guide to seeing the predominate trend direction or seeing visually the predominate price momentum. An up trendline is not invalid if it cuts through an extreme low or two, as long as prices rebound again in short order.

IMPLIED RESISTANCE IN NASDAQ
The Nasdaq Composite (COMP) closed at a new closing high and very close to the prior intraday high from early-January at 2190. Therefore COMP closed at or very near what we can assume to be current 'resistance'. This is also not far under the upper line of the steep uptrend channel and near the upper trading 'band' or moving average 'envelope' line.

The moving average envelope lines are set at the percent figure that represents where the particular index has been at the high and low extremes of prior months. These moving average envelope lines (based on the 21-day average), when reached, at least suggest that COMP is 'overbought'. Knowing the market is at an extreme is quite useful to holders of long calls from lower levels, particularly from the 2050 area.

The recent strong rally began from the area of prior lows. Again, note that there was ONE daily close below 2050, but this was reversed the following day. I point this out as an example of how a cluster of prior lows 'defines' current support; and an area to buy Nasdaq calls such in the popular Nasdaq 100 (NDX) options.

If there is a decisive upside penetration of 2190-2200 in the Composite, we of course need look at the weekly chart to see the next level of likely overhead resistance. Per the weekly chart below, I've noted potential next resistance in COMP as beginning in the 2250 area.

Good Trading Success!

NOTE -
Please send any technical and Index-related questions for possible use in my next Trader's Corner article to Contact Support with 'Leigh Stevens' in the Subject line.
 

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