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Moving Averages Pinpoint Resistance and a 'Sentiment' Question

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One OIN SUBSCRIBER wrote me asking about whether I thought the retracements to date of the last big run up, would be exceeded given that the market hasn't been able to gain any traction and with the weak close of today, plus asked:
"... isn't it unusual for a low bullish sentiment day by your indicator occurring before another sharp sell off? I haven't seen it in the last couple years that I remember."

RESPONSE: Every once in a while, especially when there's conviction that the Fed may go on another inflation fighting rate raising tack, traders take advantage of a rally to buy puts; exactly what happened before this latest round of selling. I wasn't bullish particularly but thought last week's rebound would carry a bit higher than it did. When I looked at the charts it was quite noticeable that:
1.) the big break that occurred recently leaves what looks like a massive resistance overhang or big SUPPLY of stock ready to be sold on any advance to higher levels.
2.) with the bearish chart patterns, it was apparent that the rallies had carried back up to the 'danger' zone of a return to key moving averages.

Given some other factors, especially the contrary opinion idea that high bearishness might mean TOO MUCH pessimism, I thought the recovery momentum would carry somewhat higher. While I didn't emphasize a strong possibility of downside reversals at key moving averages in my weekend (Index Trader) commentary, it is one of my basic trading rules when I SEE it develop.

The 'key' moving averages I use for the major stock indexes are the 21-day, 50 and 200-day averages. The first, the 21-day is a more common trading average benchmark, as it's only infrequently that the 50 or 200-day gets pierced, on the upside or downside; with the index then coming back to that average for an upside or downside 'test' of upside or downside momentum.

In the recent market situation, ability of the indexes to get back above these particular moving averages was going to be a test of the strength of the recovery rally and buying interest. A moving average is not unlike a trendline. Once a trendline is pierced, a rebound back to it often finds renewed selling interest or resistance coming into play. Support 'becomes' resistance and vice versa. The same with moving averages at key junctures.

Some of the current charts will serve to illustrate these points, plus will pinpoint the retracement levels that remain intact to date.

S&P 500 DAILY CHART:

The recent S&P 500 (SPX) price action offers one of those occasions when there is no 'slippage' back above the 21-day average on the rebound. Rather the SPX rally closed just over, but practically AT this average, followed by a reversal the next day. And, with today's weak Close, coinciding with the intraday low, we have another instance of a 1-day close under the very important 200-day moving average and the index looking weak.

My rule of thumb is that one close under a key trendlines, as well as a key moving average, is not conclusive if this action is reversed the next day; as it was the first time, the prior instance of a daily Close under this average. This was followed the next day by a significantly lower intraday low when SPX reached a 50% retracement (of its Oct to April advance); however, this was followed by a rally into a Close that put the Index back above its 200-day average. Stay tuned on what happens tomorrow. A close back above 1260 keeps bullish hopes alive.

A close below 1247, at the 50% retracement suggests that SPX could then next retreat to the level that would represent a 62% retracement in the 1229 area.


S&P 100 (OEX) DAILY CHART:

The recent rebound stopped right at the 50-day average. Today's low then fell under its 200-day, a very important average in terms of how institutional money managers tend to judge the relative strength or weakness of the market.

A retreat to below the 50% retracement at 573 would be bearish and suggest a possible next downside target to the 566 area, at the next lower retracement marked on the chart below representing a 62% give back of the last major run up; 62% being the next retracement level that's considered technically significant. Another key test would be the low end of the multimonth trading range at 570.

Contrary to 'contrary opinion'!, the last dip in my trader 'sentiment' indicator seen above, wasn't associated with UPSIDE potential or possibilities at least not to date. Stayed tuned on that! Quite the opposite, there's been a sharp and renewed decline after that (Friday) reading. The majority opinion is exactly right sometimes, but is a rarer occurrence on the street of dreams!

DOW INDUSTRIALS (INDU) DAILY CHART:

The Dow came back up to close to its 21-day average on Friday but price action reversed back to the downside at the beginning of the week. The best example of prior support (once pierced) 'becoming' resistance later on, was seen with the previously broken up trendline. That's at the first down arrow seen on the chart below.

Today's INDU close under 11000 generated some public press coverage, but if you look back at the prior lows, the more important level is just above 10,900, at the early-May intraday low and representing a 50% retracement. The next lower retracement target is in the 10,730 area.


NASDAQ COMPOSITE (COMP) DAILY CHART:

The important retracement here is the 2/3rds or 66% level at 2145. A close under 2145, not reversed the next day, would suggest the possibility that COMP was headed all the way back to the rally starting point in October. The prior low made in February was the support that 'became' resistance, as was the key 200-day moving average. Stay tuned on what comes next. A significant couple of days are coming up.


NASDAQ 100 (NDX) DAILY CHART:

The Nas 100 or NDX chart is another story in terms of retracements. Although I measured only a 66% retracement to date if we went back and the index's JULY low, this was a bit of 'fudge'.

The rule of thumb that has stood the test of time, would suggest that if NDX exceeded a 2/3rds retracement of its last major upswing, it was headed to a 100% retracement of its prior advance, suggesting a downside target to the 1515 area. Stay tuned on that one too!


RULE OF THUMB ON RETRACEMENTS:
A retracement that goes further than a 38% Upside or Downside retracement will reach 50%. A retracement that carries beyond 50%, particularly on a Closing basis (and not reversed the next day), tends to lead to a 62%, or 66%, retracement. If more than 66% of a prior move is retraced, there's a good chance that a 100% retracement back to the starting point (of the advance or decline) will occur.

Of course, not ALWAYS! If it was that simple, always just buy the 50% retracement for example, 'too many' traders would make money doing so. I say it like this because techniques that work reliably in the market get NOTICED and will get used by more and more traders; and, presto, the technique doesn't work anymore.

Or, it's a 'self-fulfilling' prophecy for a while. But the market will always go where it wants to go eventually. However, because the market does trade in reoccurring patterns and cycles, some techniques work very well indeed, especially when used with skill and knowledge.


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