Three trend lines stand out in this chart.  All are ascending.  The lowest line traces the trend of higher lows that started in November.  The top line tracks the trend of higher highs and the middle line follows the trend of higher lows, but only since late December.  The top two trend lines create the boundaries of the trading channel that the SPX has been trading within for a month and a half.  Each touch of the upper trend line (as seen on Friday) results in a flat to lower market for the following few days until the lower trend line catches up to offer support.  This trading channel will break apart at some point and the cracks tend to come to the downside, especially after such a long run within a narrow path.  That is when the lowest trend line will be tested again.  This line is not much lower, but would give the index a much needed rest period to consolidate its gains.  A fall below this trend line could foreshadow much bigger losses to come before another area of support is identified by traders.

While the trend lines battle out support and resistance, the moving averages have their predictions to make.  The large cap index is trading above all of its moving averages from as short as 5 days to 200 days.  This is a bullish sign in itself, but always comes to an end eventually.  The first key moving average to watch is the 10 day moving average (dma).  The SPX has not had a full day trading below the 10 dma since mid-December, when the last mini-correction bottomed out.  This past week saw multiple intraday crosses of the line which in itself is a red flag for bulls.  Early in the week the S&P closed on the moving average one day and beneath it the next day.  If the following day would’ve been a confirmation day lower, chartists would have expected a much bigger sell-off to ensue.  Instead it recovered and kept the bears off the playing field a little longer.

Traders will quickly shift their attention to the nearest area of potential support once the 10 dma breaks.  This will result in a sudden drop in stock prices until the index reaches its target.  That target could be the 50 dma which just had a bullish crossover above the 200 dma.  Moving average crossovers that see a shorter time frame move above a longer time frame tend to signal better days ahead.  Unlike trading channels marked by trend lines, rallies defined by moving averages do not move in such straight paths.  A retest of the 50 dma would be considered healthy before the next leg of the bull market took place.  If traders see support work at the 50 dma they will pull money off the sidelines and into stocks very quickly and investors will be in store for another long run higher.

As with the trend lines and moving averages, the Williams %R indicator is not giving a sell signal yet, but does show a reason to suspect a period of consolidation is due.  As long as the indicator is in the gray overbought area then the rally still has momentum on its side.   Investors can expect further declines to follow once the indicator moves below -20 for at least two days in both the 14 and 28 day periods.  When the indicator climbs above the -1.0 area as it did on Friday, the next few days tend to be flat to lower.  In other words, Williams %R is in agreement with the trend lines.  While the future has promise, the next few days are not the time to buy into it.  While an active trader might risk shorting the index now, an investor with a longer time horizon would be wise to wait for a clearer bearish signal before taking profits.

At the beginning of December, I charted the S&P 500 index and pointed out how the 50 and 100 day moving averages (dma) crossover tends to foretell the early days of a longer bull market.  So far that prediction has held true.  These moving averages had their bullish crossover on December 1st on the DJIA chart too.  Since then the Dow has pulled away from its 50 dma by more than 500 points.  During this run higher the index has followed a tight trading channel as shown by the three trend lines in the chart below.  Each touch on the upper end of this trading channel’s trend line of higher highs sends it lower for a few days until one of the lower trend lines of higher lows comes back into play.  On Friday the two lower trend lines converged just below the 10 dma and acted as support.

Now the question is – how much longer can this tight trading channel last?  It’s uncommon for stocks to maintain such a narrow trading range for more than a month, if even that long.  It’s been more than 31 days for the DJIA so far.  In all likelihood this collection of 30 large cap stocks won’t maintain its trajectory for much longer.  Another trip to the top end of the channel could be its last move to these elevated levels for weeks.  We might not even see it get back up there before the Dow finally cracks again.

Investors should watch the trend lines of higher lows and the 10 dma to see if any of these technical indicators break support.  The 10 dma has broken support intraday only a few times since mid-December, but always closes above it by the market’s close.  The same thing happened on Friday again.  Closing below it will be the first major red flag for bulls.  The warning goes for the shortest trend line also.  Now that this chart’s longest trend line is moving above the shortest trend line, the space the Dow will be “allowed” to trade within will be increasingly narrower as it chases the upper trend line.  One line will have to give and it tends to be the lower ascending line more often than the upper ascending line.

Once support breaks the next question will be - how far will the DJIA fall?  As I mentioned at the beginning of this analysis, the 50 and 100 dma crossover tends to spell out longer bull market rallies.    That doesn’t mean we won’t witness a few minor corrections along the way.  Investors should expect the DJIA to test its 50 dma multiple times during this extended rally.  A move back down to its 50 dma from Thursday’s intraday high would mark a 5% correction and could be all the market needs as a catalyst to reduce allocations from bonds and into equities.  The first half of 2011 was filled with 4-5% mini-corrections.  2012 is ripe for one.

The first small hint that the move lower is upon us can be seen in the Williams %R indicator.  It fell below the overbought level on the 14 day indicator by the end of the week.  It needs a couple of confirmation days lower along with the 28 day period cracking too for it to show a true sell signal.  At this point, even a single confirmation day could also bring about a close below the three demarcation lines I mentioned above.  It’s time for active traders to be ready to take some profits or add some hedges.  Investors focused on the longer term might not need to panic yet.  The chance of a sell off beyond 5% is low, but could quickly change if the 50 dma doesn’t hold support.  Stay nimble and watch the charts.

As I mentioned last week in my Dow Jones chart, technical analysis can be an art as much as a science when using certain technical indicators.  Three of my go-to indicators are trend lines, moving averages and Willliams %R.  None is telling the story of a major sell off coming yet on a scientific view, but the art behind them might be whispering something different.

The S&P 500 moved to the top of its trading channel again on Thursday and hit resistance at the trend line of higher highs.  Each time it has done this over the past month it was foreshadowing of a few points lower in the coming days for the index.  Lately it’s only been a few points, some sideways days and then another run higher.  As with each pattern, this only works for so long.  So after the third touch to the upper trend line I started to wonder if this is the last time the large cap index will use this same trend line without having a bigger dip.  The science says don’t ditch the rally until the lower trend line has broken.  The art says to be wary after such a long run.

The lower side of the trading channel is approaching 1,300 quickly and would allow for a 15 point drop, barely more than 1%.  1% is hardly worth noting, except that this has been the pattern since mid-December and is due for more of a shake-up.  The lower trend line of higher lows that started in November could easily be a good area of support 40 points lower.  This would allow a 3% step down and allow in more buyers who missed the beginning of the rally, but are scared to get in at the current level.  If it happened quickly enough it would move the S&P close to its horizontal line of support around 1,267.

The science behind the moving averages says ride the rally.  We haven’t seen any bearish crossovers and the SPX is above each time frame I watch.  The art says the SPX has moved so far above its moving averages that if we wait until they have a bearish crossover we will have missed the first 3-4% of the sell off.  Since I’m bullish for the year, I’m not sure how big of a sell off we’re going to get and missing 3-4% could be half, if not most of a sell-off in 2012.  The moving averages certainly don’t call for shorting quite yet, but they do indicate it might be time to take more off the table to see how the next week or so plays out.

Williams %R hit the ceiling of its indicator for overbought on its 14, 28 and 56 day periods.  I always preach the science says don’t sell until the indicator has fallen below the overbought range for more than two days.  The art says going neutral at these extreme levels can be a safer way to work the indicator.  Williams %R can stay in the overbought range of long periods of time, but rarely stays this close to the “-0″ area for long.  Williams %R isn’t showing a sell signal, but it is saying the gains from here should be limited.

Volume is still stuck in the lower side of its average.  Friday’s pop was probably only due to January options expiring.  I’m taking it with a grain of salt, especially with the flat day we ended up with.  Indicators aren’t saying its time to run for the hills yet, but with so little upside available with all of the indicators, there’s not a lot of reason to be heavily invested right now.  The downside appears to be the path of least resistance over the next couple of weeks.  That doesn’t mean it can’t melt up, but any spike seems like it should be sold as a last ditch effort by the bulls.

The chart below shows multiple horizontal lines that have worked as support or resistance over the past few months.  It illustrates the reason I expected support to show up yesterday or today and where I could see TLT rallying towards.  TLT had held at the same (or very close to the same) intraday low for weeks.  I thought we might see a dip closer to $115 before it came back to life (which is why my March limit order didn’t hit today), but today showed the turn sooner than expected.  I’d like to see the ETF move back towards the $122 area before it takes another dip.  Otherwise today could just be a blip higher on a longer trend lower.  If TLT gets back up to the next horizontal line before my TBT (ultra short 20+ year treasury ETF) options expire I’ll keep both sides open to see which one works out.  I’m planning on both sides going my way.  If I can make it through next week with my TBT January $18 puts still being out of the money I’ll re-write new contracts to go along with this TLT expiration in February.  I plan to work this trading range until it no longer works.  The only change I might make is lowering my TBT strike to $17 since $18 didn’t offer support as I thought it was going to last time.  Then again, the sub-$18 move was short lived.

The upside is limited at some point due to the extremely low yield 20 year treasuries are already offering.  The yield isn’t worth the downside risk when TLT is above $125.  This is why I like selling TBT naked puts when TLT spikes.  There’s enough fear in the markets to offer support when TLT falls closer to $115 and the yield improves.  My cost per share will be $115.80 if I’m assigned today’s option contract.  I have a hard time seeing TLT drop more than another $5 from there (the bottom horizontal line).  I’ll be able to stay long, receive a good dividend and write out of the money covered calls every month or two and maintain a profitable position fairly easily.  And that’s if the position goes wrong for me.  If TLT does tank, that will mean my equity positions are doing well in most scenarios.  That day will come, but I don’t think it’ll be in 2012.

The S&P 500 is approaching resistance at its October 27th intraday high of 1,292.66 and volume will likely stay light until the large cap index can move past this key technical level.  The bulls have the advantage going into this challenge based on several technical indicators.  These indicators include a bullish chart pattern, bullish moving averages and momentum as seen through the Williams %R indicator.

SPX has two ascending triangles within this chart.  The smaller one has a horizontal line around 1267 and an ascending trend line of higher lows that converged with it on Friday.  Using this bullish pattern alone indicates a break out is due that should take the index another leg higher during the current rally.  The larger ascending triangle started with the October 27th intraday high and has an ascending trend line of higher lows that is moving higher at a lower angle.  These two lines still have weeks remaining before they converge.  As happened with the smaller triangle, a period of consolidation is expected at the horizontal line.  If the line of resistance breaks and stocks are allowed to move higher, then volume should surge above its average and stocks should leap higher.

The moving averages support this bullish outlook.  The 200 day moving average (dma) has been a strong point of resistance for months.  The index moved back and forth across this moving target during the last week of December and finally started to use the line as support rather than resistance.  Technicians expect one more test of support on the line before the SPX can move higher freely.  This retest could come at the same time the longer trend line of higher lows reaches the same point to offer further support.  In addition to the 200 dma, the 20 dma had a bullish crossover above the 50 dma in the second half of December.  By the end of December the 10 dma (not shown) moved above the 20 dma for further emphasis of the trend.

After the bears failed to push the S&P 500 to new lows after December 19th, the bulls regained momentum.  Although volume did not accompany the move, Williams %R showed the clear momentum shift.  Technically, stocks are currently shown as “overbought” in the Williams %R indicator.  As history has shown, being overbought is not as important as when it stops being overbought (a move below -20).  Indexes can stay elevated for weeks if not months.  Waiting for the break in momentum is the time to sell, not while momentum is still bullish.

The Dow lurched higher during the few days leading up to the Christmas holiday only to reach the area of previous resistance by the time the closing bell rang.  Without this line of resistance having such a powerful track record, the other technical indicators would lead technicians to believe the index was ready to move higher still.  Those other indicators such as trend lines and moving averages have proven to be false positives in the past few months.  A move to new recent highs all hinges on breaking this resistance.  (That’s kind of obvious, a move higher depends on stocks moving higher, but you know what I mean when you look at this chart.)

If resistance wasn’t looming like it is, we’d be able to rely on two trend lines of higher lows drawing in closer to the DJIA’s current levels.  Typically that would mean support was nearby and we’d expect another leg higher.  The crossover of the 10 day moving average (dma) over the 20 dma was a reliable bullish indicator before late August.  Lately the crossover has indicated a good place to take profits.  The reverse crossover appears to be close to occurring again, but the index moved north of this crossover and could foil it as it pulls the 10 dma higher again.  Sometimes, like any technical indicator, it doesn’t pan out so easily.  If it did everyone would use it without fail.  When I’ve seen it fail in the past, the crossover typically works on the second occurrence soon after.

Last week’s run higher kind of felt like traders were trying to game the “Santa Claus” rally that typically hits the week between Christmas and New Year’s Day.  Based on the expectation that a rally was due this coming week, traders bought in early and maybe pulled it forward a week so that we won’t see follow through worth much now.  You can also see this in the Williams %R indicator based on it being very close to the extreme top end of the overbought range.  This shows momentum might have topped out and is now due for a breather, even if it’s for a short period.

The convergence of the horizontal line of resistance with the two trend lines of higher lows should force a decent sized move (up or down 5% or more) within the next couple of weeks.  Without my typical go-to indicators being as reliable these days I’ll have to stay more to the sidelines until there’s a better move higher.  The path of least resistance looks to be to the downside, in spite of the higher trend line of higher lows.  The lower trend line is probably the better one to watch, especially as it converges with the lower horizontal line that has acted as resistance and then support for months.

The technical indicators aren’t all in agreement this week which makes traders more skittish going into the lower volume last two weeks of the year.  When the picture isn’t as clear traders tend to sell or at least not buy.  At some point the price action will change and one side will have a clearer picture to work from and that’s the time to trade.  This might be a better time to stick with a wait and see approach, but while ready to make a move in either direction quickly.

The trend lines show severe resistance just above the 1250 area.  One trend line of lower highs has been the major ceiling for the past two months and continues to fall and hold stocks back.  Another line (that I had to stop drawing all of the way through because it blocked other lines) was support until the end of the summer, but is now acting as resistance too and adds to the size of the hurdle the bulls have to get over.  The other two trend lines go together and form the trading channel since the market first sold off in August.  It shows the trading range with a few exceptions and puts the current $SPX level almost at the midpoint of upside potential and downside risk.

That leaves the moving averages and Williams %R for this chart.  The moving averages show a very bullish 10/20 week moving average crossover that started three weeks ago.  Since then the index hasn’t followed through on the technical event that usually indicates the beginning of a strong rally.  However, the same fake came to the downside in July when the reverse crossover occurred and the 10 week moving average moved below the 20 week moving average.  The 10/20 indicator worked then and leads me to believe the bulls still have a good fight left in them.  Williams %R isn’t crystal clear since the 28 and 56 week indicators never made it to overbought.  The 14 week indicator did nudge into the overbought area barely and then faltered.  For now, I’m taking it with a grain of salt, but still include it as an indicator that shows all arrows do not point higher yet.  It also reminds me that any new push into higher territory might not last too long and could be sold after taking some profits at a higher point.

There’s always the Santa Claus rally that often kicks in during the last week of the year.  That might be the biggest hope for the bulls while the chart’s technical indicators play battle for which one is stronger this time around.

After the Willliams %R indicator fell off the bottom of the Dow chart for the first time I can remember ever the index came shooting back like there was no issue in Europe and all worries were for nothing.  Just seven trading days after hitting a recent intraday low the Dow added nearly 10% before hitting resistance around the highs of late October.  The fallout from not moving past this previous high only lasted a day and then the bulls came back in to resume their buying efforts.

The bump on the head from resistance shouldn’t have come as a huge surprise.  The previous trend line of support had been acting as resistance for the prior week’s ascent and just gave the horizontal line extra fire power.  Now that the Dow took a breather for a big down day on Thursday it can return to its bullish ways.  The horizontal resistance area around 12,255 – 12,285 still poses a threat, but the ascending trend line of higher lows has moved on and gives space for the DJIA to advance.

The moving averages are playing their roll for the bulls’ case too.  The 200 day moving average (dma) acted as crucial support on Thursday which is a strong buy signal.  At the same time the 10 and 20 dma had a bullish crossover which is one of my favorite indicators to promote a reason to buy, along with Williams %R.  That said, volume probably won’t have more than a single day above the moving average until the horizontal line breaks and the index has fewer technical headwinds.

However, the downside risk isn’t small from here.  A retest of the October lows is still on the table, just as is another bounce off the trend line of higher lows.  Keep an eye on the moving averages.  Each one could act as support and every time one gives in to selling pressure the more likely a much bigger sell-off is in the cards.  For now, the bulls have the momentum and could carry it through the end of the year, but that could spell out a nasty quick correction in January if the buyers get too far ahead of themselves while chasing performance.

The large cap index just finished its second best weekly point gain ever, but is facing resistance from its 200 day moving average (dma) now.  Although the SPX has made it above the key moving average this fall, it hasn’t closed above it for three consecutive days since July.

One bright spot comes from the bullish break of resistance from the trend line of lower highs.  This past week’s rally took the index above this trend line only to see it use the same line as support the next two days.  The line that was once resistance could (as it often does) turn into support, albeit with a declining trend.  At the same time the line that was ascending support for two months in the form of higher lows now appears to be acting as resistance.  This sets up an expanding wedge where the days’ highs and lows could get wider until a new trend is found.

The 200 dma will have to break resistance before this upper line of resistance can come back into play for more than another day.  To the downside, support could come from the 50 and 100 dma which just converged.  The 50 and 100 dma are actually showing a bullish crossover.  The index tends to be at the cusp of a multi-month trend when these two moving averages cross.  For now this trend favors the bulls which means this past week’s 7+% gain might just be the beginning.  The Williams %R indicator is also favoring the bulls.  At the end of Thanksgiving week the indicator literally ran off the bottom of the chart for its 14 and 28 day periods.  This is an extremely rare occurrence and showed an excessively oversold market.  This aided the bulls when shorts were squeezed out of their positions and were forced to buy back their positions.

If history does not repeat itself and the bears have more fight left in them, the S&P 500 could fall back to its lower ascending trend line of higher lows that started with this year’s low and touches the Thanksgiving week low.  This trend line is the next major line after the moving averages that computer based algorithmic traders will be watching and a break below this could send the index back down closer to the 1,100 area.  If history does repeat and this is the beginning of a new long term uptrend, the bulls will have to be patient before going all in until the October high of 1,292.66 is taken out.  This is the magic line for the computer models and a close above this line should send in mass buy orders over the following days.  That line is almost 4% above Friday’s closing level and leaves a lot of room for day traders to toy with longer term investors before patient bulls are fully rewarded.