I charted the daily prices for the past six months on the S&P 500 index ($SPX) after the index closed at 1,553.28 on Friday, April 5, 2013.
Since November, the S&P 500 has traded in a narrow ascending trading channel with only two prior dips to the trend line of higher lows. This trend line was tested again on Friday and for the third time the large-cap index found support and moved higher from its morning lows. Starting in early January, this trend line has run close to even with the 50-day moving average (dma). The two combined technical indicators have worked together to keep the bears in check, but when these lines finally lose their battle, the sell-off could be steep and quick.
The warning signals are starting to add up on the chart. The SPX is trading below its 10 and 20-dma. Falling below these moving averages intraday on Wednesday and Thursday sent up red flags. The gap move below them is a more significant sign for caution. The 10-dma has not fallen below the 20-dma yet. This bearish crossover will be the technical indicator that confirms sentiment has shifted beyond any one-day event. The reverse occurred in late November when the 10-dma moved above the 20-dma and a new leg of the bull market was confirmed.
The Williams %R indicator turned bullish in November, a week before the moving averages confirmed the move. The same pattern could emerge in April to the downside. The 14-day indicator issued a sell signal when it moved below the overbought three trading days ago. The following two days worked as the needed confirmation days. To avoid being whipsawed out of the market, traders pay attention to the 28 and 56-day indicators also. The 28-day indicator moved outside of the overbought area on Friday, but needs two confirmation days to show this isn’t another short-lived dip. The 56-day indicator is still within the overbought area and has not presented a reason to sell yet. By the time the 56-day indicator catches up, the SPX could be another 2-3% lower. This creates a balancing act for traders. Should they wait for the longer-term indicator to confirm it’s the bears’ turn to control the market or should they start taking profits now? The answer depends on each investor’s risk tolerance and their time horizon.
The long-term bull market is still in motion. Opportunities present themselves to add to positions on dips during a bull market. By timing the entry and exit in these cycles, traders can reduce downside risks and increase returns. The upside is limited for stocks while the technical indicators are sending warning signals. The upside potential opens up 50 points (not much more than 3%) for the SPX if the index makes a run above its 10-dma within the next few days. The downside could be more than 130 points on the S&P 500 before it reaches longer-term support. A fall to the 1,420 range would be close to the definition of a correction, a 10% drop from recent highs. If the S&P 500 reaches those levels, it will be a great buying opportunity followed by a massive price surge again as value investors take advantage of the depressed prices. Investors who start to nibble in after a 5% drop in prices can build onto a smart long-term strategy.
