What’s in a number? Well, if that number happens to be the all time high set by the S&P500 Index back in January, it might be the number that traders aim for when attempting to spur a me-too rally causing the crowd to rush in for fear of missing out. That number at the start of yesterday’s session was 2872 for the S&P500 and traders set their sights on it from the open. With very little in the way of news or tweets, the bulls managed to push the index to new intraday highs by lunchtime but failed to get the even more critical new-high close. The Dow also ran but at a far less feverish pace. The NASDAQ 100 barely eked out a gain as growth stocks continued to rest this round out. The small cap Russell 2000 index became the star of yesterday’s equity trading posting a new all-time high close proving that three times is a charm, after all. Small caps logging that bullish close is a positive confirmation in this latest leg up as small caps tend to lead the pack into new territory. So, you may be wondering what the difference is between an intraday high and high close. Remember, yesterday that the S&P500 made an intraday high but could not manage to close at a new high. In fact the S&P500 closed right below a resistance line of 2873. OK, there it is again, a resistance line. So what is a resistance line and why are those numbers so important? Because it is geek-out Wednesday I will give you a little background on the importance of those numbers.
Support and resistance are two core principals in the technical analysis of financial markets. Technical analysis involves the use of charts containing historical prices in which traders look for patterns that will offer them insight into the future direction and behavior of prices. These rules apply to markets, indices, and individual securities but in the following discussion I will focus on markets to simplify things. Amongst the many different types of technical patterns, support and resistance are two of the most highly discussed and utilized. Support is defined as a concentration of demand which can cause the downward movement of a market to halt. So as a market trades down, more and more investors view it as being cheap which increases demand (buying) causing its downward movement to slow, thus creating support. Conversely, as a market trades up more and more investors perceive it as being rich causing demand to wane (selling) halting its upward progress and, ultimately, resistance. Ok, so that makes sense, buy low and sell high, as the old saying goes. But how can we tell what is low and what is high? Most traders turn to the charts for those answers and what they look for first are zones of support and resistance, which they use as entry and exit points for their investments. First, it is important to recognize that there are two types of traders: value and momentum and they each use these levels differently. As usual, there are many ways to interpret these patterns but for now I will cover the basics. Value traders looking to buy cheaply will view support levels for entry points. Refer to chart 4 on my attached daily chartbook – the red horizontal lines are support levels and the blue ones are resistance. The S&P traded down in late June and a support level began to emerge in the area around 2691 / 2700 / 2713. The support level emerged because traders would buy every time markets approached those levels. Traders will often observe market behavior at those levels waiting for a bounce off as a confirmation of a bull move. If markets trade and begin to close below those levels it is referred to as a failure, which is bearish. Traders may sell out of positions as support levels are penetrated thus accentuating the move. In fact, many traders place stops right below support levels. In the case of the S&P, you will note that the support level held and the index rallied from those levels bringing us up to the intraday highs achieved yesterday. Momentum traders who like to buy on breakouts will look at resistance levels as entry points. Those momentum-based swing trades actually have a higher probability of success as they capitalize on the psychological herd mentality of humans. In those cases traders will buy only when markets trade through and close above earlier set resistance levels. A good example of this is a resistance line set in mid April at 2717. The S&P was in the midst of trying to recover from a difficult first quarter of trade having bounced off of its 200 day simple moving average but it began to develop resistance around 2715 as buyers became exhausted and sellers came in. The markets traded down after having reached those levels. Eventually the S&P once again bounced off of its 200 day moving average but this time (on May 9th) it managed to close above, or break out of the resistance level. Swing traders will typically buy these breakouts capitalizing on the animal spirits and the S&P did actually rally after that breakout in mid May. Support and resistance levels also occur at round numbers, trend lines, and moving averages further explaining the impact of human psychology on markets. So, to sum things up value traders will buy at support levels and take profits at resistance levels and conversely momentum traders will sell at support level failures and buy at breakouts through resistance. Ultimately both styles, as I have shown, have merit in practice but ultimately the real winners are long term investors who are able to capitalize on the longer term, or secular trends of the market ignoring the daily tug of war between fear and greed. Many technical indicators apply to these as well but for now lets just say that support and resistance levels are a good way of gauging shorter term market movements and aid us in determining entry and exit levels.
Today, the Federal Reserve will release the minutes from its last FOMC meeting and analysts will read through it carefully hoping to find hints of future Fed moves. A rate hike is largely expected to occur at the Sept 26th meeting. In fact there is a 93.6% probability of a hike. There is a 60% probability of a December rate hike, and while it is better than even odds, it is still not a high probability, hence the interest in getting a better understanding of the Fed’s mindset. Bearing in mind that the minutes will reflect a meeting that occurred before the Turkey contagion risk, traders will put more creed in next month’s release and the Jackson Hole speeches occurring over the next few days. Equity markets are, right around or above key resistance levels or all time highs (not only equity indices but also the treasury yield curve, which made new lows) and are subject to animal spirits, so the Fed release can become a stimulus for a move. After all, what’s in a number?