As investors have been jerked around left and right by news headlines out of Washington and Europe, the one resource many are turning to is technical analysis to filter out all the noise. Technical analysis is the process by which we try to find rhyme and reason in the markets. It is a tool that every investor uses when they pull up a chart of their favorite stock, commodity, or index. The idea of support and resistance has been around for a long time. Let’s take a look at a confluence of resistance zones and lines that may hold the Nasdaq Composite Index from here.
Yes, this article is going to be another knockoff from the movie, “The Perfect Storm” because there are five different key resistance zones that are honing in on the Nasdaq today just as the perfect storm, described by the National Weather Service, developed from multiple storm fronts. This will be a short article today, because I’ll be explaining some of the technical underpinnings without getting too “technical”. While I don’t expect the Nasdaq to hold up under these five resistance levels, a break above them would be a seriously blow to the bear and a feather in the cap of the bull. Your weather forecaster is here, and a perfect resistance storm is on the horizon. This might be a good time to stay in the harbor until this one passes.
Resistance #1
The Nasdaq Composite has formed a top. This occurred in August when the index fell below both the March low (2616 closing 2603 intraday), and the June low (2616 closing 2599 intraday). Those two lows formed a significant support zone between 2600 and 2616. Since we broke below those levels in August, we have rallied to test that breakdown twice, including today. For the bears to maintain control of this market, and to maintain the “fear” of recession, it is important for the bears to hold the market below this level. If they do, then that continues to support the image of a top in the Nasdaq Composite index.
Resistance #2
Markets behave in two modes: trending and trading. One of the ways we can track which behavior is being mimicked is by using the 50-day moving average, an intermediate technical indicator that will rise and fall with the trend or not at all if there is no trend. Typically, when the market is trending, it will act as a support for the trend. In a trading environment, like we had between February and July, it’s not much help at all as price oscillates. But here, after the market has fallen this summer, the 50-day average is in decline, telling us the trend is down. Today, we were just a few points shy of testing the average. This is resistance #2.
Resistance #3
There has been quite the debate in technical analysis spheres on whether the market is forming a bottom by which the market can reverse trend, or whether it’s merely pausing before the downtrend resumes. Both have merit, but I’m in the camp that this is a bear market rally based on a few behavior signs. One of those signs is that we appear to be forming a triangle trading range. The probabilities are high that triangles are continuation formations (or counter trend rallies) instead of tops and bottoms based on historical research. Triangles typically form in a 5-wave sequence (a, b, c, d, and e) and each wave has a sub-wave form of 3 waves. The August rally appears to be taking this form. It also appears that the triangle has fully formed with wave e up to its current level. The support and resistance lines can then be drawn as follows. As the last wave in a triangle, we are currently right up against the resistance line of this chart pattern. This is resistance #3.
Resistance #4
While we’re on the subject of triangles and waves, that brings up the subject of Elliott Wave. The main determination of the trend in the market is exhibited by the movement in which long waves drive the direction of trend and short waves retrace the trend as profit-taking and drivers of the trend take a breather. In Elliott Wave, triangles are typically countertrend reactions to the main trend. If it takes 5 waves to move the market in the direction of trend, triangles are typically found in the fourth wave. I do apologize if this subject is too technical, but in technical analysis, the behavior of the market is paramount to understanding trend, and Elliott Wave is one of the tools at our disposal. Trendlines can be drawn within the 5-wave trend to create support and resistance lines, i.e. a trend channel. Here’s what the current channel looks like if the market continues to exhibit a 5-wave downtrend in the index. The triangle is typically the end of the wave 4 countertrend. This represents resistance #4.
Resistance #5
The relative strength indicator (RSI) is a momentum indicator that aggregates the speed and change of price movements. It is an oscillator that is bounded by 0 and 100. It is considered overbought when above 70 and oversold when below 30. In the book, Technical Analysis for the Trading Professional, a concept is featured that discusses the bull and bear market ranges for RSI. Typically, in a bear market, the oversold condition at 70 is shifted down to 60 and in bull markets, the oversold condition at 30 is shifted higher, at 40. In the case of a bear market in the Nasdaq Composite Index, bear market rallies will be rebuffed near 60 on the RSI. Having risen from a low of 19.50 on August 8th to the current reading of 55.8 (very top portion of the graph), we are well within the range of a bear market rally. We are near resistance #5 and the market has not shown us the characteristic of a bull market until it can show an overbought reading above 60.
We’re at a confluence of resistance levels for the Nasdaq Composite Index. Judging by the same mechanics, the S&P 500 has some room to go before it completely forms a triangle, touches its 50-day moving average, or nears the 1250 March and June lows. That might be why the Nasdaq was only up 1.34% today while the S&P 500 was up 1.72%. As I said earlier, I don’t think the Nasdaq will break above such a perfect resistance storm. If it does, it will likely come from a very bullish catalyst, one that could put a serious feather in the cap of the bulls, such as a better than expected accommodation move by the Fed next week. As likely as that seems now after Jackson Hole and the FOMC minutes, it is unlikely we’ll see a huge move like we did last year with QE 2 with rampant inflation. Some FOMC voters have expressed that the responsibility to stimulate the economy rests solely on politicians in Washington. Either way, the current price level for the Nasdaq is at an important juncture that will likely continue to support a downtrend if we fail to breakout, or it will shift momentum and confirm an important bottom. In my opinion, it’s best to stay in the harbor and let this storm pass.
