Michael Gable is the founder and managing director of Fairmont Equities and a regular expert guest on ausbiz.
We have been cautious on the S&P 500 all year, and we still believe that risk is to the downside. But there have been opportunities along the way. In early March, the charts were telling us that the S&P 500 would bounce, and that presented some great buying opportunities for traders. It will once again present some opportunities, if we know what to look for.
At the start of May, it became clear that the market was establishing some support near 4200 (horizontal line). Breaking under that level in early May had put the S&P 500 on a much more negative footing. When a support level gets broken, it can often turn into an area of resistance. This means that what the S&P 500 does around here is crucial in determining its next move.
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A failure to rally back above that 4200 region would leave the S&P 500 vulnerable to a swift move lower. As we can see in the chart above, the S&P 500 is testing the underneath of that level right now. The index needs to get above this crucial line very quickly. A failure to do this in the next day or so means that it will likely fall to new lows for the year. This should see it back at levels near 3600. If this selling leads to a capitulation, then we could briefly head to levels even lower than that.
However, if the S&P 500 can get above 4200 in the next day or, then that is likely to lead to some more buying in the short-term. Would that mean that the lows are in place for the year? Not necessarily. In the chart below, we can see that the market is in a downtrending channel. Pushing through 4200 should lead to more buying, but then we have the upper end of the channel to contend with. Investors would then need to be mindful that the market can turn back around near that channel resistance and head all the back to the bottom of the channel again.
So what does the S&P 500 need to do for us to be confident that a decent low is in place? These are the two scenarios that I am looking for at this point that will give me confidence that markets have bottomed out for the year.
Number 1 - Capitulation
If the S&P 500 starts to fall again this week and we see a 10 - 15 per cent decline occur in a very short period of time, that is, in the space of about a week, then that would likely be a capitulation. It would be the sign that investors are giving up and are throwing the baby out with the bath water. That would be a good time to start buying. You would likely get a decent enough bounce off the lows to make some quick trades worthwhile and prices will generally be low enough to give us some better risk/reward opportunities. A capitulation also is a situation where stock prices have overshot to the downside because investors are selling on fear and emotion.
Number 2 - The sideways move
Most of the time at the end of the downtrend, a stock or an index needs to build a base first. This is where good buying support steps in but there is still some selling pressure out there to stop prices from rising too quickly. If this happens to the S&P 500, then we are likely to see it move sideways for at least a few months. I will be looking for little nuances along the way such as higher lows, a break of some resistance levels, and some small "re-tests" along the way. The daily trading ranges will start to die down and volatility will also be decreasing.
If you would like to know when I think the S&P 500 has bottomed and it is time to start picking up some great trading opportunities, then make sure you jump onto our mailing list.
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Fairmont Equities Australia Pty Ltd (ACN 615 592 802) is the holder of an Australian Financial Services Licence (AFSL 494022) and is licensed to provide general advice.
The information contained in this report is general information only and is copywrite to Fairmont Equities. Fairmont Equities reserves all intellectual property rights. This report should not be interpreted as one that provides personal financial or investment advice. Any examples presented are for illustration purposes only. Past performance is not a reliable indicator of future performance.
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* All share price charts are courtesy of AmiBroker