Why the S&P 500 Chart Suggests Caution for Investors

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I am not usually one for a lot of technical analysis, particularly when it comes to broad measures of the market. Even for individual stocks, fundamental factors are far more important for future pricing than what happened in the past, and that is even more so when you look at a market index such as the S&P 500.

That said, after decades in dealing rooms spent looking at charts all day, reading them is second nature and at times something is so obvious that even in the case of the S&P, it cannot help but have an impact.

Right now, for example, a simple reading of the 1 year chart indicates that, absent any dramatic news, there will be a period of consolidation at least before the stock market climbs meaningfully higher.

That belief isn’t based on any fancy mathematical formula; just the simple fact that when a level has been reached before and proved to be a turning point, that level will attract sellers again. In chart-speak terms it becomes a point of resistance.

At the beginning of this year the drop in the market was so steep that there were hardly any bounces, so very few such levels appeared. In turn, that meant that when the recovery came, it was also steep and uninterrupted. The chart took on a “V” shape.

That drop started from around 2075. When we got back to that level a couple of weeks ago, progress halted and the market backed off and hovered around 2050 for a while. That consolidation was natural and needed, but then on Wednesday we pushed up and broke through the 2075 level.

Under normal circumstances that would clear the way to resume a fairly rapid upward trend, but in this case it may just herald in another period of range trading and sideways movement.

The reasons for that are the three closely grouped red lines at the top of the chart above. They represent highs at various times last year, culminating in the all time high of 2134.72 achieved in May. To those unfamiliar with the ways of traders, the fact that those events were last year and a lot has changed since then would suggest that those levels are not particularly significant, but they are.

Traders are always looking for a reason to do something, and reaching a point that has for some reason attracted sellers in the past is as good a reason as any to sell in the future.

At the start of the year, 2075 was obviously a level that triggered some selling so, when it was reached again two weeks ago, traders sold. Now that we are above it, they will be eyeing the next resistance level at 2105, then 2120, and then the high itself.

That makes for probable slow going to the upside. In addition the 2075 level and 2031, which was the low on the retracement, become points of support. It isn’t hard to see why, in the eyes of an experienced chart reader, a period of lower volatility and lack of direction are expected.

From an investor’s point of view then, it may be a good time to play a waiting game. Which way we break out of the expected range will be dictated by actual fundamental factors and news, not by any technical pattern. Based on early reports it looks unlikely that earnings will be strong enough to push through to new highs, but that could still happen.

To the downside it is equally unlikely that the Fed will raise rates in the near future, but neither is that impossible. Those or any number of unforeseen events could dictate the next move.

One thing is for sure, though. The longer we stay stuck in a range, assuming that we do, the more dramatic the move will be when we break out, regardless of direction. That means that buying now has significant risk, but if we do push higher there will still be plenty of reward available to those that wait. That risk/reward imbalance makes waiting the smart thing to do.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.