August lows have held - so far. Now what?
When the market gets hit by wide range expansion days, and pulls back from the highs, there are three key factors I look at to determine when it’s time to buy the dip. I discussed these in my previous article.
To summarize, I look for confluence of :
● Support in the indexes
● Signs of life in market leaders
● Bias slant in the market
You can read more about this here.
Well, this has all come through, as the indexes held the August lows (so far). But now, we are at another key decision point.
Generally as an options trader, when I start buying the dip after a 5% pullback, I know there is a very high probability that the market will run directly into a brick wall of resistance. As such, I generally employ short-term options trades, meant to capture quick rallies off the lows. I do this while being very aware of overhead resistance. I keep my positions small and time frame short-term, until overhead resistance is broken and an uptrend is resumed.
They key here is identifying overhead resistance, so I know when to adjust my strategy.
Identifying Overhead Resistance
To identify overhead resistance, I always start with the Nasdaq daily chart. Why? The Nasdaq is and has been the leading index for quite some time. The behavior of the Nasdaq leads the way both up, and down. I personally like to use the Nasdaq futures daily chart, so that I can see overnight action as well. This is particularly important in a news-driven market state, which we are currently in.
Then, I overlap a combination of moving averages, Fibonacci retracements, symmetry levels, and key psychological zones.
Here’s a look at the full picture of the Nasdaq daily resistance levels. This is a combination of all the above mentioned levels, and then I will work through them one by one.
Nasdaq Daily Chart with Overhead Resistance - 8/21/19
On this Nasdaq daily chart, I have identified two key areas of resistance: $7739 and $7900.
Here are the final zones of resistance after my analysis is done. Let us talk about how I got there in the first place.
Breaking it Down
Step One: Using Moving Averages
The easiest spot to start is with the moving averages. They are free on most platforms and provide a great starting point. I use a combination of fast and slow moving averages. I like the 8, 21, and 34 EMAs, along with the 50, 100, and 200 SMAs.
I am looking for price in relation to the moving averages (for example, right now price is stuck below the key level of the 50 SMA), and I am looking to see how buyers and sellers react at these key levels. Often times, you will see sellers coming in as the index approaches the 50 SMA and loses steam.
Nasdaq Daily - Highlighting Moving Averages
When viewing a simple daily chart, with primarily price bars and moving averages, you can clearly see how the index is having trouble breaking through the 50 SMA to the upside. This is a key area of resistance.
Step Two: Using Fibonacci Retracements
Fibonacci analysis is critical to my method of technical analysis. While it may seem esoteric, the concepts are quite simple.
Fibonacci retracements are areas of key resistance, that come from measuring the most recent swing. With every swing in the market, on any time frame, you can draw these levels using simple drawing tools within your platform to identify these areas.
With any major swing, the most important factor for me is the 61.8% retracement level, though I use the 50% and 78.6% retracement levels as well. Almost all, with the except of the strongest swings, pause at this area. So it is a critical level to be aware of.
If you’re not familiar with Fibonacci, I can tell you where I learned everything I know...from the Fibonacci Queen, Carolyn Boroden. This is just a little piece, but spending time to learn the whole kit and kaboodle has been critical to my trading. Let’s look at the charts.
Nasdaq Daily Chart - Fibonacci Retracement Zone
Fibonacci analysis is critical in identifying key areas of resistance that typically come in at retracement levels.
Step Three: Symmetry
A key concept in Fibonacci analysis is symmetry. Symmetry is a measurement of previous similar swings in the market. The idea here is that, “if it has done this before, it is likely to do it again.” I also like to call it quantifying the personality of the market.
I measure each rally that followed a sell-off, as that is the current climate we are in. At least initially, failure at these levels of symmetry resistance is typical. What I am interested in, is when we break symmetry. For instance, when symmetry was broken in the beginning of January and the bullish rally resumed. Generally, when price breaks through the symmetry of the previous swings, that is the signal that the trend is shifting.
Step Four: Psychological Values
For whatever reason, the indexes are particularly prone to pausing at key, psychological values. For me, these are big round numbers - especially if that number has a history of being hit multiple times in the past. Think numbers like $7,000, $7,200, $7,600, $7,750, and $8,000. These are typical areas traders and investors step in front of the market.
Nasdaq Daily - Key Psych Values 8/21/19
$7,000 provided support at the lows, as did $7,200. $7,600 represents an area where price gets stuck, all the way up to $7,800. Of course, the top was right near the key area of $8,000, ultimately with the all-time high right near the key value of $8,050.
What to Watch For - A Potential Breakthrough
Currently, we are teetering on the brink of either failing or breaking resistance. Typically we need a positive news catalyst (such as strong earnings, news from the Fed, or tariff war
de-escalation) for price to break, and close above these zones. Having a high put/call ratio also helps.
For a resumption of the bullish trend, I want to see a break and positive close above the $7750 level, which would mean a break of the 61.8% retracement (the key psych level and symmetry). I want to see a higher close the following day for confirmation. This also should be led by at least a handful of S&P sectors, such as consumer discretionary, technology, and consumer staples.
Until that happens… these rallies are just rallies that have lead us directly into a wall of resistance that gives investors an opportunity to get short.
What the Breakthrough Looks Like
Here is an example of the overhead breakthrough in resistance we saw in May 2019. Initially, there was a failure which lead to lower prices. Until, the market was finally able to regain
enough strength to break through the ceiling and close above it.
As of August 21st, 2019 we are closing right up on resistance. Will we get the breakthrough soon?
Well, if we do - you’ll know what it looks like. Until then, I’m staying cautious, sticking with short-term time frame trades, looking for weakness in weak market areas (the Russell, Dow,
energy, financials) and keeping an eye out for relative strength to jump on once the overhead resistance breaks.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.