The Technical Level Investors Should Be Watching This Week
For traders, there are two basic types of analysis that can prompt trade ideas. First you have fundamental analysis, which considers economic conditions and outlook, whether on a macro or micro scale. Then there is technical analysis; the study of charts, looking for patterns and signals that hint at what the market taken as a whole might logically do next. I have often said that the strongest trades are when both agree, and that is what is happening now in the stock market.
I have been making the fundamental case for caution by investors for a few days now. On Tuesday of last week, for example, I wrote that you may want to consider averaging out of some stock positions, and continued with a bearish tone for the rest of last week. I began to feel like a bit of a broken record as I repeated the reasons for that, but I guess the decline of over four percent in S&P 500 futures since Tuesday’s close justifies the worry.
As Friday’s session drew to a close, though, there was another reason for pessimism.
Over the last few months, as stocks have not just recovered from the March lows but in many cases gone on to achieve new highs, the broad market, as represented by S&P 500 E-Mini futures (ES) in the chart above, has been supported by one major technical factor, the 50-Day Moving Average (MA). That is the blue line on the chart, and as you can see, before Friday the market had challenged that line four times since June. Each time, after trading close to or just beyond the average (marked by the white arrows on the chart), ES has pulled back to close above it.
That is the textbook definition of a strong support.
However, for traders, the stronger a support level is, the more bearish the sign is when and if it is broken. That break came on Friday when we closed below the 50 MA, so it is no surprise to technical analysts to see this morning’s big drop.
You will no doubt hear people say today that that drop is down to rising coronavirus cases in the U.K., or a bad week in the polls for Trump, signs of economic weakness in the U.S., or for any of a number of fundamental reasons. All of those reasons are real, but they have been real for a month or two now, even as stocks have powered on up to record highs.
What has changed is that we have broken the 50-Day MA. That suggests that the downward momentum has legs, and that in traders’ minds, the real-time problems of the economy (unemployment over eight percent and a massive decline in GDP) have superseded hope for the future and faith in the Fed and Congress to keep propping things up.
That is what it really means when technical analysis starts to support the fundamental: that traders are now focused on those fundamental factors. Given how bad they look right now, that is hardly encouraging.
I am sure many are reading this and thinking “So what? You just told us what happened and why, but how does that help me now?”. Well, if you accept that the 50-Day MA was significant, the 100-Day (the yellow line on the chart), which we are fast approaching, should be too. If that holds, then this drop looks like a needed pullback that sets up for further gains. If it breaks, though, there is little or no technical support until we get back down to June’s lows below 3000 on the index.
Markets can defy logic and fundamental analysis for quite some time, but eventually, things like massive unemployment, negative growth and a forty plus percent year-on-year decline in corporate profits have to be factored in. The break of the 50-Day MA suggests that is beginning to happen now, so investors should keep a close eye on its close cousin, the 100-Day average, for clues on whether or not the move downward will continue.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.