The stock market action yesterday was “devastating” according to one headline. “Stocks plunge” screamed another.
But if you step back and take an objective look at the stock market… really… nothing happened.
Oh sure, the S&P 500 lost almost 3%. The Dow Jones Industrial Average was down more than 740 points at the worst level of the day. And, for those of us glued to our computer monitors, it sure looked like the market was falling apart.
But, the market isn’t falling apart. It’s still stuck inside its month-long trading range. All the S&P 500 did yesterday was pull back from the resistance line of that range. Now it’s testing the support line of that range.
Take a look at this updated chart of the S&P 500 I first showed you on Wednesday…
On Wednesday, we noted the market was gearing up for a big move in one direction or the other. And while stocks have pulled back from where they were on Wednesday, we haven’t yet seen that “big move.” Instead, the S&P has simply pulled back from resistance and is now approaching support.
No big deal… yet.
So, where do we go from here?
Let me describe the two possible scenarios I see…
If the S&P can hold up here, bounce, and head back up towards the 2930 resistance level, then the odds greatly favor an upside breakout. Lots of technical indicators are quite oversold. The proverbial rubber band is stretched pretty far to the downside. Investor sentiment – a contrary indicator – is extremely bearish. So, there’s lots of tinder available to fuel a breakout rally.
On the other hand, if the S&P 500 continues lower and breaks below support at the 2740 level once again, then the market is most likely going to break down.
I’ve often commented that multiple tests of support (and resistance) are similar to jumping up and down on a frozen lake. Each test weakens the ice just a bit – until, eventually, it breaks.
You can see a perfect example of the ice breaking if you take another look at the above chart and notice what happened last December. Back then, it was the third test of support that finally broke the ice.
The current setup looks eerily similar to how things looked in early December – with one really important distinction…
We’re still holding above support.
Like I said… If the market can hold here, bounce, and start to move back up, then the odds favor a breakout to the upside rather than the downside. Traders should pay close attention to what happens early next week.
Best regards and good trading,
Jeff Clark
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