I’m sure you’ve probably noticed by now . . . the financial markets are one exciting roller coaster ride. As the media throws headlines at us faster and faster, our manic stock market reacts by propelling prices higher one day, and the next day pounding them even lower.
As players in this stock marker, whose goals are to earn consistent gains, how do we succeed?
One way is to remain aware of the “big picture” trends, and zones of price support and resistance on the S&P 500 Index.
Hold it! you say. “Why do I care which direction the S&P 500 takes?”
You care because in bull markets, three out of five stocks (excluding penny stocks and some commodity-related stocks) will follow the S&P higher. In bear markets, or market downturns, four out of five stocks will follow the benchmark lower.
Bottom line: traders and active investors are wise to glance at the S&P daily or weekly to stay on top of the markets direction.
“Okay,” you continue. “That makes sense. But why do I care about the S and P’s zones of price support and resistance?”
You care because support and resistance zones on the S&P 500—and whether the index is able to climb above them (bullish), or plummets below them (bearish) gives clues as to future market direction and possibly the equities in your portfolio.
How Demand & Supply Fuel Greed & Fear and Produce Support & Resistance
The entire world—and especially the financial markets—are driven by two ruling emotions: greed and fear. These two emotions and varying levels of each (optimism, hope, or anxiety to downright panic) fuel demand (buying) or supply (selling) in equities and other financial market assets.
When demand is high for a financial asset, price expands; market players are willing to pay higher and prices for it (greed). When that price stretches too high for investors to continue buying, they hold or sell.
At that point, supply floods the market, driving price lower (fear). If supply continues to overwhelm demand, the selling will drive prices lower . . . until the supply of shares for sale is exhausted. Then, quickly or gradually, demand (buyers) will return.
If demand absorbs supply, support forms, as a cluster of buyers believes the value of the asset will expand over time. And the process repeats all over again.
Being able to evaluate basic support and resistance levels on a price chart is an invaluable trading and investing skill, because these reversal zones can influence price movement into the future, in both the short and long-term.
Furthermore, support and resistance zones can act as “go,” “caution” and “stop” signals for entering new positions and risk management strategies.
The seven-month daily chart of the S&P 500 Index, below, shows current support and potential resistance. Keep in mind these are basic—but important—zones.
Chart Courtesy RealTick®
We can see that in January of this year (to the right of the dotted line), the S&P 500 performed a dumpster dive, plunging from its opening on January 4th at 2038, to that month’s lows of 1812 on January 20th—a 11% move.
The S&P bounced nicely from its 1812 low up to about 1950, creating potential support at 1812. Then, however, fear returned (as it often does), and the index made a U-turn, flushing out the “weak hands,” and sending it back to retest the 1812 level.
At this point, bulls stepped in. The resulting demand created optimism, and the retested, stronger support zone encouraged bulls to keep on buying, fueled by hope that this time the S&P would maintain its uptrend.
Once the S&P 500 reached the 1950 level, it struggled with that resistance zone—investors had sold there before and they would do it again—but the bulls prevailed, and the index muscled its way to the next rung of resistance at 2000 – 2020.
This week’s market action will tell us if the benchmark index can continue its move to the upside and head back toward its old highs at 2173 (May 2015). If the ceiling of resistance holds at 2020, some bulls may choose to take profits and limit share size of new positions.
Being able to spot demand and supply, greed and fear, and the resulting support and resistance zones on the S&P 500 Index is an invaluable skill that we can use to make wiser and more successful trading and investing decisions.
Until next time, keep green on your screen,
Toni Turner is the President of TrendStar Group, LLC, is an accomplished technical analyst as well as a popular educator and sought-after speaker in the financial arena.
She is also the author of best-selling books: A Beginner’s Guide to Short-Term Trading, Short-Term Trading in the New Stock Market and Invest to Win: Earn and Keep Profits Bull and Bear Markets With the GainsMaster Approach, co-authored with Gordon Scott, CMT.