S&P Still Rangebound – But Is Support/Resistance Valid for Indices?

S&P Still Rangebound – But Is Support/Resistance Valid for Indices?

The S&P has been rallying towards the upper end of its recent 1040-1130 trading range over the past week and a half.  Since the S&P entered this range, it’s been profitable to “swing trade” the extremes – by going short near the upper edge of the range, and either covering, or going long, near the lower end.

Of course this is all obvious in hindsight!  I suppose if we’d had a working crystal ball back in June, we’d all be rich from swing trading S&P futures, and would have no financial need to return to our “day jobs” post-Labor Day.

S&P 500 Trading Range September 2010 1

Source: StockCharts.com

As noted in the chart above, the rally has been on declining volume, and looks like it could be gassed here near the 1110 mark.  Then again, who knows – the pattern of declining volume on rallies, and increasing volume on declines, has been in play since spring, and we’re still in this range.

Though are support and resistance lines even valid for entire indices?  I’m starting to call this “for granted” assumption into play while working my way through Harry Browne’s excellent book Why the Best-Laid Investment Plans Usually Go Wrong & How You Can Find Safety & Profit in an Uncertain World.  Browne tears down many sacred cows taken for granted in the investing world, sparing no hallowed element of traditional or fundamental analysis.

One of the few elements of technical analysis that Browne allows for is the observance of support and resistance – but only for individual stocks.  He believes that support and resistance occurs because, logically, there are pools of buyers/sellers camped out at certain price levels.  And when the stock price falls to a certain level, or rises to a certain level, these folks swing into action.

Hence, he denies that support/resistance can occur for a stock index, because there are no pools of buyers/sellers acting on an entire index (though he wrote the book in 1987, before the proliferation of index funds and ETFs).  Still, his thesis still seems to make intuitive sense to me, and it’s one that I plan to keep an eye on.  Are any market participants actually jumping into stocks when the S&P approaches “key support” levels?

Here’s a recent example – remember the S&P’s strong support at 1040?  It was tested during the “flash crash” lows – then broken a few weeks later – and it was supposed to be all downhill for the S&P from there.  The 1040 line had been violated!  But, instead, we’ve since rallied above the 1100 mark.  And, armchair market analysts like me still draw the support line at 1040 – basically ignoring the drop below this line!

From a broader picture, support/resistance may make more sense when determining the flavor of the market (bull, or bear).  Note that the Nikkei over the last 20 years has been in a textbook bear market patter of lower lows, and lower highs:

NIKKEI 25 Year Price Chart 1

If we are indeed “turning Japanese”, then perhaps instead of another violent crash below the March 2009 lows (as seen from 1930-1932), we’ll see a very prolonged, slow slide that will grind down the bulls, while also chopping the hell out of the bears trying to short the market.  Hence the market would extract maximum pain from all participants!

Let me conclude by saying that I have no crystal ball, and no clue as to how the markets are really going to unfold.  Nobody actually knows.  What I’m trying to figure out – and this is the premise of Browne’s book – is how to position my investments appropriately, given our limitation of not being able to see the future.  Given the reasonable possibility that we’re slipping into a Japanese-like soft depression, I’m starting to think it might be wise not to get too aggressive on the short side.  A small percentage is fine, a large percentage though would probably get you chopped to death by volatile bear market rallies if the slow slide scenario plays out.

Further reading: Why the Best-Laid Investment Plans Usually Go Wrong & How You Can Find Safety & Profit in an Uncertain World by Harry Browne