S&P and Nasdaq: Has the Bulls’ Train Derailed?
The main US stock indices rallied hard since they broke out over resistance in July 2020. In this article I will show you how you can use a widely available simple tool of technical analysis for a long-term macro analysis.
When a technical analyst wants to understand the big picture he or she zooms out to a weekly chart:
As you can see on the weekly chart of the main US stock index S&P 500 shown above, the post-pandemic rally hit a cyclical resistance in July 2020. (You can read how the Monkey Cycle Trader Indicator identifies underlying cycles and draws those support and resistance lines here and here).
When price tests a new cyclical resistance there are three main scenarios:
(i) price turns down off the resistance line and starts a down cycle, or
(ii) bulls push price over the resistance and then keep pushing it higher switching to a trending mode. That can happen if a cycle on a higher timeframe points up and it overpowers the down cycle on that base timeframe.
(iii) the third option is that price overshoots the resistance but then bears push it back under resistance and start a new down cycle. In that case power of a new down cycle finally does its job.
Because we have three very different scenarios every time price tests a cyclical resistance, trading breakouts is not a reliable winning trading strategy. You basically never know if that resistance will hold. If price slices through resistance from the get-go, it makes things even more complicated because there is not guarantee that you deal with an overshot, a temporary move over resistance that will get brutally faded.
Therefore, the only reliable way to trade a breakout is to wait until price first goes over a resistance, and then comes back down and tests the resistance-turned-support from above.
This is exactly what S&P did in July 2020 (see green arrows pointing up to re-tests by price of the broken resistance). S&P retested the red horizontal line of the cyclical resistance in September and October 2020. Nasdaq followed a similar pattern:
Nasdaq retested the broken resistance in July 2020 and started a big bull run, a trending move up.
When price breaks over a cyclical resistance it starts an accelerated part of a rally because all the short sellers that expected a bearish reversal and borrowed stocks to sell them at resistance with the plan to buy it back after decline have to buy back stocks regardless of the price.
At this point you may say I lied to you with my headline promising to explain “how you can use a widely available simple tool of technical analysis for a long-term macro analysis”.
Let’s get right to that point now. That instrument is Exponential Moving Average with a period of 21. Look at the upper green line on both charts shown above. Those are two EMA 21 lines on a weekly timeframe. All the pullback bears managed to produce during eighteen months rally (from June 2020 to December 2021) found solid support at that 21 EMA line.
That weekly EMA 21 worked as a rail for bull’s train that kept pushing price higher and higher pulling the lagging EMA line up. Look at numerous yellow arrows pointing to several pullbacks the US indices made during that period. Each of those pullbacks became a great buying opportunity for raging bulls.
But “Trees Don’t Grow to the Sky” as a popular German proverb says. Every bull run finally approaches a point of inflection when there are no more bulls left willing to buy at sky high prices. This is when a trending move up reaches its peak, price turns down and a corrective move down finally starts.
And here, again, our 21 EMA comes at handy. The crucial moment is when price first breaks under support of 21 EMA but then fails to reclaim it. Look at two red arrows on the charts. They point down to failed tests of 21 EMA lines from below.
Note that EMA 21 lines changed slope from upward to downward. The upward sloped EMA lines worked as rails for that ever-climbing bulls’ train. But now the rails point in different direction, they point down.
Now I hear your questions: “Where that Bears’ train is heading now?” and “What Will Be the Next Buyable Support?”.
When EMA 21 confirms change in trend what you should immediately do is to switch to a higher timeframe. If a weekly up trend shows signs of reversal we should check what is going on a monthly timeframe:
We can see a very similar pattern on that monthly chart. Nasdaq-100 hit a cyclical resistance 1,988.89 as identified by the Monkey Cycle Indicator in January 2010. In March, April and May 2010 bulls kept fighting that resistance but could not break over that level. Failure to break out was followed by three-month consolidation in Juny, July and August 2010. And then, finally, bulls manage top break over resistance in September 2010 and then re-tested that resistance-turned support in August, September and October 2011 (see the dark green arrow that points up).
Once the resistance-turned-support got tested from above the rally started to accelerate. It kept running higher for more than 10 years leaving the broken resistance way below!!!
Look how 21 EMA worked as solid rails for that speed bulls’ train. You can see four yellow arrows pointing to big pullback on the way up that got bought out by bulls in August 2015, January — February 2016, December 2018 — January 2019 and March-April 2020.
So far, we have got two red monthly candles off the top. That pullback has not even tested the trending EMA 21 on a Monthly timeframe! What that means is that bull train has NOT derailed on a monthly chart yet!
We can expect the EMA 21 on Monthly to work as a solid support for that move down. I hope you noticed that there are two green lines show on the monthly chart of Nasdaq-100. You may wonder what the second line is. I am going to share with you one good trick. When people chart moving averages, they always deal with averages calculated based on closing prices. If you plan to buy a pullback in a trending stock, you need to find an entry point that is as close as possible for a potential bullish reversal point. If that is your goal you should add to your charts moving averages calculated based on low prices, not on closing prices!
Just compare those two lines in comparison to lows made by Nasdaq-100 by three last pullbacks. As you can see, the EMA 21 calculated based on low prices did a much better job helping traders to find bullish reversal points.
Those are levels that should work as support for that decline:
Most likely both US stock indices, S&P 500 and Nasdaq-100 turned down on a weekly timeframe and have room to drop lower. But the indices have not completed a topping sequence yet. This decline will most likely find a temporary support around 21 EMA on a monthly basis. This is when the Daily Down cycle will bottom. In our Premium Trading Chat room we will be waiting for a new cyclical support printed by the Monkey Cycle Trader indicator together with the “Strong Buy” signal on a weekly timeframe. That buy signal should be confirmed by a cyclical support printed on a daily timeframe.
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