Looking For the Line in the Sand With Technicals and Fibonacci

The price action of the past two and one-half weeks makes it clear that stocks have entered a correctional phase of some sort. The next logical question, of course, becomes how low will the pullback go? There are several ways to try to answer this question. For example, a garden-variety pullback generally runs somewhere between negative two percent to negative five percent. So, with the current decline being -3.6 percent, one could argue that we might be closer to the end than the beginning. Another way to determine the potential damage a pullback might inflict is to look at the key technical levels. For example, first there is the issue of support and resistance zones. Then there are trendlines to consider and where a "lower low" would come into play. Next, if you want to get fancy, you can utilize Fibonacci retracement levels. And finally, there are the popular moving averages that seem to attract a lot of attention from the press. The problem with a market that has been making fresh all-time highs for a while (such as this one), is that during the first pullback, support levels are virtually nonexistent. And this is most definitely the case with the current market. From a near-term perspective, there is some support at S&P 1600 for example (the top horizontal black line on the chart below), but after that you have to go down to the 1540-1560 zone to find any real support on the charts.

Next, let's turn to the issue of key trend lines. As has been detailed in recent reports, there is an uptrend on the charts that has been in place for almost six months now. Thus, this becomes an important line in the sand for our two teams. The current level that puts this trend in play (shown in the circle on the chart) is just above the 1600 level on the S&P 500. Also in the circle on the chart is the 50-day simple moving average (at 1604.17). While this is not exactly a sophisticated indicator, it has been generally adopted as a key trend identifier. As long as the market is above its 50-day and the 50-day itself is moving up, all is right with the world as far as the bulls are concerned. But if prices cross below and then stay below the 50-day, well, that's a horse of a different color. And since the S&P hasn't spent more than one day below its 50-day since December, this is something to pay attention to. Then there is the question of a "lower low" on the chart, which is also something that even amateur technicians such as myself watch for. In short, as long as an index is making a series of higher highs and higher lows, then the trend is up. Yep, sometimes it is indeed that simple. For the record, it would take a drop below 1540 in order for the S&P to put in a "lower low." And finally there is the Fibonacci retracement levels to consider. Leonardo Pisano Bigollo - known as Fibonacci - was a 13th century Italian mathematician generally viewed as the most talented in his field during the Middle Ages. Although Leonardo did not actually discover the number sequence that today bears his name, he did use it in one his books. Back to the point. The key here is that markets tend to retrace .25, .382, .50, and .618 of a move in both directions. So, if you find yourself wondering how low a market pullback might go, consulting the "Fib numbers" can be helpful. If we look at the intraday low of the recent rally that occurred on November 16 and the most recent high of 1687.18 from May 22, we can apply the Fibonacci retracement matrix. For the S&P 500, the .25 retracement occurs at 1601.66, the .382 is at 1556 and the .50 is at 1516. So again, these are levels to pay attention to.

If we now take a step back from the charts and look at our various levels, it becomes obvious that there are some very important levels that could come into play in the near-term. Clearly the most obvious and important level on the chart is at S&P 1600. This is the first level of support, the current level of the 50-day moving average, the current level of the key uptrend line, and the first Fibonacci retracement level. Therefore, it's reasonable to opine that a meaningful breach of the 1600 level that lasts for more than a couple days, would be very significant to the chart watcher crowd. Because of this, we can probably expect:

As such, whichever team emerges victorious in this fight will likely control the ball for a while. Finally, please remember a couple things. First, chart analysis is more art than science. And second, computer algorithms don't pay attention to levels once they get on a roll. Therefore, it is important not to get too caught up in exact levels on the charts. But at least now we know what levels to be watching intently.