After the recent carnage in the stock market, it seems that a test of a critical long-term support level is coming soon, which could provide footing for a bottom and give way to an upward reversal into year end.
Only five short months ago the S&P 500 was trading at the 2011 highs around the 1,370 price level on the S&P 500 index. Since then, the price action has devastated investors and traders alike. As of the close on Monday, October 3, the S&P 500 had worked over 270 handles lower in five months. The price action since September 27 has been a bloodbath.
It is true that the S&P 500 could be carving out a double bottom on the daily chart, but I am of the opinion that there may be more work to do to the downside. We are oversold on the daily and weekly price charts, but I have yet to see the kind of panic-level selling that typically precedes a price reversal.
The chart below illustrates the number of stocks that are currently trading above the key 50-period moving average:
While most market participants are concerned about a trap door that causes prices to cascade lower, I am concerned that at some point news will come out that could rip the bears’ faces off.
The majority of retail investors are running for cover. The sentiment levels are decidedly bearish and the last thing most traders are looking for is a rally. The contrarian trader in me cannot deny that a rally would do a lot of damage in the near future, but Mr. Market needs to suck in a few more bears in order to do the most harm.
One sound bite out of Europe could alter the price action almost instantly in favor of the bulls. The European Central Bank (ECB) could suddenly cut interest rates or announce that Eurobonds are going to be made available. Either of the two headlines or a combination of both would most likely drive prices significantly higher.
After the last nasty downside move, there are layers of buy stops above current pr! ice leve ls. If price worked high enough, the stops would be triggered and an all-out rally could play out. Anything coming out of the Eurozone that appears to be either stimulative or that appears to push an ultimatum out on the time spectrum will be viewed as positive.
Often, news and price action play out together at key support/resistance levels, and it would make sense that some form of announcement will be made when the S&P 500 price is sitting right at a long-term support level.
As can be seen from the weekly chart of the S&P 500 index ($SPX) below, the 1,008-1,050 price level is of critical importance.
The primary support levels I am watching on the S&P 500 if it continues lower are the 1,080 price level, which should act as short-term support. If that level breaks, the 1,050 area will become a major support level that bulls will likely defend fervently.
Additional long-term support will come in around 1,008. I would be shocked to see the S&P 500 push through both the 1,050 and the 1,008 price levels on the first attempt, but stranger things have happened.
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