Testing The Channel

12/10/04 08:05:26 AM

by David Penn

An early November channel breakout + an early December test of resistance-turned-support = higher prices for the S&P 500 in the near term.

Security: $SPX
Position: N/A

Stocks in the Standard & Poor's 500 have been in a bull market of sorts for nearly four months. This bull market of sorts began with the August bottom in the S&P, and a major move higher--anticipated by the positive divergences surrounding the October low (see my "Divergences And The Bush Bounce," Traders.com Advantage, November 9, 2004)--in the autumn appeared to confirm the bullishness.

An interesting acceleration of this advance came in early November, as the S&P 500 broke out above a trend channel that extends back to the August lows. What was required for this breakout to hold was a test of the upper boundary of the price channel. A successful test would be an excellent example of resistance-turned-support.

Figure 1: The trend channel that contained the S&P 500's rally from the August lows may prove instrumental in supporting an accelerated move higher.

Graphic provided by: Prophet Financial, Inc.

So far, so good. Since breaking out above the trend channel on November 4 (the day after the US Presidential election), the S&P 500 has repeatedly tested the topside of the upper boundary of that channel. Specific test dates were November 10, November 19, and December 7. Yesterday's action (December 9), which saw a sharp selloff turn into a sizable short-covering rally late in the morning (see my pair of articles for Traders.com Advantage, "An Intraday Diamond In The S&P 500" and "An Intraday Flag In The E-Mini S&P") was effectively another test of how much support that upper trend channel boundary could provide.

The trend channel is approximately 60 points wide. If we treat the trend channel like any other technical chart pattern (such as a triangle, head-and-shoulders bottom, or flag) and treat the early November breakout as we would any other breakout from a chart pattern, then it would be reasonable to project that the current advance in the S&P 500 might make a minimum upside move to 1220. This is derived by adding the width of the trend channel to the value at the breakout point in early November (approximately 1160). Any move toward a new high (for instance, a close above 1191.25 or so) would make a run on 1220 or higher all the more likely.

If, indeed, the primary impetus for the rally on December 9 was short-covering, then there is an excellent chance that the upper boundary of the August-December trend channel will hold. Such support would likely draw in true buyers, as opposed to those merely covering short positions. And it is that cohort of true buyers who would be instrumental in pushing the S&P 500 up above the 1200 level.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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Testing The Channel

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