Key MidCap Index Runs Into Resistance

10/25/05 12:34:25 PM

by Arthur Hill

The S&P MidCap Index broke support in early October, and the recent rally over the last two weeks is running into resistance from this broken support level.

Security: $MID
Position: Sell

Broken support turns into resistance: This is a classic tenet of technical analysis. For the S&P MidCap Index ($MID), the buyers lined up at 695 support and bought in late August and late September (Figure 1, green arrows). This level represented demand, and prices bounced accordingly.

FIGURE 1: S&P MIDCAP INDEX. Buyers lined up at 695 support and bought in August and September (green arrows).

Graphic provided by: MetaStock.

Graphic provided by: MS QuoteCenter.

The third test was not so lucky; MID broke support at 695 with the third attempt in early October. Buying pressure dried up and sellers drove the index below this key demand line. Buyers who bought the last two bounces are now holding losses as prices trade below broken support. This creates an area of supply as these buyers seek to unload when prices return to broken support (breakeven). Supply means resistance, and the index is likely to stall around 695.

In addition to broken support, 695 marks a 50% retracement of the prior decline (722 to 665). After a sharp decline, securities often become oversold and need to work off this condition. There are two ways: bounce or consolidate. MID has chosen to bounce, and the typical retracement bounce is 38-62%. The midpoint is 50%, and this acts as the base case.

Why so much effort to find resistance? The index broke a major support level at 695, and this turned the trend bearish. Securities rarely go straight down and usually zigzag lower. With the larger trend bearish, the current advance is viewed as a corrective rally that should fail. Based on this evidence, I would expect it to fail around broken support and the 50% retracement.

Arthur Hill

Arthur Hill is currently editor of TDTrader.com, a website specializing in trading strategies, sector/industry specific breadth stats and overall technical analysis. He passed the Society of Technical Analysts (STA London) diploma exam with distinction is a Certified Financial Technician (CFTe). Prior to TD Trader, he was the Chief Technical Analyst for Stockcharts.com and the main contributor to the ChartSchool.

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