Wednesday, October 6, 2010

Long Term View: S&P500

This is a long term technical view of the S&P500.

Sometimes (or rather most times) to get an idea of where the market might be headed it is important to step back and take a longer term perspective of where we have been.  That means getting out the monthly charts.

My long term forecast for the S&P500, which I presented back in January, was based upon this kind of analysis, and it appears to be taking shape.  Back in January, the over riding theme was patience -- wait for your pitch.  Buy when sentiment turns bearish (i.e., near the lows) and sell when prices return to the previous highs.

Figure 1 is a monthly chart of the S&P500 (symbol: $INX).  The price bars marked in pink are negative divergence bars.  The divergence is between price, which is heading higher, and an oscillator used to measure price, which is heading lower.  For the record, the oscillator is called value charts, but any oscillator would suffice.  I use value charts because it is easier to write computer code with.

Figure 1. $INX/ monthly

What we know about negative divergence bars is the following: 1) they tend to show up at market tops but they do not necessarily mean a market top; 2) they represent slowing price momentum; 3) typically, prices will trade in a range as defined by the highs and lows of the negative divergence bar; 4) a clustering of negative divergence bars most often means a market top.

The recent negative divergence bar, which was printed in May, 2010, has done exactly what it was advertised to do.  The lows of the negative divergence bar (S&P500 1040) are our "line in the sand".  The highs of this negative divergence bar are at S&P500 1205.  Based upon this analysis, this rally is about three quarters over.  

I do not see the S&P500 trading significantly above 1200, and in all likelihood, the price action will remain range bound.  It will be important to maintain a discipline of buying when the market is oversold and selling when it becomes overbought.  The presence of a negative divergence bar on the monthly charts suggests a range bound market.      

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