Stock Market Oversold But Threatening Critical Support Level

By: Hans_Wagner

Originally written 30th June 2008 - Following the market trend is a proven way for investors to beat the market and grow your stock portfolio. Basic technical analysis provides the tools to identify and follow the trends of the market as determined by the S&P 500.

It is best to begin with the big picture in mind and then work our way down to weekly and then daily views of the charts. You will notice that the chart and the value of the indicators change as we move from a monthly to a weekly and then a daily chart. This is a normal part of the technical analysis.

Let's start with the long term view of the S&P 500. The Relative Strength Index (RSI) is a good indicator of the cyclical bull and bear markets. In addition, the 78-week Exponential Moving Average (EMA) acts as support in a bull market and resistance in a bear market.

In January, we fell into a bear market as the RSI dropped below 50. The index fell through the rising trend line and the 78-week exponential moving average and MACD crossed below zero. This is consistent with the fundamentals of a weakening economy, and a recession. It is best to remain nimble during times like this.

The first support level looks to be just above the 1200 level. The 78-week exponential moving average remains as resistance.

The weekly S&P 500 below was in a bullish ascending triangle that broke to the down side. The recent move up turned back down at the 50-week moving average.

Support is now at the 1220 area. RSI below 50 indicates a downtrend. MACD fell through the 9-week moving average, a sell sign. Slow Stochastic is trending down.

As predicted, the market tested the 50-week moving average and then turned back down. We may see an oversold bounce here, but the overall trend is down.

The daily S&P 500 chart below shows resistance at the 200-day moving average and the 1,400 level. As expected, these levels held and the market turned down from there. There is support at the prior low. We are likely to see an oversold rebound here before the market turns back down again.

RSI is below 50 indicating a downtrend. The MACD continues to trend down. When it turns up through the 9-day moving average, it will be a buy sign. The Slow Stochastic signaled a move down when it fell through 80 and is now below 20. When the Slow Stochastic turns up through 20 it is often an early sign of a move up.

In bear markets, it is best to be nimble and/or use risk protection such as trailing stops, protective put options and even covered call options. Of course, you can go short or use any of the short Exchange Traded Funds (ETFs).

Given this perspective, it is important to have your portfolio positioned for the down turn. I expect the market to rebound from this support level as it is currently over sold. However, it is most likely to turn back down again. Any rebounds are good places to add more down side protection by using short ETFs, put options or covered calls. Of course, you can also sell long positions that can be bought back after they have fallen further.

While it is tempting to buy when the market falls, it is a better strategy to be sure the market has formed a base. Most likely the prices of many companies will be even lower. That does not mean you cannot buy high quality companies that are in sectors that are trending up. Just keep in mind, Warren Buffett's first rule of investing is to not loose money.

To learn more about analyzing market trends and technical analysis I suggest reading:
Ahead of the Curve: A Commonsense Guide to Forecasting Business and Market Cycles by Joe Ellis is an excellent book on how to predict macro moves of the market.

Encyclopedia of Chart Patterns (Wiley Trading) by Thomas N. Bulkowski is the only definitive study of chart patterns that includes statistical analysis of the success and failure of over 50 chart patterns. While expensive, it is worth it.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/

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