In the pre-market update of February 14, I anticipated that 1514 would become an important short-term support level, and so far the market's bounced twice from that level. I'm going to use this opportunity to unveil a bit of the "magic" behind technical analysis, and discuss some of the logic behind it, and a few of the reasons why anticipating future price action based on technical analysis works more often than it doesn't.
The 10-minute SPX chart now sports a pretty decent triangle consolidation, which has been formed with two rejections at the 1524 level, and two bounces off the 1514 level (see chart below). 1514 has been tested several times now, and support becomes more important each time it's tested. In a moment I'll discuss why. I'll also discuss why we can further anticipate that this is now quite likely to have turned into a market where additional buyers will show up at higher prices, while additional sellers will arrive at lower prices.
Let's study a real-life example, using the 10-minute S&P 500 (SPX) chart. When we study this chart a little more closely, we can see that sellers came in at 1514 in a pretty big way on two occasions during the first week of February (on the way up). Unfortunately for some sellers, due to the gap up on February 8, it's a fair bet that any sellers who came late to the party got trapped short. We can then see the back-test of 1514 on February 11, and further reason that some of those trapped sellers surely elected to cover their positions -- but it's unlikely that all of them did. SPX has only moved up about 10 points since then, so it's also a reasonable bet that a fair number of swing-trader bears are still holding onto their shorts.
Looking to the upside, 1525 has rejected the advance twice, and thus now becomes an obvious stop-loss level for shorts. Typically, most traders will leave a bit of cushion beyond the obvious level, so we should assume 1525 plus a few points. The chart also shows us that ever since February 8, the market has been in a battle between buyers and sellers -- the pinball back and forth action tells us that bulls and bears are pretty equally balanced in this zone. And that then tells us another piece of information about 1525: if the market does more than take a quick peek above that level, additional buyers should show up in the form of short covering (and possibly also in the form of bulls who are hoping to buy in lower, but will feel the urge to chase a break higher). The reverse is true of 1514 on the downside: 1514 (minus a few points) has become an obvious stop-loss level, so we can make a reasonable assumption that additional sellers will show up below that level. This is why the triangle breakout or breakdown can be projected to run at least 10 points.
So, sustained trade beneath 1514 is very likely to lead to a test of the next support shelf, in the 1495-1500 zone, where buyers are likely to show up again. Sustained trade above 1525 is likely to lead to 1535 (+/-), where many short-term traders will take profits.
Technical analysis really isn't a bunch of voodoo, it's simply based on trader psychology.
We've discussed and charted the triangle above. In classic technical analysis, triangles typically show up as continuation patterns to the prior trend, which in this case was up; more rarely, triangles are reversal patterns. In Elliott Wave analysis, triangles always show up as continuation patterns, but typically show up as the penultimate (second to last) wave in a waveform. There are two challenges here for Elliott Wave: the first challenge is determing whether or not this is a true Elliott triangle, and thus "destined" to resolve higher. The second challenge is which wave it would actually complete if it is a triangle. Neither question has a clear-cut answer right now, so this becomes a bit of a "confirmation" market. Trade below 1514 would rule out an Elliott Wave triangle, while trade above 1525 would largely confirm it. (continued, next page)