Wall Street started the week off on a fairly pessimistic note and equities sold off across the board as investors digested unsettling news. On the home front, indexes broadly declined as Standard and Poor’s cut the rating outlook on U.S. debt from stable to negative. S&P credit analyst Nikola G. Swann commented, “More than two years after the beginning of the recent crisis, U.S. policy makers have still not agreed on how to reverse recent fiscal deterioration or address longer-term fiscal pressures”. The news overseas was just as bad, if not worse. In the Eurozone, Greece came into focus again as the country is seeking to restructure its debts, while talks of a Portugal bailout and an unfavorable Spanish bond auction all weighted down on the Euro and local stock indexes. Gold was one of the few assets to finish in the green yesterday as the precious metal tacked on a few points to close near $1,495 an ounce. Surprisingly enough, oil tumbled lower towards $107 a barrel even after news of Saudi Arabia cutting output.
After a sell-off as severe as this one, investors will ask themselves the most intuitive question that comes to mind: to buy or not to buy? Taking advantage of a market correction can prove to be quite rewarding if your timing is spot-on. Likewise, many investors often get fooled into buying after a sell-off, only to discover that a new downtrend is in fact developing. Considering that the S&P 500 Index is one of the most closely followed benchmarks for U.S. equity performance, it only makes sense to analyze the biggest and most liquid fund tracking it [Talking ETF Weighting Methodologies With Tony Davidow].
Technical Analysis: SPDR S&P 500 (SPY)
Below is a daily chart of SPY starting in September of 2010 until today, with the 200 (yellow) and 50 (blue) day simple moving averages plotted.
First and foremost, notice how the fund has consistently traded above its 50 day moving average. Since September, SPY has undergone only two corrections, selling off in the second half of November last year, and more recently during March of 2011. When the fund is in an uptrend (trading above 200 day moving average) its 50 day moving average acts as support. Notice how in the beginning of December in 2010 SPY managed to just touch and bounce off the 50 day moving average and continue its robust uptrend [see SPY Technicals]. Moving forward, take a look at the month of March, during which the SPY managed to close below its 50 day moving average, and subsequently decline further. Since peaking at $134.69 a share in February of 2011, SPY has since been struggling to regain its footing and continue marching higher.
The recently discouraging economic news (lackluster earnings and U.S. debt downgrade) have put additional pressure on the markets [see Closer Look At S&P 500 ETF Options]. SPY must maintain its head above $130 a share, otherwise the fund might be headed far lower towards the $125 level.
The first rule of technical forecasting is to assume that there is a link between the past and the future. When we look at the daily chart of SPY posted above, its fairly easy to give in, pull the trigger, and buy it while its cheap. However, it important to remember that while “dips” in uptrends are great buying opportunities, they may also simply be the beginning of a new downtrend that is just starting to develop. In the case of SPY, this sort of analysis is fairly complex, since we are in essence trying to pin point whether the broad U.S. equity market will turn around or continue to trade lower [check out the new ETF Head-To-Head Tool].
By drawing a Fibonacci retracement from the start to the end of an uptrend, we get projections of likely levels that the fund will retrace down towards. In the chart below we have drawn a Fibonacci retracement from the last time the SPY bounced off its 50 day moving average (11/29/2010) up to its most recent peak of $134.69 a share (2/18/2011).
The first level of support comes it at the 23.6% level, which SPY has managed to break below. The next level of support for the fund lies near the 38.2% level, or just above $128 a share. The 50% retracement level is also significant since that is where the fund previously held support on March 16th.
If SPY manages to establish support above $130 a share in the coming days, then its fairly safe to assume that the fund is headed higher. If the uptrend is still intact, the first level of resistance for SPY comes in at the $134 level, which the fund topped out at previously. However, if SPY does not establish support above the $130 level, then the fund is likely headed lower to anywhere between $126-$128 a share. A close below the $126 level would call for reassessment of the uptrend, as the fund may be headed lower towards its 200 day moving average [For ETF Investors The Details Matter].
As always, investors of all experience levels are advised to use stop-loss orders and practice disciplined profit taking techniques.
Disclosure: No positions at time of writing.