Broken Support Everywhere – Why It’s Important and What’s Next

As the old saying goes, “The more times a level is tested, the higher the likelihood that it breaks”. This goes for tests of support as well as resistance. Think about it – Every time a stock or index hits a level and bounces, there are now less people that are willing to buy at that particular price. Why? Because they already bought. Lets use today’s S&P500 break as an example: 1100-1120 was really the key level. Every support test was met with buyers. But after 3 or 4 times, the buyers start to run out. They already bought. So eventually when the buyers completely dry up, sellers are all that’s left.

Assuming we see follow through to the downside tomorrow, any attempt to get back above this level should be met with sellers. Why? Because as we mentioned above, the buyers at that price have run out and sellers are all that’s left. This “Supply” of stock that we have at this price now is why polarity plays such an important roll in our analysis. What used to be support, will now become resistance.

Sometimes, you see temporary breaks of support that cause short squeezes because the shorts get caught. In other words, obvious support levels get breached, and very quickly price recovers and gets back above it. Longs that were stopped out need to buy back. Shorts getting squeezed have to buy back in order to cover. The natural buyers at that price are buying, causing more shorts to cover and stopped out longs having to buy back. This cycle creates a vicious rip-your-face-off rally. I don’t think this is one of those cases.

We need to see prices above 1120 quick for that to occur, and based on today’s action I think the likelihood of that is slim to none. And slim just left the building. For 401K investors out there, let’s hope I’m wrong.

As I tweeted earlier on Stocktwits, most of the other major averages had already broken and were making new lows. So it wasn’t a huge surprise that the S&P500 closed at new 52-week lows today. Here is the chart:

So now where do we go? Well as we’ve been discussing here for a couple of months now, the Fibonacci levels could and should come into play. They have been spot on so far during this decline. You can see that the 38.2% retracement held for close to 2 months after bouncing off it in August. The next big area of support is between 1020 and 1040, which is the 50% Fib retracement and last summer’s lows:

So are we really heading that much lower? It certainly appears like we are. Most of the other major indexes (except the Nasdaq100) had already broken the August lows. Most of the S&P Sector SPDRs had broken their lows. I would need to see some serious buying come in quickly and take this S&P500 back above 1120 for me to change my mind. Until further notice, lower lows are to be expected.

The Russell2000 ($IWM) has been leading this market lower and has really gotten decimated. We are extremely oversold so a dead cat bounce should come at some point this week. I would expect the Russell2000 to outperform the other averages during that rally so watch for a turn there first. But keep in mind this rally will be short term in nature and comes within the context of the downtrend that we’re still currently stuck in.

Pick your spots out there.