TimingCube - Resistance and support - resistance lines,support price,trend lines,trading volume,supply and demand,price floor

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Signal Update

Current Signal Performance as of

Signal Type	Trade Date	Index	Return since issued
		Nasdaq 100
		Russell 2000
		S&P 500
		QQQQ

Cumulative Returns since First TimingCube Live Signal () as of

Index	Long Only	Long Only with Margin	Long & Short	Long & Short with Margin	Buy & Hold
Nasdaq 100
Russell 2000
S&P 500
QQQQ

Note: QQQQ returns are included for continuity sake.

Market Update

Except for small caps, markets moved significantly higher this week, with the S&P 500 closing at a new four-year high. Large-cap tech stocks, which had lagged since early June, are now outperforming, as investors were encouraged by excellent earnings reports from Apple and AMD. We received good news on the economic front too, as inflation numbers for June were better than expected: the CPI (Consumer Price Index) was flat last month while the core CPI, which excludes energy and food costs, only rose 0.1% and is currently running at a 1% yearly rate. Inflation therefore no longer seems to be a threat. As for retail sales, they surged 1.7% last month after dipping 0.3% in May, showing that the economy may be stronger than many expected. This is all good news for stocks.

For the week, the Nasdaq 100 and S&P 500 respectively gained 2.91% and 1.33%. Investors apparently rotated money out of small-cap stocks, as the Russell 2000 lagged, finishing the week only 0.24% higher. All three indices rest well above both their 50-day and 200-day exponential moving averages (EMAs). Our active Buy signal remains in effect.

Trend Timing School

Resistance and support

Looking at the recent behavior of the stock markets, analysts have detected a technically important occurrence: the breakdown of a strong resistance line. While our Model does not take resistance or support lines into consideration, they are good to know because they call our attention to crucial turning points in the market.

Technical analysts talk of resistance and support as price levels that represent and frequently act as virtual barriers. The price movement of a stock or index frequently reverses as it comes close to such lines. Resistance and support price levels should really be viewed as price areas instead of a precise pinpoint number.

When approached from below they act as a price ceiling and are called resistance lines. Resistance lines are formed by drawing horizontal lines through previous intermediary tops. Once a resistance line is penetrated to the upside (a bullish breakthrough), it frequently changes its role to behave as a price floor and offering price support. It becomes a support line.

Just as with trend lines (see the April 22, 2005 Trend Timing School article on Trend lines), the strength of resistance/support lines varies. There are several tests used to determine how technically significant a resistance/support line is, such as the number of times this price area has been visited without decisively breaking down, or the length of time it has held (the longer the stronger). Maybe the most significant test of all is the change in trading volume which created the tops or bottoms on which the lines are drawn. An increase in volume at these turning points (or the absence thereof) dictates how resilient the resistance or support is.

You may ask "how is it possible for markets to care about, or be influenced by, an artificial line drawn on a chart?" The answer is, as with all things having to do with the price and volume of the market, that they are a function of investor expectations and supply and demand.

Looking at the Nasdaq Composite index over the last 6 months, as depicted in Chart 1 below, we can see the resistance line at 2,100 which has been tested quite a few times before finally being penetrated on July 8th. Smartly we have been on a Buy signal since May 12th and have been benefiting from the rise. The breakdown of a resistance line is generally viewed as a bullish sign, and the market generally moves higher afterwards. However, if after the breakout investors started to question this new price level, and if large enough numbers of them reconsider and sell, the market could fall back well below 2,100, At which point the breakout from resistance would turn-out to have been what is known as a bull trap.

Chart 1 - Nasdaq Composite, 6-Month View

If on the other hand the breakout holds, we can then start looking upwards as the resistance line becomes a support line. The support line becomes harder and harder to breach with time and the number of successful attempts at stopping pullbacks. The market is then expected to continue moving up, but as we can notice from Chart 2 below we see another resistance line above us, at around 2,178, which corresponds to the intermediate top established in late December 2004.

Investor psychology admittedly plays a big part, but there is nothing mysterious about why resistance and support lines work. The basic laws of supply and demand tell us that the price is the point of equilibrium at which buyers and sellers are willing to buy/sell. Looking at the volume data at the bottom of Chart 2 one can notice that the December 2004 high was achieved on low and declining volume, but that the selling that followed occurred on surging volume. The point is that there are many investors out there who bought these many thousands of shares and now, after over half a year under water, might be happy to unload them at or near breakeven. This is why this resistance line is likely to be a strong one, involving a hard fight between bulls and bears, buyers and sellers. The flip side is that if the strong resistance line is overcome it will mean that the breakthrough rally is to be equally strong.

Chart 2 - Nasdaq Composite, 1-Year View

Only time will tell which way the market is going to go. But in the meantime we are reassured to have our Trend Timing Model to rely on, instead of having to guess which of the resistance/support lines will be broken, and when.

FAQ of the Week