(By Tycoon Report) The U.S. stock market is pushing up to its April, 2012 high. Are you going to sell because we are near resistance levels?
I'm not saying I'm convinced we will break out to new 2012 highs -- I'm just saying that the market has the legs to do so. If it's going to happen, it will almost certainly happen after
an intermediate-term correction.
Savvy investors consider both the bearish case as well as the bullish case. They know how to divide their stock market posture into:
- Short-term (days to weeks)
- Intermediate-term (weeks to months) and
- Long-term (months to years)
the stock market is overbought.Intermediate-term,
the stock market is overbought but still looks strong ("overbought doesn't mean over").Long-term,
the stock market may appear to be overbought, but it's not. It has a chance to push to new highs.
The reasons the stock market may be overbought are very clear in the charts of the S&P 500. The reason I'm saying it has legs is not obvious to the average investor.
Check out the charts of the S&P 500, below. They date back to December, 2011.
The first chart shows the volume. Notice how the stock market is trading in the upper end of its range, but also that the volume over the last month or so has dried up significantly.
When volume is drying up while prices are in the upper end of a trading range, it usually means that demand hasn't been overwhelming supply. Instead of buyers pushing prices higher, it implies the sellers have just stopped selling (in an effort to allow prices to move higher). Of course, sellers want prices to advance so they can sell, later, at higher prices.
The bottom line: Advancing prices on decreasing volume is a red flag. It means prices will likely correct, especially when they are at the upper end of the trading range.
Now let's talk about why we view the stock market as short-term overbought.
I will show you the same chart, gradually marked. Looking at the first image, see if you can determine for yourself why the stock market is overbought...
Below I drew two channels (red). The one on the left isn't that important, but I drew it so you can get a sense for how channels work. The one on the right shows that the stock market is trading right at the top of the channel that it's been trading in since October of 2011.
You can also see there are two blue lines.
One (diagonal) is a major down trend line that I've discussed in recent Tycoon Report
articles. Because the stock market broke above that line and has held above that line, it is likely that it will now act as the new support level (instead of the old resistance level it once was).
The other (horizontal) shows the most recent major high which was set on May 1, 2011. That will likely be a major resistance level for the next month or so. Even if the stock market breaks above that horizontal resistance level (between 1,405 and 1,415), there is more resistance just above that level at about 1,420 (the horizontal purple line below).
So there are two horizontal resistance levels, as you can see in the chart below:
- 1,420 (set April 2, 2012)
- The 1,405 - 1,415 range (set May 1, 2012)
Because the stock market is trading near the two major horizontal resistance levels, and because the volume in the stock market has declined significantly as the market made the recent move higher, it appears that in the short-term the stock market is likely to run out of steam.
Look for a correction or for prices to consolidate (trade sideways to slightly lower) for a period of time before moving higher.
I highlighted, in yellow, what the likely new trading range will be -- between the horizontal resistance level and the old blue down trend line, which should now act as the new support level.
Of course, there may be some support at that lower (red) channel line, but we will have to wait and see.
Today, at 2:00 p.m. eastern time, I will explain to members of my Technical Analysis Mastery Program
why the stock market appears to still have some bullish legs. It has to do with market internals and sentiment. But I will write about that in next week's article. So stay tuned!