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Wednesday, 30 May 2012

Mean Reversions

I'm a trendline and support/resistance level chartist mainly, and these should be important tools in any chartist's toolkit. Both of these are what I would describe as linear support/resistance level tools, as in the case of a trendline it is a straight line moving upwards or downwards at an angle, and in the case of support and resistance levels and areas, these are static levels that have been demonstrated by past market action to be important.

These can last a very long time indeed, and a good example of that can be found on the BP monthly chart, where I used a 13 year support level on 25th June 2010 to argue for a low in the 26-7 support area, and a three year declining channel to argue further that BP might well close June back above 28. BP bottomed the next day at 26.51 and closed June back above 28. You can see that post here, and it's worth noting as an aside that BP then recovered back to the top of that declining channel, made a potential double-top there, and has since retraced half of the move up from the 26.51 low. The point I'm making is that trendlines and support/resistance levels can last a very long time and have real force.

They're obviously only a part of the tools in an analyst's toolkit though, and I'd like to look in more detail today about bollinger bands and moving averages as they relate to the technical picture that we are looking at on SPX at the moment. On the SPX daily chart below I have the SPX daily bollinger bands since October, and have also marked the daily 50, 100 and 200 SMAs.

Bollinger bands are obviously a mean reversion tool, with the middle bollinger band being the 20 period SMA, and the upper and lower bollinger bands on a standard setup are two standard deviations away from the 20 period SMA. Moving averages and bollinger bands are therefore two non-linear methods for assessing support and resistance levels.

So how have these performed since the low last October? I've marked eleven tests of the daily middle bollinger band in the period since then, and of those four reversed at the middle bollinger band, two closed beyond the middle bollinger band to reverse at the 100 SMA, one closed beyond the middle bollinger band to reverse at the 200 SMA, and four closed beyond the middle bollinger band to hit the far bollinger band.

How does this relate to what we are looking at now? The daily 200 SMA is a key bull/bear dividing line, and is support at 1282.90, slightly below the current retracement low. The middle bollinger band is obviously the next key target and resistance level, and that is at 1344.22 today, with a static resistance zone in the 1340-3 area. A daily close above there opens up a test of the 100 SMA. The 100 SMA is at 1356.83, with the valley low for the April double-top at 1357.38 as static resistance. This is the second key resistance level. A close above these opens up a move to the upper bollinger band, currently at 1406.70, and would most likely mean that 1291.98 was a retracement low that will last a while:
Short term SPX is struggling above the double-bottom neckline on the 60min chart, and while the possible triangle I mentioned yesterday really needed another touch of the lower trendline to confirm it, the upper trendline broke yesterday and then retested as support. The bulls need that to keep holding in the 1320 SPX area today:
On the SPX 15min chart I have a possible rising wedge forming, though it's too early to describe it as one for certain. If that wedge continues to form then we will most likely see this rally fail in the 1340-3 area. In the short term rising support from 1296.53 is again just above 1320, and a move below 1320 would be a signal that this rally may have already ended:
Is there any reason to think that this rally may already be topping out? Yes, though I'd be happier with a touch of 1340 as a near miss of the middle bollinger band on the daily chart. The Vix is showing clear support at the IHS neckline and the middle daily bollinger band there. That might break of course, but until then it is limiting any rally on equities:
The other reason is the AAPL chart. This is at a level that suggests that we will see failure here or rally hard, but as of the close yesterday it is clearly out of the falling wedge and testing the IHS neckline. A clear break above would look very bullish, but until then it is testing strong resistance and repeatedly failing there:
The last chart today is the updated daily IHS chart on USD. Obviously we have a conviction break of the IHS neckline and the pattern target is 90.5, but short term USD is looking rather overbought and is approaching a significant resistance level in the 83.5 area. We might well see a reversal there to retest the IHS neckline:
For today I'll be watching the 1320-2 SPX level as short term support, and the 1340-3 level as the next upside target and strong resistance.

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