Like the question of how high is high, where there is no limit as to how far the stock market can advance to, there is also no limit as to how far the stock market can decline, at least in theory. The stock market crash of 1929 and the ensuing Great Depression structural bear market proved that extreme market conditions led to a 90% loss in market value when the bear market finally ended in 1932.
Are the recent market actions a shot across the bow warning of an impending bear market decline, or is this another pullback or corrective phase within the structural bull trend that started in earnest in May 2013?
Many market indexes such as S&P 500 Index, Dow Jones Industrial Average, Dow Jones Transportation Average, NYSE Composite Index, and others closed January 2021 with losses for the month. Based on the popular January Barometer and the belief the investment performance during the first month of the year can predict its performance for the rest of the year, many are concerned 2021 will be a challenging year.
Sharp and volatile declines can create fear and anxieties among investors. It can be daunting, whether one is investing or trading a market when it declines. No one wants to catch a falling knife. However, a correction or a technical pullback can also present an opportunity to purchase stocks at a discount.
A pullback is typically a retracement or a counter-trend move in an uptrend. If the dominant and prevailing trend is an uptrend, the market or stock will once again strengthen and resume its primary trend. Therefore, most pullbacks are common and are a function of an uptrend. A pullback does not change the underlying trend. They are typically an exercise in profit-taking following a strong run-up. It is normal and healthy to witness pullbacks and corrections as they alleviate overbought conditions.
With a correction, investors and traders need to be more careful as it often leads to a more extensive and more sustainable decline. Corrections are usually 10% or more and generally occur very quickly with volatility often soaring. Corrections can sometimes break the prevailing trend and violate a few shorter-term support levels. However, corrections will most likely find pivotal support again and soon recover.
So, are the market indexes undergoing technical pullbacks or corrections?
Since the primary trends for most US stock market indexes are in uptrends, the recent market actions are likely technical pullbacks or corrections rather than the start of bear declines. Nonetheless, the explosive rallies from November 2020 to January 2021 and from the March 2020 market bottoms have created overbought market conditions.
The recent consolidations will help reset market prices to levels that will prevent speculations from escalating into market bubbles. The key to any recovery is how much technical damages occurred in the downturn and at what levels the market indexes rebound. It is common to see market indexes find pivotal supports near the 50-day ma, 200-day ma, key trendlines, prior breakouts, retracements zones (38.2%, 50%, and 61.8%), reaction lows, reaction highs, etc. Strong markets will often not reach these technical support levels, rebounding sharply before these critical levels. On the other hand, weak markets will quickly fall below supports like a hot knife through butter.
Enclosed below are the near-term technical levels for market indexes such as S&P 500 Index, Dow Jones Industrial Average, and Nasdaq Composite Index.
S&P 500 Index (SPX – 3,773.86)
Support 1 = 3,694-3,711 (1/29/21 low and 50-day ma) - 4.57% from 1/27/21 high
Support 2 = 3,627.5-3,633 (12/11 & 12/21/20 lows and 38.2% retracement) -6.29%
Support 3 = 3,544-3,552 (11/19/20 low, 10/12/20 high, and 50% retracement) -8.34%
Support 4 = 3,477 (61.8% retracement) -10.18%
Support 5 = 3,428.5 (200-day ma) -11.43%
Resistance 1 = 3,784-3,797 (1/25/21 low and 2/1/21 high)
Resistance 2 = 3,837-3,848 (1/27/21 gap down)
Resistance 3 = 3,861.5-3,871 (1/21 and 1/26/21 all-time highs)
Resistance 4 = 3,898 (top of Nov 2020 channel)
Dow Jones Industrial Average (INDU – 30,211.91)
Support 1 = 29,856.30 (1/29/21 low) -4.53% from 1/21/21 high
Support 2 = 28,958-29,313 (10/12/20 high and 38.2% retracement) -7.40%
Support 3 = 28,708-28,902 (11/12/20 low and 50% retracement) -8.20%
Support 4 = 28,103 (61.8% retracement) -10.13%
Support 5 = 27,612.5 (200-day ma) -11.70%
Resistance 1 = 30,327-30,336 (2/1/21 high and 50-day ma)
Resistance 2 = 30,564-30,613 (1/15/21 and 1/25/21 lows)
Resistance 3 = 31,234-27,272 (1/14/21 and 1/21/21 all-time highs)
Resistance 4 = 31,725 (top of uptrend channel)
Nasdaq Composite Index (COMPQ – 13,403.39)
Support 1 = 12,950-12,985 (1/12, 1/15, 1/29/21 lows) -5.67% from 1/25/21 high
Support 2 = 12,751 (50-day ma) -7.12%
Support 3 = 12,525-12,619 (12/21/20 & 1/4/21 lows and 38.2% retracement) -8.77%
Support 4 = 12,215-12,276 (12/10/21 low and 50% retracement) -11.03%
Support 5 = 11,933-11,965.5 (10/12/20 high and 61.8% retracement) -13.08%
Support 6 = 11,066 (200-day ma) -19.40%
Resistance 1 = 13,538-13,603 (1/27/21 gap down)
Resistance 2 = 13,728.98 (1/25/21 all-time high)
Resistance 3 = 13,891 (top of the uptrend channel)