Updated: Nov 25, 2020
Technical analysis investment discipline is all about price, breadth, and sentiment.
Price is typically the final judge and jury. The long-term trend is more important than the medium-term trend, and the medium-term trend overrides the short-term trend. A price breakout or breakdown can also offer insights into the validity of new highs or new lows.
Although there continues to be macro, geopolitical, economic headwinds, the S&P 500 Index (SPX) has been resilient as a well-defined trading range has developed between 3,200 (support) and 3,600 (resistance). The trading range resembles either a double bottom (W pattern) or a triple top (M pattern). The former is a potentially bullish market condition, and the latter is a potentially bearish market setup. The outcome will help to decide the next directional trend of SPX into the end of the year and possibly into early-2021. Above 3,588 suggests the next SPX move will be a 388-point rally to 3,976. On the other hand, below 3,200 warns of SPX decline toward 2,812.
Breadth means participation. The advancing issues minus declining issues indicator (A/D) is a popular measure of market breadth. Breadth analysis is a way to determine whether the rally or decline is broad-based or narrow-based. When the market trades to new highs, a narrowed advance (weak A/D trend) suggests relatively few names are lifting the trend higher. Conversely, a broadening or expanding breadth (strong A/D trend) equals many names are participating in the rally. A healthy bull market and hence a sustainable long-term uptrend often requires a lot of stocks achieving new breadth highs as SPX also records new all-time price highs.
Since SPX remains in a trading range as represented by the recent 2-plus month consolidation. The backing and filling process appears to be reaching yet another critical phase. It will be interesting if the market pushes higher into year-end on expanding or contracting market breadth. A breakout above the top of the uptrend channel in the Advancing-Declining issues trend line would greatly help support the basis for an SPX price breakout. On another note, the new 52-weeks high indicator has rallied sharply to a high of 147 (11/9/20) but has suddenly reversed direction to a recent reading of 7. It would be decisively bullish if the two breadth indicators (A/D line and New 52-week highs) confirmed technical breakouts when SPX records new all-time price highs (above 3,600).
Market sentiment is also called investor sentiment. Sentiment analysis is used primarily to determine the attitude of market participants (retail, professional, smart money, informed, and uninformed investors). Generally, sentiment indicators can be interpreted in two ways – bullish or bearish. Sentiment indicators are contrarian by nature. That is when investors are extremely bullish it implies a market may be nearing a peak, and a reversal is forthcoming. On the other hand, when investors are extremely bearish this is interpreted as everyone has sold positions and the market may be reaching a bottom. Numerous market sentiment indicators are used to track investment behavior. Among the widely used sentiment indicators are AAII bull/bear surveys, Put/Call Ratio, and VIX implied volatility.
AAII Bullish sentiments have been rising over the past few weeks. It is now nearing 38% or levels from Mar 2020. However, the AAII Bearish sentiments have steadily declined in recent weeks. Currently trading at 31.5% the trend suggests a continued drop possibly toward the Mar 2020 levels (the high 20s). From a contrarian perspective, the interpretation is neutral. CBOE Put/Call Ratio (1.02) is approaching the top of its 6-month trading range indicating increasing pessimism as traders/investors are purchasing puts to hedge SPX. A peak near 1.02 hints of a contrarian technical buy signal. VIX Index or the SPX implied volatility continues to trend lower. The fear indicator currently trading at 23.45 can decline further possibly toward the low-20s, and even to the high-teens to retest the bottom of its 6-month downtrend channel. A declining VIX trend is favorable for higher SPX prices. However, the ability of VIX to maintain above the low-20s may also signal higher volatility prompting the next SPX price correction.
Attached is the daily chart of the SPX Index and the associated technical indicators.