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Rising Resistance

There is at least some evidence that someone's been using the current rally to sell.

We're talking about the concept of rising resistance, and it couldn't be clearer on the S&P 500. The S&P has been turned back four times on the same line in the daily chart, each peak higher than the previous one (see chart below). That's usually a sign of distribution, or selling. And rising resistance is very difficult to overcome, because sellers can be counted on to appear every time that line is approached. Flat-line resistance, on the other hand, is easier to overcome, because supply can eventually be exhausted at a single point.

A rising resistance line is usually a sign of something else: a bearish rising wedge or pennant, which is a rally with converging boundary lines, meaning that the rally will run out of room eventually. The S&P 500 is forming a rising wedge or bear pennant here. That pattern would break down at 1063 today.

Taken literally, a rising wedge predicts a retest of the previous lows, and often lower lows. It also means that the primary trend is still down. Don't take our word for it; that comes directly from the 1948 seminal work "Technical Analysis of Stock Trends," by Robert Edwards and John Magee. Edwards lived another 20 years and Magee another 40, and they never saw fit to change that description through several revisions.

However, that doesn't mean that the market will go down in a straight line, although it could. From May to August of last year, the Nasdaq 100 formed and broke at least three rising wedges before heading down in earnest (see chart below). A correction, say to the 38.6% Fibonacci retracement level at 1030 on the S&P 500, might be a good target before another leg up. The corresponding target on the Dow would be 8753.

The market will enter an interesting period next week, with some important cycle turns coming on October 11 and October 22. Mid-October is a potential window for a panic, per the excellent cycle work of the Princeton Economics Institute, which also called turns in August 1998 and March 2000. However, there is a chance that that window could produce panic buying, so it's a good period to be flexible in.

And one final note about yesterday's peak on the S&P (1083): in addition to being the March bottom in the S&P (old bottoms are strong resistance points), the top of a rising wedge, and a Fibonacci retracement level, it is also the average price at which money was invested in the S&P 500 since 1995. Now that they're no longer playing with the house's money, investors may begin to have less patience with the bear market. In the long run, that's probably a good thing, because an important part of capitulation is when investors begin to give up and walk away from the market.