Pullback to first line of support is where investors should take new positions

The big breakout from a stubborn resistance zone on the S&P 500 affirmed the bull market. But breaks following large percentage runs often use such a high level of energy that the advance falters and profit-takers drive prices back down.

In yesterday’s Daily Market Outlook, we examined the question of how high the S&P 500 can go following such a massive break. Today, we will consider the question of how low it might decline before the breakout is voided.

Many double-top (reverse head-and-shoulders) breakouts retrace their advance and fall back, or “correct,” to the breakout line. If this occurs, then the S&P 500′s first line of support is the former resistance line at 1,344 to 1,340. This is the area where sellers gave up and buyers overwhelmed them. But since not all of the buyers got in, this line gives those who missed the initial move up a second chance to get into stocks that they missed earlier.

The bullish support line, which is now at about 1,285, is the line of final support and, thus, the most important feature on the chart. A penetration of the major support line and the low of March at around 1,250 would negate the breakout. The bullish support line and the prior resistance line form a “support zone,” which currently extends from 1,285 to 1,340. And in the middle of the zone is the 50-day moving average, now at 1,318 (blue line), which often holds back potential sellers.

I’ve also included the Moving Average Convergen! ce/Diver gence (MACD) oscillator, which is telling us that the market is somewhat “overbought” but has not rendered a sell signal. It is an internal alert mechanism that says “be careful, stocks at current prices are somewhat expensive and subject to profit-taking.” The MACD would issue an outright sell signal if the red line crossed down through the blue line.

Conclusion: All current chart features are telling us that prices will head higher but that there is some near-term exhaustion. This could bring about a quick correction to the first line of support where we should take new positions.

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