For the first time in many weeks, the S&P500 failed to rise. Sure it moved up a tiny bit—0.05%—but for all intents and purposes this was a zero gain week. Volatility didn’t change much: the VIX index ended the week roughly where it started, in the mid teens. And trading volume was light.
So what happened to the S&P last week? As mentioned here many times over the last month, the S&P500 finally ran into overhead resistance, coming from the 200 day moving average which acted as a ceiling on the index, helping to keep the index from rising beyond the ceiling. Many traders and investors look at the 200 day moving average as a signal of the general direction of the stock markets. When the 200 day is rising and prices are generally above it, then traders treat the stock market as a bull market and buy more stocks whenever prices dip close to the 200 day, because they know that the 200 day will provide support—making further price drops more difficult to stick, and making the likelihood of bounces up from the 200 day greater. On the other hand, when the stock market prices finally crash below the 200 day moving average….and stay there (as they have since October 2018)….then these same traders will treat the stock market as a bear market and sell stocks whenever prices rise up to (from beneath) the 200 day moving average, because the know that the 200 day will provide overhead resistance.
This is precisely what happened last week in the S&P500. Not only did the S&P touch the 200 day moving average from underneath, it promptly started dropping after touching it. And this is what traders would expect—as we’ve discussed over the last month here—to happen. And the fact that it actually did happen will strengthen the conviction of traders who use technical analysis to trade the stock markets.
The next test is clear—the S&P500 must continue to sell off from beneath the 200 day moving average. If this happens in the next week or so, then many more traders will jump embrace the bear market hypothesis, and this will act to reinforce the sell off.