Technical Analysis: What A Trend Change Really Means

| October 22, 2012 | 0 Comments

momentumThe S&P 500 had a great run this summer.

Over a three month period from June 4th to September 15th, the large cap index shot up 16%.  During that time, the S&P set a series of higher highs and higher lows.  And it established a strong uptrend.

But what a difference a few weeks can make…

As the third quarter earnings season got underway a few weeks ago, the S&P continued to move higher in its established uptrend. 

But it failed to make a new high on October 5th.  Then the index quickly reversed lower and broke through support of the uptrend.  For all intents and purposes, the three month long uptrend in the S&P 500 was over.

Here’s where it gets interesting…

As soon as the uptrend ended, investor sentiment took a turn for the worse.  In fact, for the first time in weeks, more traders are bearish than bullish on stocks.

But here’s the thing that most traders get wrong… 

The end of an uptrend doesn’t indicate the beginning a new downtrend.  The trend change merely tells us the previous trend has come to an end.

As you can see in the chart below, the S&P hasn’t begun a new downtrend.  It has merely entered into a trading range with 1,425 as support and 1,460 as resistance.

S&P 500 Large Cap Index Chart

Put simply, the bearish turn in investor sentiment doesn’t match the price action were seeing in the S&P 500.

Keep in mind, the S&P is just as likely to enter into a new uptrend as it is a downtrend. 

At this point, any new trades should be made with the expectation that the S&P will remain in this trading range.  Or better yet, wait for the confirmation of a new trend before placing new trades. 

How will you know when a new trend has been established?

The deciding factor in which way the S&P moves next lies with the support and resistance levels. 

If the S&P falls through support at 1,425, it would indicate the beginning of a new downtrend.  However, if the S&P rallies and breaks through resistance at 1,460, it indicates the beginning of a new uptrend.

Once the S&P breaks out of its trading range is the time to place your trades on the emergence of a new uptrend or downtrend… but not before!

Placing trades before a new trend has been established is a recipe for disaster.  And it’s one that can easily be avoided now that you know what to look for.

Good Investing,

Corey Williams

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Category: Technical Analysis

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.