A funny thing about the S&P 500 is that it sometimes hits a brick wall when approaching a major resistance level, and other times plows right on through.
The most recent example of the S&P plowing through resistance occurred this past week. After setting an all-time high near 1850 back in mid-January, stocks experienced a significant pullback. Often times, such a pullback will essentially set such an all-time high in stone, so that a subsequent rally will have difficulty surpassing the previous all-time high – like hitting a brick wall.
Readers here were alerted to the possibility of the S&P encountering no such brick wall this time around. Here’s what was discussed back on February 9:
At the current stage, Stage 2, the market has only pulled back slightly, despite media portrayals of an apocalypse. As long as the S&P falls no lower than the bottom of Stage 2 (above the yellow line on the chart), there is a good argument that the S&P could soar past its recent highs of 1840 – 1850 with little or no resistance.
Little or no resistance – that’s exactly what happened as the S&P approached its old high near 1850 this past week.
- Monday, traders tried and failed.
- Tuesday and Wednesday, they tried again.
- Thursday, they succeeded and the S&P closed at 1854!
- Friday, they confirmed their success, and the S&P closed at 1859.
Three days of trying was all it took for traders to push the S&P above the 1850 level – a level which had the potential to act like a brick wall. Historically, though, brick wall development requires the market to first enter Stage 3 – the “resistance†stage. Since the market remained at Stage 2 in recent weeks, and did not dip to the level of Stage 3, brick-wall resistance was much less likely.
click on chart to enlarge
*All strategies involve at-the-money options opened 4 months (112 days) prior to this week’s expiration using an ETF that closely tracks the performance of the S&P 500, such as the SPDR S&P 500 ETF Trust (NYSEARCA:SPY)
You Are Here – Bull Market Stage 2
Recognizing whether the stock market is currently at Stage 2 requires a quick analysis of the three categories (A, B, and C) of option strategies shown in the chart above, using a plus (+) for profitable strategies and a minus (-) for unprofitable ones.
- Covered Call trading is currently profitable (A+). This week’s profit was 2.8%.
- Long Call trading is currently profitable (B+). This week’s profit was 2.2%.
- Long Straddle trading is not currently profitable (C-). This week’s loss was 0.7%.
The combination, A+ B+ C-, occurs whenever the stock market environment is at Stage 2.
Stage 2 normally represents a market that is digesting recent gains. Digestion tends to occur as stock prices move up and down within a range, but make no real progress in either direction. This is to be expected, as some traders are focused on selling stocks they bought several weeks ago at all time highs and held through the recent dip in prices because they can now get out of those stocks without a loss, while others are focused on buying stocks at a bargain prior to what they expect may be the next leg up into higher prices.
So, that’s where we are this week – at a point where the S&P has pretty much digested all of the gains of this past December and early January. Everyone who bought stocks at the January highs has now had plenty of time to unload those stocks at a profit, or at least at break-even; and everyone who was waiting for the S&P to breakout to new highs, as a signal to go long, has now had several days to load up on stocks.
