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March To The 50% Retracement Continues

I thought it would be instructive to see what condition the bear market is in, so I brought out a chart with Fibonacci retracement levels that we haven’t examined here in a while. We continue to push higher toward the 50% retracement level of the entire bear market, at 1119. Today, we ended at 1109, so this key psychological level is less than 1% away.

sp-500-bear

In past posts, I’ve noted how the key retracement levels of 38.2%, 50%, and 61.8% represent psychological points for the market in its battle to regain ground it lost during the bear market. What we see now is that we’ve battled back strongly from the March 9th low. The Fed liquidity has raised the market to its current level, but we will probably have a bit of a struggle to get through 1119.

Why is that? To understand retracements better, I thought I’d cut/paste from Investopedia their discussion:

Fibonacci retracement is a very popular tool among technical traders and is based on the key numbers identified by mathematician Leonardo Fibonacci in the thirteenth century. However, Fibonacci’s sequence of numbers is not as important as the mathematical relationships, expressed as ratios, between the numbers in the series. In technical analysis, Fibonacci retracement is created by taking two extreme points (usually a major peak and trough) on a stock chart and dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%. Once these levels are identified, horizontal lines are drawn and used to identify possible support and resistance levels. Before we can understand why these ratios were chosen, we need to have a better understanding of the Fibonacci number series. (For a more in-depth discussion of this subject, see Fibonacci And The Golden Ratio.)

The Fibonacci sequence of numbers is as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc. Each term in this sequence is simply the sum of the two preceding terms and sequence continues infinitely. One of the remarkable characteristics of this numerical sequence is that each number is approximately 1.618 times greater than the preceding number. This common relationship between every number in the series is the foundation of the common ratios used in retracement studies.

The key Fibonacci ratio of 61.8% – also referred to as “the golden ratio” or “the golden mean” – is found by dividing one number in the series by the number that follows it. For example: 8/13 = 0.6153, and 55/89 = 0.6179.

The 38.2% ratio is found by dividing one number in the series by the number that is found two places to the right. For example: 55/144 = 0.3819.

The 23.6% ratio is found by dividing one number in the series by the number that is three places to the right. For example: 8/34 = 0.2352.

For reasons that are unclear, these ratios seem to play an important role in the stock market, just as they do in nature, and can be used to determine critical points that cause an asset’s price to reverse. The direction of the prior trend is likely to continue once the price of the asset has retraced to one of the ratios listed above.

I try to explain to people that it is really just a psychological phenomenon. Investors see the gains they’ve made from the lows and lock them in. It is coincidental that people tend to act in concert near these key levels, but it happens enough that it is statistically significant and requires us to monitor it.

We have had great earnings so far this reporting season, and they have pushed the market higher by increasing enthusiasm. However, the volume has been below the moving average which tells me that there are people waiting for any excuse to raise some cash. The 50% retracement level is as good of a reason as any.

I still think we will rally into year-end, so ultimately I think we will break through the resistance. But we might just see a buying opportunity for anyone that is sitting on cash as the market bounces off the resistance before pushing through it.

Anyway, its worth watching (as is the above video of the First Edition with a pre-Islands In The Stream Kenny Rogers on lead vocals – yes, there was life before The Gambler).

Mark