Weekly ETF SPY: SPY ETF vs S&P 500 – Technical Analysis Variations

The S&P 500 Index triggered a beautiful ‘kiss good bye’ signal on Tuesday, before Bernanke spoke and sunk stocks. Interestingly, the sell signal for the S&P 500 could not be seen in the chart of the SPDR S&P 500 ETF (SPY).

SPY S&P 500 ETF or S&P 500 Index. What’s the difference? It’s like tomato or tomato (imagine the second ‘tomato’ spoken with a British accent).

I always try to base my analysis on the purest representation of any given index or asset class. When it comes to the S&P 500, the purest representation is the actual S&P 500 Index you always see quoted.

The SPDR S&P 500 ETF (SPY) tracks the S&P 500 very closely, but even minor variations can make a major difference.

For example: The June 18 Profit Radar Report (released the night before Bernanke opened his mouth and buried the market) noted that the S&P 500 is at an important inflection point and warned:

There is a parallel channel going back to the October 2011 low. Indexes often touch a previously broken support (in this case the black October 2011 parallel channel at 1,655) before dropping to a new low. The S&P touched this channel today and failure to move above could spell trouble.

The first chart below shows the S&P 500 parallel channel referred to in the Profit Radar Report (if you aren’t a subscriber, I tweeted a close up picture of this channel on Tuesday).

I have often observed the S&P 500 (and other indexes) double back a broken support before letting go and peeling away for good. This upper line of the parallel channel was a key ingredient to the bearish forecast (the recommendation of the Profit Radar Report was to go short at S&P 1,635 and Nasdaq-100 2,970). I call it the ‘kiss good bye.’

Drawn in the second chart is the exact same parallel channel for the SPDR S&P 500 ETF (SPY). However, unlike the S&P 500 Index, SPY’s channel is placed differently. There was no kiss good bye for the SPY ETF.

Key support (red line) was broken for both, when prices dropped below the June 6 low (160.25 for SPY and 1,598.23 for the S&P 500).

The SPY chart allows us to draw a support trend line (green line) that’s unique to SPY. I wouldn’t say there is a clear winner in the SPY vs S&P 500 debate, but I prefer to base my S&P 500 technical analysis on the S&P 500 chart. It’s as pure as it gets.

Why further down side is still ahead, what the down side is, and why stocks will rally again when this is all over is discussed in Thursday’s special Profit Radar Report.

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S&P 500 – Technical Analysis Shows the Trend

Markets are inherently unpredictable, but technical analysis is the most accurate forecasting tool available to investors. Since technical analysis is based on past price action, it is quite simple to confirm (or expose) when and where technical analysis has been right or wrong.

Some define technical analysis as mumbo jumbo, others (and that’s the official definition) see it as a method of forecasting prices based on past market activity.

Isn’t using past market activity (or prices) to forecast future prices like driving by looking in the rearview mirror? That’s a great question.

The Past Matters

Why does the past matter? Allow me to use a tennis analogy. Roger Federer (possibly the best ever all-around tennis player) has never won a clay court match against Rafael Nadal (possibly the best ever clay court tennis player) at the French Open Tournament (one of the big four Grand Slam tournaments).

Who do you think has a mental advantage the next time Federer and Nadal meet at the French Open? Federer knows he’s never beaten Nadal at the French Open, Nadal knows he’s never lost to Federer at the French Open.

Federer has to overcome a mental ‘resistance’ to beat Nadal at the French Open. I use the term mental ‘resistance’ because it relates to resistance (and/or support) seen in the securities market.

Charts of specific securities, such as the S&P 500, reflect the mental state of the composite of all investors. Charts reveal past price areas where either sellers or buyers prevailed, creating areas of support or resistance.

Being unaware of previously established support/resistance levels is like climbing a ladder without knowing which steps are broken.

Past Significance of Support/Resistance Levels

The proof is in the pudding, so let’s take a look at a 14-year chart of the S&P 500 Index (corresponding ETF: SPDR S&P 500 ETF – SPY).

The chart includes four long-term support/resistance levels made up of two trend lines (red lines) and two parallel channels (black and dashed lines).

The trend channels are created by connecting the 2002 and 2009 lows with the 2000 high (dashed black line) and 2007 high (solid black line). Since the last touch point of this channel is the 2009 low, it could be used as a guide only thereafter.

2000 High Parallel Channel

In May 2011, the S&P approached the upper dashed parallel channel resistance (gray circle). I remember that time vividly as my wife and I were vacationing on a little island in the Bahamas (for some reason the market usually sells off when I’m on vacation).

My May 1, 2011 update for subscribers featured the chart below and stated: “The chart below updates the S&P’s position relative to various resistance levels and the ideal target range for a potentially historic market top. The ideal target range is between 1,369 and 1,382.

The next day (May 2, 2011) the S&P briefly spiked as high as 1,370.58  (right into the 1,369 – 1,382 target range) on news that Osama Bin Laden had been killed. The stock market euphoria was short-lived, as the S&P sold off, fell below trend line support (pink line) and ultimately plunged as much as 20%.

The S&P 500 paid attention to this parallel channel once more in November 2011, when it was used as a springboard for the most powerful leg of the post-2009 QE bull market.

2007 High Parallel Channel

In January 2013 the S&P 500 approached the ‘big brother version’ of the same parallel channel (this time the upper line was created by the 2007 not the 2000 high – gray circle).

The parallel channel resistance coincided with trend line resistance (red line). This was powerful resistance and I thought stocks would pause and temporarily reverse there … but they didn’t.

With that resistance out of the way, it was clear that the S&P wanted to test its all-time high and the next trend line resistance (red line) around 1,593.

It barely shows on the weekly bar chart, but the S&P was actually repelled by trend line resistance at 1,593 in April (subscribers of the Profit Radar Report went short at 1,593 and closed out short positions at 1,540).

This (temporary) decline from 1,593 to 1,536 left several open chart gaps (one at 1,588), that’s why we expected a deep retracement. That deep retracement however, turned into a rally to even higher highs.

With the S&P above the last trend line resistance and with no other overhead resistance levels caused by prior support/resistance levels left (the S&P carries no more ‘inherited technical burdens’), there is nothing holding stocks back.

That doesn’t mean stocks can’t and won’t decline, but as long as prices remain above trend line support, the larger trend is simply up.

Unlike the S&P 500 and Dow Jones (which are trading at all-time highs), the Nasdaq-100 still trades well below its heyday highs of the year 2000. This means there are more well-defined support and resistance levels available.

Those support/resistance levels are powerful risk management tools and can be used to find low-risk entries and high probability trade set ups.

At the time of this article’s publication, the Profit Radar Report is long the Nasdaq-100 with a stop-loss just beneath an important long-term support.

The Profit Radar Report reveals key support/resistance levels along with low-risk and/or high probability trade set ups.

Confession Time: The S&P 500 Went Higher Than I Thought

A smart person learns from his mistakes, but a truly wise person learns from the mistakes of others. There is no such thing as a truly wise investor, but learning from my mistake may make you smarter.

We all have our fears and we all need to face them eventually. My fear as a stock market analyst and forecaster is being wrong.

Unfortunately, that happens more often than I’d like it to be. Still, I just can’t get used to that feeling. Every time the market outsmarts me, I analyze what happened.

This analysis benefits me – as I try to reduce the amount of future ‘wrongs’ and increase the amount of ‘rights’ – and I thought it might benefit you. So here’s my latest slip up along with the ‘post game’ analysis.

In short, the S&P 500 pushed higher than I expected. I thought the S&P would reverse lower around 1,492. Here’s why:

What Went Wrong

In late January triple resistance converged at 1,492. The chart below shows two of the three resistance levels (the third was a 70-day trend channel, not shown because it doesn’t display well on the monthly chart).

The red trend line connects the 2002 low and 2011 high. The gray line is a parallel channel that connects the 2002 and 2009 low with the 2007 high. One resistance line is often enough to stop an advance, but triple resistance is pretty solid (at least so I thought).

Additionally, I ‘had faith’ in the repelling ability of the 10+ year parallel channel, because a very similar channel (dashed gray line: 2002 and 2009 low connected with the 2000 high) repelled the S&P in 2011 and caused a 20% decline.

But nothing trumps price action, and regardless of the rhetoric, the S&P went higher.

What Went Right

Prior to viewing resistance around 1,490 as a reversal point, I considered it a target. In the January 2 Profit Radar Report I wrote that: “Around 1,490 is now key resistance and the most likely target for this advance.”

This was consistent with prior comments, made at a time when Wall Street, the media, and investors were bearish (partially because of the fiscal cliff).

From the September 30, 2011 Profit Radar Report:

“The September 14 recovery highs for the S&P, Dow, Russell 2000, and XLF were all accompanied by new RSI highs. It would be rare for stocks to form a long-term peak without a bearish price/RSI divergence. Because of this lack of divergence we expect new recovery highs.”

This was reiterated on December 2: “The decline from September 14 – November 16 was a correction on the S&P’s journey to new recovery highs. This scenario is supported by the lack of bearish price/RSI divergences at the September 14 high, continuous QE liquidity, and bullish seasonality. There is no specific target, but any new recovery high marked by a bearish price/RSI divergence could mark the end of this rally.”

The move above 1,492 unlocked my ‘alternate’ target range of 1,515 – 1,530. The S&P has stalled here, in fact five daily doji candles last week reflect indecision. But indecision doesn’t have to be bearish. It will take a break below nearby support to unlock the potential for a somewhat deeper correction.

What’s the key lesson? An up market, especially in a QE world, should get the benefit of the doubt until momentum is broken. Instead of using technical analysis to pinpoint a reversal range, I should have followed the trend and focused on support levels, that – once broken – confirm a turn around.

The meaning of the recent string of doji candlesticks along with a comprehensive 2013 forecast is available via the Profit Strategy Newsletter.