Investors in a bear market are like children on a road trip, always asking if we're there yet. For investors, the "there" is a market bottom, not a long promised amusement park. Last week's stock market rally, which saw the Standard & Poor's 500-stock index gain 11%, spurred renewed hope that we might be there at last—at a true market bottom.
Not so fast. Technical analysts—who use charts and indicators like market breadth and trading volume to discern whether investors will be buying or selling—urge caution. The bounce has been "perfect," says independent technical analyst and author Ryan Litchfield. But it may be nearing its end.
For starters, the market was due for a breather. While mutual funds may warn that past performance doesn't predict the future, technical analysts rely on the market behavior to remain largely consistent, and that includes lengths of bounces and drops. Since January, nearly every market move—up or down—has lasted between four and six days. Part of this is human psychology. After four up days in a row, says Litchfield, "traders get nervous. They don't want to be the last one at the party."
Support and Resistance
But the market also had some help. At first glance, the S&P 500 didn't do much on Mar. 16, when it dropped 2.7 points, or 0.35%. But for technical analysts, the intraday trading was interesting for what didn't happen: namely, the big-cap benchmark didn't trade above 780.
What's so important about 780? Technicians look for a level of support, or a "bottom"—a price that a falling stock does not trade below. They also identify a level of resistance, or a "top"—a price that rising shares won't trade above. And they look for recurrences of these levels.
Just before the 22% drop in February, the market tried five times to close above 780, but each time it fell back. Twice on Mar. 16, traders pushed the S&P 500 as high as 775. Each time the market fell back, the last time dropping 21 points to close at 753. For the market to go higher, it will have to break 780. "That's the technical line in the sand," says Barry Ritholtz, CEO and director of equity research at FusionIQ and a widely followed blogger.
Looking at Trendlines
But if 780 is a line in the sand for the S&P 500, 805 might be a brick wall. If the market does manage to nudge higher, many investors burned in the recent downturn will use rebounding stock prices as a selling opportunity.
Technical analysts draw straight lines between market tops to create what is known as a trendline, and for the current portion of a bear to end, the market will have to break above that 805 line. Not many technicians expect it to—at least not yet. Mark Arbeter, a technical analyst at Standard & Poor's, sees the S&P 500 breaking 780—but, he wrote in a Mar. 13 report, he expects the index to hit a wall of resistance at 805 and retest the February market lows at 677.
Ritholtz, too, isn't getting too optimistic. "Right now, this is just a bounce, a bear-market rally," he says. This market is guilty until proven innocent."
Levisohn is a staff editor at BusinessWeek covering finance and personal finance.