Potential for a Bear Market

by Guy Lerner

I write a lot about key pivot points, which I have defined as the most important areas of buying (support) and selling (resistance). How I derived these unique points is proprietary, but if you have been following me enough, you should realize that they are an effective technical tool to understanding the price action. Last week’s price action in the SP500 was rather significant not only because of the losses but because prices closed below key pivot points. A close below support defines a down trend, and old support becomes new resistance. In addition and as the data will show, closes below key pivot points can lead to fairly significant losses.

Figure 1 is a weekly chart of the SP500 with key pivot points noted by the red dots. Last week’s price action saw a weekly closely below a prior key pivot point (see gray oval on chart). Since 1991, there have been 41 key pivot points in the SP500, and there have been 17 times when price closed below a prior key pivot point. Obviously, not all closes below a prior key pivot are ominous as can be seen by the price action from August, 2010. It was looking bad for equities, but then Helicopter Ben saved the day with QE2. Of course, this fake out led to a significant bull run.

Figure 1. SP500/ weekly

But back to my point and my concern. Of the 17 closes below prior key pivots, there have been 7 times when the market (i.e., SP500) kept going lower by 10% or more. 4 out of 7 lost more than 15% from the close below a prior key pivot point to the next bottom.

Of course, there have been 10 times when a close below a prior key pivot point was either a fake out (August, 2010) or led to only mild losses (before prices bottomed and reversed). So how will I know which scenario we are dealing with? If prices close back above resistance (old support) levels, then the trend will have gone from down to up and this whole past week was one gigantic fake out.

From this perspective, there is no reason to get long equities until this level (i.e., the new resistance or old support) is breached to the upside or sentiment turns more extreme. It is not worth the risk. This isn’t the time to hope. This is the time to take some action to protect yourself and your money.

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