If you haven’t noticed, we’re in the midst of the second longest bull market in our nation’s history. Yep, eight years last month, and still counting. Just to give some perspective, this run is longer than the one in the Roaring Twenties, the post-World War II, and the early Reagan Presidency. This one’s beaten them all. But we’ll have to go another four years into 2021 to best the all-time record run of 1987 to 2000 and the dot-com bubble.
Even though the U.S. stock market has more than doubled the past eight years, the crash of 2008 is still planted in everyone’s memories, and the most asked question I get is when the next one is coming. Who knows? There’s nothing certain in the stock market, and no one has a crystal ball. But one of the great things about technical analysis is that with some experience you can learn to notice signs when danger lurks ahead. There is a trick of the trade that has moved me to safety before several stock market corrections. Let me teach you a simple two minute drill that can warn you a possible crash may just be on the horizon.
You will need one blank sheet of paper. On your sheet of paper draw a straight horizontal line across the middle of the page. On top of that line write the number “2,210”. From the day after the election the S&P climbed over the next two weeks up to 2,210. But there it stopped going up. In traders terms that level became resistance.
Now draw a second horizontal line about an inch above the first line, and write the number “2,275” on top of it. After meandering just below the 2,210 mark for a week or so, the S&P blew right through the 2,210 resistance level the first week of December and soared to 2,275, a new record level.
The index stopped at 2,275 and over the next month rolled around between this new 2,275 resistance level and the old resistance level of 2,210, which now acted as support in the continuing bullish trend. So now if you want to get fancy you can take a green marker (for money, which the market was giving away) and color in between the two lines. Make sure you do a good job coloring and stay within the lines, because that’s what the S&P did.
Now draw another line about a half an inch above the 2,275 line. On that line write the number “2,300”. At the end of January the S&P broke through the 2,275 level, up another 25 points to 2,300.
After setting new highs at 2,300 that last week of January, the S&P moved up and down over the next week between 2,300 and, you guessed it- right around 2,275- which acted as support.
Bullish price action.
It’s funny but the first week of February I must have received at least a half dozen emails and phones calls asking if I thought the market was about to drop. It was hard to see any signs of an impending market crash when 500 of the largest companies in the country were collectively setting new all-time highs. The S&P was marching through lines of resistance again and again, each time gently revisiting all resistance levels that acted as new support.
So go ahead and color in between the two lines with your green marker.
Now draw one last line about two inches above your 2,300 line. Why two inches? Because the next move was a doozy. On this last line write the number “2,400”. Like it was shot out of a cannon, on February 9th the S&P broke through that 2,300 resistance, and proceeded to climb 100 points higher through the month of February.
Quite a move.
March was a boring month as the S&P drifted between the 2,400 resistance and the 2,300 old resistance now support. So one last time you can color between the two lines.
Now step back and look at your drawing. Folks, a sheet of paper with horizontal lines that keep being drawn higher, and colored with green, is a good looking sheet of paper.
A stock market that continually breaks above resistance, and never breaks below support, is a bull market.
And that is where we are right now.
So how can you tell when the stock market may be headed for a crash? Simple. You will first see the S&P break its first line of support, then another, and then another. It’s when prior support becomes new resistance. That’s when you know we may be in trouble.
If, for example, during the month of April the S&P suddenly drops below the 2,300 support level I will sit up in my chair and take note. If it breaks below 2,275 I will sound some alarm bells. If it drops below 2,210 I put on my helmet. And if it falls below the 2,085 mark I will assume the crash position. It doesn’t mean we would be heading for a crash, but I would be buckled up just in case.
So you kind of see the picture, right?
The trick of the trade in spotting potential crashes is to chart basic support and resistance lines, and to recognize when those support lines are broken. Typically resistance lines are broken slowly in bull markets. Think long, slow grinds higher, like we’ve experienced since election night.
Conversely, support lines can be broken fast and furious, and offer little time for an investor to think and plan. In my 25 years I’ve witnessed three support levels taken out in less than two days.
So you tell me. What do you think the odds of an impending market meltdown?
Based on support and resistance, I believe the odds of a crash are low right now. Note I said odds. Anything can happen. Yes, we’ve been rolling around for a month, like I talked about in The Big Picture, and sure, I would like to see the 2,400 level taken out pretty soon so we can keep this party going. But until we see some kind of a bearish pulse, the odds are higher. What would make me change my mind? A piercing of that 2,300 support level would be a start.
If that 2,300 line is breeched, I will be moving to cash. If it breaks below 2,275 I will be tucked away in all cash. And if it breaks below 2,210 I will be warning that a major correction is possible. Again, understand below 2,210 doesn’t mean a crash is certain. It just means the odds will have greatly increased. And if you have lived through several major corrections like I have, you tend to want to do everything possible to avoid them.
As I write this, the S&P sits at 2,360, meandering between the 2,400 resistance and the 2,300 support. Nothing is for sure, but as long as the S&P stays above 2,300, my humble guess is the odds of an impending stock market crash are low.
And with this two minute drill, you now you have a simple, quick method of making your own educated guess.