50% Retracement Level Remerging for the S&P 500

Bulls need not be worried, if history is any indicator

Senior Quantitative Analyst
Apr 5, 2023 at 8:00 AM
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The S&P 500 Index (SPX) has rallied over 15% off its October 2022 low. For the second time since then, it’s running right into it’s 50% retracement level. It was rejected by this level in February, falling around 8% before rebounding. Now, it’s time for a second go round with this level. 

The 50% retracement level marks the halfway point between the all-time high reached in January of 2022 and the low since then last October (the blue price line does not reach the red line marking the low because the red line is determined using intraday prices while the blue line shows closes). 50% retracements are popular points of interest in technical analysis. For the rest of this piece, I will try to find evidence that these levels impede a rising S&P 500. Otherwise, maybe it’s just a random line we draw sometimes.

iotw april4 chart 1

50% Retracement Levels as Resistance 

I went back to 1950 and found times that the S&P 500 fell at least 20% from an all-time high. Then I considered it a signal when the index got to within 1% of the 50% retracement level. Monday of this week, the 28th signal occurred of the S&P 500 running up into this level.

The table below shows how the index performed after these signals. The second table shows typical returns for the S&P 500 since 1956 (the year of the first high to low cycle studied). Using this method, the 50% retracement level is not an obstacle for the market. The S&P 500 has averaged a better return for each time frame after these signals compared to typical returns. One week after running up into this supposed resistance point, the index was up an average of 0.44% compared to the typical return of 0.16%, over a week. It has been positive after a signal at the same rate as usual (56%). The longer-term returns have been more impressive. Three months after a signal, the S&P 500 averaged a gain of 6.35% with 77% of the returns positive. The typical three-month return was about 2% with 65% positive. The average six-month return for the S&P 500 after running up to its 50% retracement level was 11.4% with 85% of the returns positive. The typical six-month performance is a gain of about 4% with 68% of the returns positive.

The signals are generated during a recovery after a low, so the market has upward momentum after each signal. So, maybe the bullish performance is not a surprise. Still, this indicates we need not worry about the 50% retracement level. Instead of it being looked at as an obstacle, maybe we should consider it a breakout level.

iotw April4 chart 2

I mentioned earlier that we tested this level a couple months ago in early February. This is a retest. I was curious whether there was a difference between the first test of the level and subsequent retests. The first table below shows how the S&P 500 has fared after the first test of the 50% retracement level. The second table shows returns after the retests. Nothing jumps out at me as a difference between whether it’s the first test of the level or a later test. The retests tend to have a bigger bump for the one-week return then pullback some (the two-week return is lower than the one-week return), but otherwise, stocks seem to be just as well. In short, I wouldn’t sweat the 50% retracement level just overhead.

iotw april4 chart 3

 

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