Option Investor
Index Wrap

Pullback and Bounce

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This week brought the markets to new 52 week highs, followed a by a sharp pullback and a bounce. While bulls and bears trade their convincing arguments, the stage is set for a resolution in the coming week.

Daily COMPX candles

The Nasdaq daily chart shows a failure of the lower trendline within a steep bearish ascending wedge, followed by the attempt to regain the lower trendline since Wednesday's break. Friday saw the Nasdaq eke out a 9 point gain after setting the day low shortly after the open, with moderate volume of 1.7B shares. The bear wedge trendline remains intact, but note that one could interpret the pattern of higher lows since Wednesday as respecting a secondary (undrawn) lower rising trendline. The oscillators are rolling over from overbought, but if the bounce from Wednesday regains the trendline, those sell signals could reverse.

One the 30 minute chart, I've used the secondary trendline to illustrate support. In fact, that lower trendline is exactly parallel to the upper rising trendline, forming a bear wedge. Herein lies the debate between bulls and bears: support has either been broken or not, depending on how its interpreted. In any event, a move below 1825 or above the rally highs above 1880 will clarify the picture. If this bounce fails from a lower high, bears will jump on and bulls will protect profits. There's a bullish divergence on the 30 minute chart oscillators, with their steeply higher lows established Friday morning. All eyes remain on the outcome of the bounce now in progress.

30 minute 20 day chart of the COMPX

Daily INDU candles

The Dow is set up similarly to the COMPX, with Friday's volume moderate at 1.5B shares. The bounce from Friday morning's lows launched from a low below Thursday's low, unlike on the stronger Nasdaq. The bullish divergence on the 30 minute chart oscillators below lends credence to the bullish descending wedge projecting to just below the rally highs. Note that the bear wedge never fulfilled its downside target below 9240, and the higher low thus established is certainly not bearish. With the daily chart oscillators toppy and the 30 minute chart oscillators bouncing, the stage is set for more upside on Monday morning. If the bounce takes out 9600, bears will have a problem. In order to do so, however, 9500 will have to fail first, no small task for the bulls.

20 day 30 minute chart of the INDU

Daily OEX candles

The OEX did not break down to the same extent as the Nasdaq on this week's pullback, and remains clearly above trendline support on the daily chart. There has been no sell signal printed on the daily chart oscillators, and the decline on the 30 minute chart from the rally highs has been far more gradual than for either the COMPX or the INDU. This relative strength in the OEX reflects bullishly on the broader market, but the lower Friday low complicates the otherwise rosy picture.

Traders found this week to be tricky in the extreme, and no wonder, given the opposing cyclicality on the daily and 30 minute chart oscillators. On Friday morning, the 30 minute and daily chart oscillators appeared to be lining up for a sharp drop, but the save at OEX 507 put in an unexpected reversal on the 30 minute chart oscillators. Whether the bull wedge projecting back to 518 plays out next week will determine whether we're in for bearish autumn or not.

20 day 30 minute chart of the OEX

Daily QQQ candles

The opposing cyclicality is clearest on the Qube chart, in which the daily chart is covered with bear tracks, including a bear wedge breakdown and clear oscillator sell signals, while we have a double bottom and buy signals on the 30 minute chart. Traders need to trade their timeframe and stick to it, but the safer approach is simply to watch for the results of the inevitable trendline tests from current levels. If we've learned anything during the past two weeks, it is that trading in chop is a stop- runner's paradise, and a veritable gauntlet for traders seeking viable entries.

20 day 30 minute chart of the QQQ

The new highs seen this week gave traders a reference point from which to base their analysis. Bears will not want to be shot above the 52 week high, and will continue to attempt to pile onto each resistance level below it. The vertical launches off the Friday lows felt like short covering/stop running frenzies above those resistance levels, and lined up well with our intraday Fibonacci levels discussed in the Market and Futures Monitors. In theory, the markets could lurch all the way up to the rally highs fueled by such moves, an enviable goal for bulls. The short covering at the top could act as jet fuel to higher highs. However, if they fail to do so, bears will begin to press and bulls will fret. This is the setup for next week. See you at the bell!

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