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Index Wrap

Bear Tracks

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Unlike a doji day, which features an abrupt 180-degree change in price and mood, a doji week accomplishes the same end but over a span of 5 days. What looked like a very bullish market on Wednesday morning looked just as bearish on Friday afternoon, coinciding with a doji top printed on the weekly candle chart.

Weekly COMPX candles

The heavier volume this week was on the sell side for both the Nasdaq and the Dow. The week began quite bullishly, and although it's just a speck on this three year weekly chart of the Nasdaq, we see this week having made a new high of the year, pushing against the upper 20-week Bollinger band and pinning the weekly chart oscillators in overbought territory. The 10 week stochastic had been printing a negative divergence, but Wednesday's spike high, subsequently reversed on Thursday and Friday, began the process of reversing that negative oscillator slope.

Nevertheless, the weekly oscillators are overbought and waiting to begin their downphases. The Nasdaq's 37.78 point, 1.9% drop on Friday, following Wednesday afternoon's and Thursday's weakness may have provided the push.

Daily COMPX candles

The daily COMPX candles show the index pinned to the upper resistance trendline of a large bear wedge covering the duration of the rally off the March lows. The selling that commenced Wednesday and accelerated on Friday was sufficient to end the oscillator upphase that has carried this leg of the rally. As we've been discussing in the nightly Futures Wraps, this cycle upphase had been dominating the 30 minute chart cycle, as those oscillators had been consistently aborting their downphases during the past two weeks. With this oscillator now rolling over, uncertainty should resolve itself to the downside.

Weekly INDU candles

Impressive weakness in a number of Dow components this week prevented the Wednesday spike from tilting the 10 week stochastic to the same extent as it did on the COMPX. We see upper wedge trendline resistance touched but not broken this week, and while the apex of the wedge could be at higher prices, the oscillators on this long timeframe are signaling a significant challenge for bull to take it there from here. A bear wedge breakdown below the 9400 level targets a possible retest of the March lows, 2000 points below.

Daily INDU candles

The weekly oscillators are topped out and sport a bearish divergence. The daily chart oscillators appear to have topped on Wednesday, but longer timeframes take longer to complete and confirm the top. With trend-following oscillators, key reversal points are always confirmed in the rearview mirror, and we're forced to intuit the moment at which such occurs. Most often, the end of a cycle will see a blowoff move in the direction of that cycle, and while Wednesday's top lacked the intensity and drama that I expected, the change in mood from Monday to Friday was impressive. Next week will tell the tale.

Daily OEX candles

Moving down to our primary trading vehicles, we see the same downphase setting up on the daily OEX chart. Resistance at 525 will be the maginot line, and while the rolling longer term oscillators and unbroken upper resistance lines suggest that the rally highs have been seen, the topping process may not be over. A move to 525 would not over disturb the daily oscillators, and as can be partially seen in the 30 minute chart below, all of the intraday oscillators were oversold and beginning upphases heading into Friday's close.

The broken trendline will provide strong resistance at 522, and the 520 confluence / Fibonacci line will give bulls a struggle. Note that the 300 minute stoch on the 30 minute chart has not been this oversold in more than two weeks, since before this leg of the rally began. For these reasons, a possibly meaningful bounce cannot be ruled out.

The difference between now and then is that the daily oscillator had not topped three weeks ago but it has now, which implies that another stage to significantly higher highs in unlikely. Furthermore, while the 300 minute and 10 day stochastics are now opposed, the shorter the cycle, the more susceptible it is of trending. I'd expect some kind of bounce on Monday to a lower high, followed by a renewed plunge to lower lows. The weakness in bellwethers, notable GE and more recently, IBM, combined with the sustained sub-20 VXO readings this week has me far from thinking bullish thoughts for next week.

20 day 30 minute chart of the OEX

Daily QQQ candles

The Qubes look every bit as weak as the OEX, and what is the beginning of a bounce on the 300 minute stochastic for the OEX is a weak twitch on that of QQQ (below). The stage looks set as of Friday's close for further decline on Monday morning, but a weaker bounce, possibly starting from 34.50 support would be easiest to imagine. 35.70 should no be exceeded to the upside, and below 34.50, 33.30 is the next downside target.

20 day 30 minute chart of the QQQ

For next week, there's the additional uncertainty of the unwinding of October option positions, which should skew Monday morning's trading.

Given how extreme the sentiment, volatility, breadth and even price-based indicators have become, it's almost irresistible to read the above charts with a bearish bias, as I have done. The cycle configuration has not been this well aligned for a sustained downside move in a long time. The Fed drained 5B via expiring repos on Friday, most likely to support the struggling dollar but in any event displaying a willingness to let the markets sink or swim on their own, and rates have been rising. These factors as well support a bearish bias.

If the 2003 rally has taught traders anything, it is to not get married to a point of view. Good traders can change perspective jion a dime, just as the market can do. While I believe that the conditions are ripe for a washout, I won't hesitate to change my stance should prices reverse strongly. Caution and capital preservation remain key, but as we've been urging for days now, bulls need to keep those stops active and snugged up (if they didn't trigger on Friday). See you at the bell!

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