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Index Wrap


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Formation of tops are always different enough to keep you wondering whether to buy puts as the market hangs up there in the air, like a ball at the top of its arc before its falls to earth. Gravity rules, eventually. Yet in many other ways, tops are often the same in terms of key technical elements at least.

It looked to me even 2 weeks back, as I wrote, that the market was going to move UP into the expiration and to look for a top after that. Tip of the Hat to the Subscriber who wrote me that: "I have noticed big volume spikes on S&P ITM (In The Money) Put options before or right at market reversals in the past". I wrote that the next best new trade, from a risk to reward basis, was going to be in puts.

This most recent market peak had these general characteristics that are similar to many other top patterns:

1.) Only one market index takes a "solitary walk" higher.
In past markets, this could have been the Dow 30 (INDU); or, the tech heavy Nas 100 (NDX) or the Nasdaq Composite (COMP). In this most recent instance it was the S&P 500 (SPX), as institutional money managers decided that the 'old economy' cyclicals were undervalued and bid up a broad array of stocks.

2.) A related concept is that a key 'bellwether' stock or index fails to 'confirm' the most recent high or starts to break down BEFORE the market does. The related index was the Dow Transportation Index (TRAN), which was not following the Dow Industrials (INDU) higher in this last move.

GE, a key S&P bellwether fell under its key support at 36.5, which was the top of its long-standing (Jan to early-Mch) trading range. While a push to a new OEX high at mid-month was occurring, GE was falling.

Moreover, GE's OBV (On Balance Volume) line was falling while the stock was still going sideways, indicating 'distribution' (selling by holders) of the stock. While this all was tied to negative perceptions re a GE restructuring, it was nevertheless also likely that the S&P had negatives ahead also.

See my Trader's Corner article on the subject of 'bellwethers' (and a bit on 'OBV') by clicking here.

3.) The retracement of the last major decline was either around half of that decline or, if a 50% retracement was exceeded, around 62-66%(2/3rds); BUT the rally stalls there. The 66% retracement is also shown on the first chart above (of INDU).

Of the major indices, only the SPX retraced more than 2/3rds of its 7-week March to April decline, retracing more like 90% and this was the 'fake-out' move; the one that made this recent top more tricky to see. However, it also fits with the "solitary walk" concept of #1.

On a closing basis, the OEX, INDU and the Nasdaq Composite, with the exception of one OEX close on the first move up to the top area, did not exceed by more than a fraction, the 66% retracement that is often the MAXIMUM move up before a reversal. [You may recall that the April market low was a 2/3rds retracement of the April '04 - early Jan. '05 advance.] NDX did overshoot a 66% retracement by a bit more, at least for two closes in a row.

Ask yourself about a rally, or a decline: how much has this rally (or decline) retraced of the prior move? Did I make a lot of this retracement business in my last Index Trader column? Some, but not enough to suggest specific puts plays. The fact that enough NYSE stocks kept advancing caused me to wonder whether there might not be one more shot up to an SPX double top. But, that's the thing: tops are never EXACTLY the same.

4.) The market gets to an overbought extreme as measured by the RSI indicator; a 13-day setting ('length' set to 13).

5.) Bullish 'sentiment' gets to an extreme. It's as if traders could only see one side of the possible influences in the market, forgetting possible bearish influences; e.g., focusing only on the Fed being possibly at the end of its tightening and not on a slowing economy due to higher rates or skyrocketing energy costs. The same is true at bottoms: trader 'sentiment' gets too bearish; forgotten is that trends reverse when prices get cheap enough.

6.) At least one, or more, key index finds selling pressure, and a lack of enough buying to overcome it, at a prior high or prior "breakdown" point. The Nasdaq Composite (COMP) hit resistance in the same area, around 2100, at the cluster of prior highs made back in Jan./early-March, before the market tanked then. The Dow (INDU) stalled in the 10605-10655 area, its 'breakdown' point back in mid-Feb/mid-March. A breakdown point is exactly what it says: a price point or area where, after piercing it, the market falls precipitously.

7.) At least one major index will often see a bearish price/RSI divergence set up, which will be seen in the case of the Nasdaq Composite (COMP) commentary further on.

Enough hindsight you say! But, good traders, especially if they were not STRONGLY positioned AHEAD of a significant reversal, will look back and study the patterns were that were pointing to the breakdown (or breakout/upside reversal), so as to get ever better at ANTICIPATING trend reversals next time.

Of course, 'fundamentalists' mostly figure that unknowable (ahead of time) 'events' come along that DETERMINE market reversals. I say that the market ALWAYS is showing, ahead of time, that a trend or cycle is coming to an end; that market-moving 'news' is only the stated 'reason' why it happens after the fact.

The market discounts everything and things developing, but not yet widely seen, such as with earnings and the economy is NOT unknown by everyone. Savvy insiders start to act sooner than others and their buying and selling activities show up in various ways ahead of the actual breakdown; or, breakout/upside reversal.

Summing up, tops can be tricky to see unfolding, more so than bottoms sometimes. And, as I keep saying, a major way to profit more in INDEX options, is to position AHEAD of when an actually breakdown comes; you know, before premiums get jacked to the sky!

I'm talking technical factors in the above 7 points, although last week (6/19), I made my 'fundamental' case for why a continued bullish market move was unlikely.

Closing index prices, a recap of market action, specific company influences and government releases are covered in the e-mailed and online OIN Newsletter, in the 'Market Wrap' section.

I am arranging my schedule after mid-July so that I can update my Index Trader column midweek (e.g., Wednesdays) as needed, especially when there's significant additional analysis worth adding to my Weekend commentary.

NOTE: In my Wednesday Trader's Corner article appearing in the e-mailed OI NEWSLETTER, I often have an updated analysis of the mid-week chart picture, at least for 1-2 of the major trading index options in response to OI Subscriber e-mail.


S&P 500 (SPX), Daily chart:

Per my prior (3/19) weekend update: 1220, at the upper trendline, was the key resistance. The sideways trend that followed formed a top. I mentioned also that an intraday break of 1213, would suggest that a trend reversal was underway, with a close below 1200 suggesting that a high for the recent move was in place.

1200-1203 is near resistance, then 1213-1215. Support levels and areas, once broken, tend to 'become' subsequent resistance; I depict this by the green up arrow, followed by the red down arrow at these points. Piercing the 21-day moving average, as happened on Thursday, was a second actionable sign of a trend reversal and suggested buying puts, with downside potential to 1185.

I note on the chart possible support at 1185; at the bottom of my 'hypothetical' lower trend channel line. This lower trend channel line is a line parallel to the up trendline but touches only the one, lowest, low. It's a benchmark however, until we see where a next low might develop.

Key technical support lower down is at the 1175 'gap' and is also at my lower envelope line and is not "support" the way a prior low or gap might be; but, SPX prices have a current likelihood to hold within 2 percent of the 21-day moving average, at least near-term. As time goes on prices might follow this line lower however.

I would cover puts on a close back above 1203 (my 'risk' point), or if 1175-1177 is reached.

SPX has had a tendency, in the period shown above at least (and in 1 of 2 prior instances), to top out when the 13-day RSI gets to an 'overbought' upside extreme; noted at the blue down arrow on the Relative Strength Index above; great 'signal' in this instance, as the index kept going sideways for 3 days (after this extreme), before the market broke sharply.

S&P 100 (OEX) Index - Daily chart:

573-574 was discussed a week ago as the key resistance in the S&P 100 (OEX). Only a close over 575 would have suggested that OEX could get back up to 585 to a double top. Instead the index reversed after repeated failures to break back above the Oct-Mch up trendline ('kiss of death' trendline) AND after it finally touched the same overbought level as at the last tops.

I mark near resistance as (at prior support) at 563; it would take a close above this level to suggest that OEX was regaining some bullish footing. 558 is my next anticipated support, as implied by the minor gap dating from the early-May advance.

A 555 target is at the lower trading envelope line and I don't have lower targets currently. I suggest covering any puts in the 555-558 zone if reached.

As those of you know who follow my commentary on my 'sentiment' indicator (see above), I thought that there has been far too much bullishness to suggest that this rally would continue much longer, given some of the underlying uncertainties out there. VERY unusually, perhaps because of increased writing of covered calls on stocks, this indicator shot up on Thursday. The sharp further fall the next day (Friday) followed.

Bullish expectations (sentiment), according to this indicator, which has had good predictive results over the years, still seems too high for there NOT to be still substantial downside risk. Markets fall the furthest when bullish expectations remain high even as sharp declines start to roil the market.

DOW 30 (INDU) Average, Daily chart:

The Dow 30 (INDU) average can trade in the most 'technical' fashion of all the indexes; last week it failed to take out resistance at 10654, at the resistance trendline and representing a 2/3rds retracement of the March-April decline.

As always, my rule of thumb on retracements is that ONLY if prices recover MORE than 2/3rds (66%) of the prior decline, can we anticipate potential for the rally to go on and challenge the prior highs; otherwise, stalling in this area hints strongly at the potential for a reversal.

I mentioned the tendency for the institutional (funds, etc.) money managers to sit up and take note if INDU closes under the 200-day moving average. The current 200-day average, which also intersects at key prior lows, suggests a key resistance (and 'benchmark') in the week ahead for the 10444 area.

Immediate overhead resistance is figured as 10340, which would put INDU back at the internal up trendline that the Dow sliced through on Friday. A close back above 10,340 - 10,350 (this trendline is rising) would regain the up trend if the average can maintain itself above the trendline. Stay tuned on that.

The 21-day stochastic (above) in INDU has some history of marking tops after a SECOND overbought extreme is hit. This recent example was a second instance this year where the 21-day stochastic plus the double extreme, was useful in trading index options; at a minimum it would have strongly suggested to exit DJX calls ahead of the sharp downside break of Thurs-Fri.

NASDAQ Composite (COMP) Index, Daily chart:

Key resistance was clear in the Nasdaq Composite (COMP) heading into this past week, as so many highs occurred in the 2095-2105 area. No bullish close over 2100 was seen.

Moreover, the recent rally to the midweek high was accompanied by a clearcut divergence in the RSI indicator ('length'= 13) as the RSI indicator was falling while prices went sideways (see chart).

You'll note that prior intraday lows have not been pierced, so immediate support is 2050. Should COMP start falling below 2050, some lower technical levels figure as potential downside support, and are noted at 2018 (a prior top) and at 2005; if prices fell to 2005, the upside chart gap would be 'filled in' and would mark significant support potential.

I still am of the same mind that the Composite is likely to remain mired in a 2000-2001 trading range for a while, especially as we head into the summer 'doldrums'. A close under 2000, not reversed the following day, would suggest still more downside potential ahead, initially to around 1980.

Nasdaq 100 (NDX), Daily chart:

Resistance in the 1550 area in the Nasdaq 100 (NDX) was never penetrated and prices reversed from this last touch to the previously broken up trendline ('kiss of death' trendline).

Once chart support at 1510-1515 was pierced, the pattern turned even more bearish. Unless NDX can regain at least 1510 and stay above this level, look for still objectives. Although they are not marked on the daily chart below, the hourly chart (not shown) suggests next lower targets (and possible support) as 1480, then at 1460.

1467 is where my lower moving average envelope line intersects currently in NDX, so is a kind of 'benchmark' for what would represent an initial 'oversold' extreme.

The Nasdaq 100 tracking stock, QQQQ: Daily chart:

The Nas 100 tracking stock, QQQQ, reversed after having intraday highs that churned around at the emerging down trendline intersecting in the 38 area. Inability to pierce this trendline was a good trading indication to short the stock. At that point, 'risk' was low and equaled setting a (buy) stop just above the resistance/down trendline.

Friday continued slide sliced through the internal (connects the most number of lows, not just the single lowest low) up trendline. Unless the Q's can regain or get back above 37.20-37.25 and hold this area on subsequent dips, I expect the stock to work lower.

Friday's decline also cut through the 200-day moving average, and this average will be watched going forward, given the tendency for it to act as, alternatively, support or resistance.

I think 36 is a target on the downside and suggest covering short positions in this area, if reached.

For traders who might still be long the stock, I would maintain an exit point (sell stop) at 36.90 and let your stop take you out; if there is a rebound, use it exit and improve your situation. [This is a follow up to my 'risk' suggestion last week, for those who might have bought in the 37.50 - 38.00 area.]
For those short QQQQ, I have stops lowered to 36.65, looking for a downside objective to the 36-36.25 area.

VOLUME note: a great plus for trading QQQQ is that we can study volume and especially see when On Balance Volume (OBV) reversed direction. Prior to last week even, when the stock was still having some rally attempts, but basically going sideways, OBV was falling. The falling OBV line suggested that money was coming OUT of the stock, on balance (no pun intended).

Please send any technical and Index-related questions to me at support@optioninvestor.com with 'Leigh Stevens' in the subject line; not only for answer, but also for possible use in my coming week's Trader's Corner article. Your emails are appreciated and where I learn what's on YOUR mind!

Good Trading Success!

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