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Index Wrap

'NORMAL' CONSOLIDATION

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THE BOTTOM LINE: That's what is looked like this past week, a nominal or 'normal' consolidation, after a sharp run up the week before. Maybe this begs the question of what such a normal consolidation looks like. Just a mild or shallow pullback; one that holds above near support areas and doesn't retracement much of the prior upswing.

A sideways to lower trend is also common after the RSI and other such measures of momentum and which also attempt to define 'overbought/oversold' areas, nears or reaches an extreme. If the rally has more to go, pullbacks will be more sideways in nature (a 'time' correction) rather than being a deeper retracement of the prior price swing.

Look for the rally to continue at some point and the time frame looks within days (not weeks), provided key support levels described below are not pierced. There's always a caveat in all these things with the market. Otherwise it would be too easy to make money trading! We wouldn't want it to be too easy, although you can imagine it is on the Street of Dreams.

MOST RECENT TRADER'S CORNER ARTICLE:
This regular Wednesday column allows me to talk about trading and technical analysis ideas relevant to current or recent market action, serving as a companion piece to this (weekend) Index Trader outlook.

In my most recent Trader's Corner (8/23/06) article I responded to an OI Subscriber who asked me to write about measuring Market 'sentiment', such as known through the various investor and trader surveys and through use of more 'objective' option volume studies like the put to call daily volume ratios. I'll write this coming Wednesday on using and interpreting the Point and Figure (P&F) method of charting.

I wrote my last column on the run in travel mode and haste does make some waste, like saying SPX closed that day at 1280, versus 1293. Well the 21-day moving average does sort of leap out in color on my chart!

To read or review this article, check your 8/23 OI Daily (e-mailed) market letter, or click here for the web page its on.

MARKET NEWS and INFLUENCES:
Closing index prices, as well as the recap of market influences such as earnings, company news, government reports and activities, are covered in the Option Investor 'Market Wrap' section.

** MAJOR STOCK INDEX TECHNICAL COMMENTARIES **

S&P 500 (SPX); DAILY CHART:
I've left the retracement level markings on my daily chart of the S&P 500 (SPX), as well as the outline of of the Head and Shoulders (H&S) bottom that was traced out with the 'minimum' upside target to1335 implied by this pattern. There is nothing in this past week's price action that suggests that the SPX (and OEX) H&S upside targets couldn't be seen in a next rally phase.

The key or pivotal technical level on the upside is the prior 1327 high. If prices keep retreating from the recent 1302 Closing high to date for the current move, the chart would have a bearish pattern in the lower rally or (up) swing highs. At best, SPX then settles into an approximate trading range. A rally to the prior top that stopped there, results in a double top and which would suggest a good put opportunity.

I continue to see 1290, the 66% retracement of the prior decline and support at last week's low as the near support to watch, especially on a closing basis. Below the 1290, the 21-day moving average, now at 1282, is a key support. A close below 1282 and not reversed the next day, would be bearish. 1260, at the prior downswing low, is the most key technical area to watch on the downside; if pierced, the near to immediate term trend reverses to down. Otherwise, the trend technically remains up.

Below on the Head and Shoulder's pattern is from last week and may be of interest for another read or as a noteworthy chart aspect if you didn't see it in my last Index Trader:

"Sometimes of course the target suggested by a Head and Shoulder's pattern is not achieved and is a "pattern 'failure'" or move contrary to the trend outlook implied by such a chart pattern. However, in one study of this pattern in many different stocks and markets and over a prolonged period of time by Tom Bulkowski (The Encyclopedia of Chart Patterns), the implied objective had a failure rate of just 5%, assuming that the pattern was correctly identified.

Identifying the H&S bottom:
With H&S bottoms and tops, there is always 3 highs or 3 lows involved. With the H&S bottom, there's a first low (the left 'shoulder'), followed by a rally, followed by a rally failure leading to a LOWER low (the 'Head'), sometimes on a pick up in volume as discouraged bulls exit. Another rally then develops, but this rally doesn't get to a higher high than before typically, and prices then fall again to the next, but higher relative low (the 'left shoulder') than the Head. Here is also a period where an equal or nearly equal ratio(s) may be seen in equities put volume relative to call volume; e.g., a 1 to 1 (or near to) this ratio, where daily option put volume nearly equals that day's total equities call volume and suggests an extreme in the level of trader and investor bearishness.

The measuring implication of an H&S Bottom:
Compute the formation height by subtracting the value of the lowest low reached in the 'head' from the 'neckline, measured vertically. [The neckline is a trendline connecting the highest high after the first low (Left Shoulder: LS), to the highs reached after the next low (the Head: H).] Add the difference to the point where prices pierce the neckline. The result is the target price to which prices may reach or rise to, at a minimum.

Sometimes the most accurate way to draw the neckline, as with other trendlines, will be the one connecting the greatest number of highs, so the neckline might cut through a high or two as in the above example. Also, after a Close ABOVE the neckline, a later pullback to the neckline sometimes happens as seen above. When the neckline then acts as support and the rally resumes and accelerates, this is a further good indication that the pattern that has been traced out was indeed a Head & Shoulder's bottom.

This explanation will also serve as an explanation for measuring a 'minimum' price target for the H&S bottom seen in the S&P 100."

THE S&P 100 (OEX) INDEX; DAILY CHART:

The S&P 100 (OEX) is maintaining a bullish pattern with its mostly sideways trend of last week, which has to be seen so far as a consolidation of the prior steep run up; i.e., continuation patterns consolidate the prior trend so to speak and are the opposite of reversal patterns like double tops or bottoms.

A rally failure below 604 is less likely than at least a re-test of the prior 604 high, which is the key near resistance. Above 604, a 'minimum' upside target implied by the OEX Head & Shoulders bottom is to 612. Stay tuned on that!

On the downside, watch the 21-day moving average at 592 as pivotal near support. The trend is not knocked back or reversed unless there's a move below the prior low at 583. Some would only look mostly or only at the prior low Close at 584. Closes under these prior lows not reversed the next day turn the chart bearish in its pattern.

SENTIMENT AND OVERBOUGHT CONDITIONS:
We got to the typical 'overbought' extreme that has often marked at least an interim or temporary top in OEX, as can be seen in the 13-day RSI above. High RSI readings like this do warn me from taking new positions in the direction of the trend as being higher risk and unlikely to have a favorable risk to reward ratio for a NEW trade. For calls bought at significantly lower levels, it's prudent trading strategy given an overbought reading like this to have taken some profits already, especially as a prior top is near; this assumes of course a multiple option position.

What keeps me hanging in with some calls is the relatively modest level of bullishness. In fact my 'sentiment' indicator seen above and which I discussed in more detail in my 8/23 Trader's Corner, was most recently near a bullish reading in terms of CONTRARY opinion; i.e., traders were taking a bearish trading stance suggesting the market might make a move contrary or opposite the majority opinion. Bull markets and bullish price swings tend to fail or get stopped when most everyone who is going to buy into a stock or index is already in the market; after that tipping point, it doesn't take too much selling to push it back down when further buying support doesn't materialize.

DOW 30 (INDU) AVERAGE; DAILY CHART:
The Dow 30 Industrials (INDU) has technical support in the 11,223 to 11,245 area and is the weaker of the NYSE related stock indexes with INDU well under its prior high. To date the Average has not been able to hold above 11,335, resistance implied by the 66% retracement of its May-June decline. Key lower support comes in at the prior low in the 11,043 area.

Above 11,335 and 11,384, a 'line' of recent highs, a next Dow target and significant resistance is around 11,500. Assuming the Dow can churn threw these levels, an ultimate or eventual objective is for a re-test of INDU's prior top in the 11,670 area. This looks far off currently, as the Dow struggles to match the stronger S&P 100.


NASDAQ COMPOSITE (COMP) INDEX; DAILY CHART:

The chart remains bullish in its pattern for the Nasdaq Composite (COMP)Index. Near support is estimated at 2115 and selling pressure/resistance has been showing up in the 2160-2168 area. COMP needs to get through this area to gain some traction on the upside. A next key or pivotal upside resistance in COMP is at 2190-2200. I assume that major resistance will be found in the 2233-2250 area and representing the 62-66 percent retracements.

2115 is the top end of the upside gap and I assume that the upside chart 'gap' will turn out to be the support area that gaps often are; next lower technical support looks like 2100, then around 2050, the area of the prior low. A close below 2050 would suggest that the upside potential of a 'minimal' 38% retracement (of the prior decline) was all that was going to be seen for the Composite in the ongoing weak tech sectors saga.


NASDAQ 100 (NDX) DAILY CHART:

Near support is at 1535 in the Nas 100 (NDX) Index, with 1500 a next likely support area and major support implied by the prior 1476 low.

1585, at the prior recent intraday high, then 1600, are the bookends for the pivotal upside resistance zone. 1635 is a possible next target however. Prices have traced up a bullish 'flag' type consolidation, suggesting at least a move up to the 1600 area; but, this should happen soon if it's going to. Typically, consolidations of the type seen on the NDX chart are relatively short-lived if their bullish implication is going to be realized. Run quickly or not at all!


NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:

QQQQ support is at 37.75, with major support at 36.25. The key resistance levels are 39.15, 39.25 and 40-40.15. I'm looking for higher prices still, probably to the $40 area.

Volume and price patterns were bullish during the sideways consolidation that ended 2 weeks ago. The Money Flow Index (MFI), a very similar indicator to the Relative Strength Index (RSI), was trending higher as prices tracked sideways to lower into mid-August, which was a bullish divergence. As telling as this, the On Balance Volume or OBV technical indicator was trending higher from 8/9 on suggesting that the stock was being accumulated on balance.

Good Trading Success!

Please send any technical and Index-related questions to me at Click here to email Leigh Stevens 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 YOU are thinking or wondering about. Yes!

NOTES ON MY TRADING GUIDELINES AND SUGGESTIONS
CHART MARKINGS:
1. Technical support/areas of likely buying interest are highlighted with green up arrows.
2. Resistance/areas of likely selling interest: red down arrows.
[Gray up/down arrows: support/resistance levels that got pierced]
I WRITE ABOUT:
3. Index price areas where I have a bullish bias or interest in buying index calls (or selling puts or other bullish strategies).
4. Price levels where I suggest buying index puts (or, adopting other bearish option strategies).

Trading suggestions are based on Index levels, not a specific option (month and strike price) and entry price for that option. My outlook often focuses on the intermediate-term trend (next few weeks) rather than the next several days of the short-term trend.

Having at least 3-4 weeks to expiration tends to be my guideline for trade entry choice. I attempt to pick only what I consider to be 'high-potential' trades; e.g., a defined risk point would equal in points only 1/3 or less of the index price target.

I most often favor At (ATM), In (ITM) or only slightly Out of the Money (OTM) strike prices in order not to 'overtrade' my account. Exit or 'stop' points, as well as projected profitable index price targets, are based on my technical analysis of the indexes.

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