Option Investor
Index Wrap

BREAKOUT BY TECH

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THE BOTTOM LINE:
A funny thing happened on the way to my midweek update in the form of my usual Wednesday (1/10) TRADER'S CORNER article, where I discussed the 'rectangle' consolidation patterns that looked like they were going to be pierced on the upside in a bullish breakout move; which, would then likely mean that tech stocks, in a real switch, would lead the S&P to new highs for the current move. Stay tuned on that!

In the DUMBEST thing I've done so far in 2007 (but hey, the year is EARLY yet!), I grabbed the wrong word document, taking one from early January of LAST year. While the charts were the correct ones I had painstakingly illustrated, the text was totally WRONG! Why do I make a point of this? Well, to note the error for one, but mostly because those charts are the perfect lead in for my bottom line commentary. So, I will re-print them here, with abbreviated commentary; hey, it's the new year, time to try DIFFERENT things!

RECTANGLE 'DEFINITION':
From my book, Essential Technical Analysis:
"A sideways 'trading range' that forms after either an uptrend or downtrend and that most often is a consolidation of the prior trend, before a further move in the same direction as this trend. The name comes from the shape of the pattern, which requires a sideways trend that goes on long enough that the pattern's width is longer than the consolidation trading range is high. Sometimes a rectangle will form a top or bottom pattern. The key is the direction of the a breakout move above or below the top or bottom lines drawn across the (trading) range's highs or lows."

There should ideally be 2-3 or more highs that form at the same price level or in the same area, to define and form an upper horizontal and a lower horizontal trendline.

This pattern, especially in stocks, classically will often have a duration of months (e.g., 6 months), rather than weeks, but in the case of the recent sideways trend in the indexes, it is a few weeks. Some analysts and market observers define TWO types of rectangles: a 'rectangle top' and a 'rectangle bottom'. However, this is for purposes mostly of separating two possibilities: that the pattern could be the formation of a top after a lengthily advance OR the formation of a bottom, after a lengthily decline. However, it should be noted that the rectangle pattern is not associated with a classic definition/prediction that EITHER a top or bottom should follow such a sideways trend. Rather we have to observe in WHICH direction is the next move, above or below the box like pattern.

Since, we should always give the 'benefit of the doubt' to the prior trend and ASSUME that the breakout of such a sideways trading range may be in the SAME direction as prior dominant trend, the following 2 situations define when a rectangle is a trend CONSOLIDATION:

1. The market (or stock) has been advancing previously, which is the current situation and this is followed by a series of sideways, back and forth price swings that end in roughly the same areas on the upside and the downside. If the next significant price swing or 'leg' is up, carrying prices decisively ABOVE the top end of the rectangle, the pattern was simply a pause/'consolidation' of the prior advance.

2. The index or stock has been in a significant decline, followed by a series of back and forth price moves that tend to top out and bottom in the same area 2, 3 or more times. If the next significant price swing or 'leg' is BELOW, the 'line' of prior lows, the pause or sideways move (the rectangle) was simply a 'consolidation' of the prior downtrend, before the dominant bear trend continued.

It's when the breakout is OPPOSITE this scenario that traders, in HINDSIGHT, refer to a rectangle-top or a rectangle bottom.

BEST 'DEFINED' RECTANGLE: NASDAQ COMPOSITE (COMP)

NOTE: The next 4 charts are used for illustration of the rectangle chart patterns and are updated ONLY through Wed., 1/10 and used to illustrate possible upside price targets/objectives only.

The Nasdaq Composite (COMP) daily chart below, outlines the possibility that an upside OR a downside breakout would equal the 'classic' objective for a next price swing equal to the WIDTH of the rectangle pattern, which is a classic sort of rule of thumb objective. Bulkowski found in his work (Encyclopedia of Chart Patterns) that 'rectangle tops' with UPSIDE breakouts had a further gain of 50% of what had come before, with the average gain equal to between 20 and 30 percent.

THE NASDAQ 100 (NDX):

The Nas 100/NDX pattern doesn't have the same 'definition' as the Composite in terms of having 2-3 'touches' to highs and lows in the same approximate areas. If we use a close-only (line) chart and assume that the Closing high to date and the closing low to date 'define' upper and lower ends of the same rectangle pattern seen in COMP, the following is projected for NDX depending on which way the breakout is, on the upper end or lower. Of course by the date of this chart midweek, it looked like Nasdaq was on a run higher.


THE S&P 500 (SPX) daily chart:

A defined trading range, at least between the highs and lows that I've outlined below, doesn't give us as much to go on in terms of the DURATION of a well-defined sideways trading range or rectangle as is the case in the Nasdaq Composite above. However, what there is in terms of the price range into midweek in SPX, is presented as follows and we come up with a possible next objective to the 1460 area, assuming that there is a decisive upside penetration of 1432; on that, we have to stay tuned to Tuesday on of next week.


THE S&P 100 (OEX) chart:

The OEX sideways trading range of late isn't highly defined either in terms of duration or the time spent trading back and forth in a set price range, but the chart below outlines a projection higher based on the minimal trading range from December into early-January.

This last chart, while again updated only through midweek, does illustrate a future price projection to the 678 area if the prior (666) high is pierced. I would note again that the longer duration a trading range (rectangle pattern) has, the more likely to see a major follow through on a breakout above or below that range. Another 12 points higher is a modest upside objective for a renewed rally and next upswing.


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:

The S&P 500 (SPX) Index is near to breaking out above its prior 1432 high; if so, I anticipate eventual upside potential to the 1460 area. Of course, if SPX should instead top out in the 1432-1435 area, that's a whole other picture in the chart, as it would then look like a double top; this outcome doesn't seem likely given the renewed upside momentum of this past week.

Near support is at 1420, then at the line of support at prior lows around 1404-1405.


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

The S&P 100 (OEX) would achieve an upside breakout on a further advance through the prior high at 666. OEX has of course already achieved a breakout on a CLOSING basis with its new Closing high for this move on a daily and weekly chart basis. A further up leg from here could carry up toward the 678-680 area. Seasonally, there is a tendency for a move higher in January, extending into February.

Near support is in the 660 area, then around the prior lows at 653.


DOW 30 (INDU) AVERAGE; DAILY CHART:

A decisive upside penetration in the Dow 30 Average (INDU) above 12,588 would then suggest an upside target to around 12,838. If there was a rally failure around the prior high it sets up a potential double top; this looks unlikely given the momentum we were seeing this past week. Especially with more news ahead on earnings, which look to be decent. Political events don't seem to be having an effect on the current market, and the global economy looks strong as well.

Near support should be found around 12,435, then at the line of prior lows at 12,338. The broad trend is still sideways but would resume to an uptrend on a breakout move above the old highs, as long as momentum kept up. Oil price moderation should help that scenario, but oil stocks look like they may have found a floor which is a bullish influence; doubtful that oil is going to fall a whole lot more based on what I see on the charts.


NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

The Nasdaq Composite (COMP) is up, up and away on Apple fever it seems as much as anything; really, I haven't seen as much excitement and buzz among my techie friends since the I-Pod and it seems great actually for their I-Phone, with more potential users for sure. A target based on the measuring objectives I spoke of above in COMP is up near 2550.

Close by support should be found at the prior highs or on pullbacks to around 2470. Next technical support is at 2438-2435, extending down to the 2400 area.

NASDAQ 100 (NDX) DAILY CHART:

The Nasdaq 100 (NDX) lost its mildly bearish look to its chart of the prior week and the upside breakout of this past week looks solid. A next target I could see would be up to around 1875 on a closing basis and as much as to the 1890 area as an intraday peak at some point.

Near support is expected on pullbacks to the 1820 area, with a next floor of support around 1800; major support is seen at 1775.

Good Trading Success!

** SUBSCRIBER MAIL **
Please send any technical and Index-related questions to me at Click here to email Leigh Stevens 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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