Option Investor
Index Wrap

A GREAT TRADING MARKET

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THE BOTTOM LINE:

I might add a GREAT trading market for Jack (or Jill) who is Quick and Nimble! I talked last week about how even the Dow 30's (INDU) intermediate-term trend had turned down, joining all but the Nasdaq 100 (NDX) with this 'honor'. The decline as of a week ago Friday (8/4) did close on the weekly low for the second week running, a definite bearish pattern. The amount that the major indexes had retraced already of the March to July advance were suggesting that a corrective upside rebound could come any time.

The 'fibonacci' retracement levels, as percentages of the prior move, up or down, are 38, 50 and 62 percent. I give a 62 percent retracement 'leeway' to 66%, based on Gann analysis of 1/3 and 2/3rds being areas to watch for retracements also. My rule of thumb is that if there is a 66% retracement but no more, there's still potential for the prior trend to resume; but, closes below 66% suggests a next objective potentially for a 100% retracement to occur or a move carrying the stock or index back to its prior low or high.

The short and intermediate market trends have been up of course and strongly, since March. (The long-term trend in the major indexes has been up since late-2002.) Coming into this past week, the retracement picture was:

The Dow (INDU) had declined only around a 'minimal' 38%.
The S&P 100 (OEX) was just under 50%, possibly headed toward a 62% retracement but was also 'over-stretched' on the downside, closing at 4% under the 21-day moving average. (The major indexes tend to range from 3-4 percent above or below their 21-day moving averages.)
The lead S&P 500 (SPX) had slide to just below a 62% retracement, but not quite to 66%. This retracement amount provided the best clue for me to suspect that the market was at or near a short-term low.
The Nasdaq 100 (NDX), like INDU was holding around a 38% retracement.
The Composite (COMP) was just under 50%.
Way out in left field, the Russell 200 (RUT) had retraced more than 50%, not of its March to July advance, but a bit more than half of its 12-month, July '06 to July '07 advance.

I saw SPX last week as a best bellwether for the near-term direction of the trend: "If (SPX) prices stabilize at or above 1428, especially on a closing basis, there remains some potential still for a resumption of the prior (up) trend; or, at least an 'oversold' rebound." We got that in rapid order!

I wrote in my Wednesday TRADER'S CORNER article more on retracements, with the latter part of my article responding to a question on the potential usefulness of retracements to gauge the possible extent of the rally that had developed from Monday on. To view this article, you can click here.

The most common retracement of a prior move is 50%. I used the following HOURLY charts on key indexes in terms of what retracement had already been reached on Wednesday. Those highs seem familiar in terms of retracements?

INDU HOURLY
I often say the Dow trades very 'technically'. Here's another example where it rebounded the 'maximum' 62% retracement before the dominant trend reasserts itself; you'll recall that in technical analysis terms as I noted above, INDU was now in a downtrend on an intermediate-term basis. And, the 'medium' term trend is probably the bread and butter for most index option traders; not all, there are the swing and scalper type traders, following short term price swings (2-3 days, versus 2-3 weeks or more).

SPX HOURLY
As below, so above.... Just as we saw SPX complete a recent downside retracement of more than 50% of its March-July advance, but not quite 62%, here we go again on the upside in the oversold rebound seen below:

COMP HOURLY CHART
Pretty much the same retracement 'story' as SPX as this index retraced a little more than half of its prior decline, and had reached the area in terms of retracements where the dominant (down) trend would typically reassert itself.

WHERE TO NEXT?

We're back near recent lows, with rebounds from at, above or not far under recent lows. However, I doubt that the market has seen a final low for this move; i.e., the downside correction that's been underway since the 'excesses' of the more or less straight up drive to the July top.

I hate to say it, or maybe it's good for us traders, but (more) excess tends to be the result of excess. In other words, I wouldn't look for this correction to be over and jump back into calls in a big way. ESPECIALLY SO, given a big jump in bullishness as measured by my sentiment indicator, shown further on in my section on the S&P 100 or the OEX chart.

When I saw the level of equity call volume on Friday, relative to puts, I felt pretty strongly that it (the downside correction) just COULDN'T be over yet. Too many traders seemingly were willing to jump right back into bullish plays. Hey, the market wouldn't be the market if the majority was right too often!!

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

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** MAJOR STOCK INDEX TECHNICAL COMMENTARIES **

S&P 500 (SPX); DAILY CHART:

After rebounding back to resistance implied by the 21-day moving average, the S&P 500 (SPX) fell like a stone again. All the media talking heads, even the ones that wouldn't know a stock from a bond, were abuzz and had experts in talking about liquidity, risk premiums and a fair number of things that don't have too much to do with what's going on. It SOUNDS like they know what they're talking about anyway. We hear plenty of the old mantra about focusing on the 5-year and longer horizon; as, of course, stocks WILL be higher over time.

I said last week: "Bottom line, another down leg can't be ruled out but don't rule out that the first phase of a decline may be close to over also. I've covered put positions that I had in SPX simply because I couldn't assess whether the further downside potential was significantly more than the upside possibilities on a rebound and I don't like even odds...."

Am I glad I got out of puts, you bet, but the rally was too good not to take out some more. The decline was the same, time to cover for me for a peaceful weekend. This volatility keeps us on our toes hey! What now?

If I had to guess, and I DO, I'd say that SPX chops around awhile, but can't pierce or take out resistance at 1500 and heads toward the 1400 area next. A close above 1500, not reversed back down the next day is bullish. A close below 1408 is bearish, and 1400 more so.

1428 is near support, 1470 is near resistance.

S&P 100 (OEX), DAILY CHART:

The S&P 100 (OEX) remains bearish in its pattern. There's a minor double bottom low to date that formed in the 665 area. Mildly bullish besides this double low is the fact that the retracement has not carried lower than 62%, keeping bullish hope alive.

I would be surprised at this juncture if the decline was over and we didn't see the index moving down again and to lower lows, especially after another rally attempt. A new leg down could carry well under support seen at 665 to around 660. A close below 660 suggests potential for a decline to the 640 area next and perhaps over time to a re-test of its 625 March low.

695-700 is key resistance. A close above 700 turns the near-term outlook bullish, especially provided that OEX didn't start declining back below 695-693 after such a move (above 700).

MARKET 'SENTIMENT':
What does not suggest a bullish turnaround to me just yet is the rather quick rise in my sentiment indicator. The jump in call volume on Friday seems premature and I've seen this pattern a lot historically when traders jump in too soon during periods of uncertainty and after corresponding periods of high volatility.

There seems to be this fear among traders about missing a next big bull move. It's hard for most to believe that the market won't just take Fed actions as all that's needed to get the market back on track consistently. Here in lies the rub. The market may also be 'telling' us that there's a tough period ahead of uncertainty about how much drag there will be on economic growth and hence earnings.

DOW 30 (INDU) AVERAGE; DAILY CHART:

The Dow 30 (INDU) chart is bearish still but price action in INDU also continues to show that there's buying interest on the dips. 13,000 may yet get tested and 12,700 remains my objective if INDU starts declining under 13,000.

Near resistance is at 13,300, then up around the 21-day moving average again, currently standing just under 13,600 (at 13,595).

My note of last week on trading strategy; i.e., "If long DJX puts, I'd look at taking profits on a decline to the low 13,000 area." The decline to 13,057 more or less met that condition. While I'm not at all sure that we won't see 13,000 or lower in INDU, it's ok to grab profits when they come in this volatile market. I want to stay out for a while, let the dust settle. See the trend sort itself out.

NASDAQ COMPOSITE (COMP) INDEX; DAILY CHART:

My downside objective for the Nasdaq Composite (COMP) Index is to the 2400 area should the index start falling through 2480. To turn bullish, COMP would need to get above the 21-day average, which has been tough resistance. The 21-day currently stands at 2617.

NASDAQ 100 (NDX) DAILY CHART:

The Nasdaq 100 Index (NDX) has support around 1900 currently. Support implied by the 50 percent retracement level is at 1885 and the 62% fibonacci retracement, at 1844. If NDX falls below this latter level, my objective for NDX is to the 1825 area.

Near resistance is 1940, with pivotal or key resistance at 1987, implied by its 21-day average. A close above this key moving average would be bullish, but this would also need to be more than a 1-day affair also to get me bullish. I don't see a sustained rally developing any time soon.

NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:

The Nasdaq 100 (QQQQ) made a new low for the recent decline, but prices rebounded some on roller coaster Friday. Near support is in the 46.6 area, next at 46.35, then at 46.0. If the index stock starts closing under 46, we could be looking at a move in the Q's down to the 45.0-44.75.

Overhead resistance is 47.80, with pivotal resistance, as with all the major indexes, coming in around its 21-day average, at 48.86. A close above the 21-day moving average, with the ability to hold this level on subsequent pullbacks, is needed to reverse the current bearish pattern.

I said last week: "the volume pattern was consistent with the prospect for further weakness." I don't see anything yet with On Balance Volume (OBV) or daily volume patterns to suggest yet that the current correction has run its course.

RUSSELL 2000 (RUT) DAILY CHART:

My downside objective for the Russell 2000 Index (RUT) as indicated last week was to 740 and RUT sure got close to that. But, stay tuned, as this index may go lower still, perhaps next to the 730 area, then on to 710 or 700 further ahead. This index got very oversold and the recent rebound has 'thrown off' some of that. It may rally somewhat further, but I think there's more risk for another wave of selling after that.

800 is near resistance, then around 820, extending up to 826.

I said last week: "The straight down waterfall type decline is what has caused a very oversold daily reading in the RSI; on a weekly chart basis, it's now at an oversold extreme also. Time for a rebound soon! I would take most if not all of the profits in puts and run; take a vacation..."

If you have exited puts, I'd take a break!! Nor would I jump into calls as I think it'll take some time before a sustained rally can develop. Puts again? Maybe again up around overhanging resistance that begins at 822 and extends up to the 832 area, which is the area I'd call the 'breakdown' point.

Good Trading Success!

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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