THE BOTTOM LINE:
A Dow Theory 'non-confirmation' where one of the averages doesn't follow the other is 1.), a sign of a bottom when the Averages have been in long-term decline, or 2.) a sign of a significant top when the market has previously been in an uptrend. Signs of a non-confirming top have been a signal that a recession was coming more often then not; not that we've had that many recessions in the last 20-30 years.
The weak close on Friday, provided a further suggestion that the Transports
werent going to go anywhere, but more than that, TRAN has closed a second time
under it's long-term up trendline (dating back to late-2002); both averages are
highlighted on my first chart below.
Not that the question of whether there is going to be a fairly major correction or bear market trend ahead is hugely relevant to us index options traders, but it does have some relevance. It helps, at a minimum, to not get 'too' bullish.
Of course we want traders in general to get bullish enough to generate a contrarian 'sell signal', which they did again on my indicator, in the requisite 1-5 day time frame PRIOR to a top. More on this when I get to my regular commentary below on the S&P 100 (OEX), where I have a habit of displaying my equities daily call to put volume indicator.
When you get a bullish extreme AND prices come up to significant resistance AND there is either a non-confirming (there's that hyphenated word again!) reading on the RSI (Relative Strength Index) indicator OR it registers in a reliable 'overbought' zone, this cluster of patterns and indicators is a sure sign to get the heck out of calls and buy puts in a significant way when prices hit resistance; e.g., implied by the upper end of a trend channel.
As I've said a million trillion times, if you can't ANTICIPATE a top or bottom before it's obviously to everyone, you get the trading edge of getting in early in a reversal and the benefit of having a break-even or low-risk exit (stop) point. If you want to wait and trade only when a trend becomes obvious, you are usually better off trading the riskier stock index futures, as you mostly only have 'fair value' to deal with, NOT a tremendous expansion (a more costly way to get long or short) of stock index options' premiums.
The WEEKLY charts in the S&P, the Dow and the NYSE Composite Index, all showed basically the SAME pattern of coming up to the upper end of their broad uptrend channels coupled with a major declining trend in the 13-week RSI. For weekly charts I use either an 8 or 13-week ('length' setting) RSI; in a major move, if I think we're nearly major resistance, always '13'. What I must have omitted in my Trader's Corner article of this past Wednesday (10/17) about this downtrending RSI pattern, and highlighted on my next two charts, is that the last time I noticed this kind of long-term diverging price/RSI pattern was in 2000. No comparison is implied about what comes next in future months, just that this kind of divergence eventually occurs ahead of a significant price break.
The following charts speak pretty much for themselves. What is unspoken in these charts is that it can take numerous times of drawing and re-drawing trend channels to get them just right. (I've written on this before and will again.) I did show these same charts, highlighting significant 'resistance' however in my Wednesday (Trader's Corner) article, so it was a useful foretelling before the big Friday break. Ah, I remember it well, 20 years ago on black Monday. It was a Monday and I was in Chicago (I worked normally in New York) in the observer area above the CBOE floor as it happened. A group of us were going to an options strategy seminar, but as we saw the chaotic beginnings of what turned into a 23% drop in the Dow, there was no way we were going to do anything but watch the market in awestruck fascination.
I would just also note, regarding SPX, the sharp decline of this past week has carried not just from resistance implied by the upper channel line, but has also meant that prices are back under the major S&P 500 top of 2000 (at the dashed red level line). I wouldn't call this a triple top, as the two recent tops are so relatively close in time, but potentially a major double top. Double tops with several years separation is usually a quite potent symbol of major resistance.
The pattern of declining relative highs in RSI is quite apparent in both charts above, but especially so in the S&P 100 (OEX) on the right as highlighted by the down trendline. Of course such divergences are don't aid in formulating near to intermediate-term trading strategy. The first top, seen in the overbought zone, was significant for a trade. It's the second and third divergence, coupled with an idea of major trendline resistance that gives direction to the idea of taking on a bigger position than one might normally. There is MORE than the consideration of whether to go into a trade or not, but ALSO how big of a position to take on (within sensible money management); there are normal bull and bear trades and then there are bull-elephant and bear-elephant trades so to speak!
The charts below are a continuation of what was unfolding in the NYSE stocks, and I include the NYA New York Composite Index chart below (right). The Dow as usually trades pretty technically and has less instances where a trendline 'overshoots' the upper and lower end of a trend/price channel. The NYA, on its last major low, did fall under what had previously been a pretty consistent up trendline but also made an exact double bottom; one way or another technical patterns will help us find tradable or tradable MAJOR lows and highs.
The pattern of LOWER rally or upswing highs in the RSI relative to the corresponding price moves was not dominant technical feature with the two Nasdaq indexes, as shown below. However, both COMP and NDX were completely consistent in topping out at the same area of the 13-week RSI. The pattern we see after such overbought situations is usually one where prices fall for at least 2-3 weeks or so; sell offs of course usually are of shorter duration than rally phases, at least within bull market trends. Stay tuned on this! Bull markets die hard if that's what is coming; as investors, we're sort of programmed to be bullish and buyers on corrections.
Whew, that was a long intro! I did also want to note with the Nasdaq, that consistent with the fact that relative strength was going up with COMP and NDX (no pattern of declining relative strength), the NDX/OEX ratio has continued to widen. At the peak level in January of last year, NDX traded at a numerical value equal to 2.99 times the S&P 100, which was their peak spread differential until recently; Friday saw the Nas 100 close at 3.04 times OEX. I'm not sure that this means that buying NDX on dips at support will have better upside potential on a rebound relative to an equal dollar amount put into OEX. Maybe so and tech stocks may continue to be the better play on the upside and resist declining as much as the big cap S&P.
MARKET NEWS and INFLUENCES:
** MAJOR STOCK INDEX TECHNICAL COMMENTARIES **
S&P 500 (SPX); DAILY CHART:
The S&P 500 (SPX) Index chart has turned bearish with the retreat not only below its prior highs but the decisive downside penetration of its 21-day moving average. Near support is now expected in the 1500 area, with next lower support around 1480. I don't expect that SPX is going to go into free-fall.
Near resistance is at 1540, then at 1555-1556.
I'm anticipating lower levels ahead such as down to 1475-1480, but possible a rally attempt first; maybe on Monday but I suspect not later than Tuesday. The bulls will find reasons to buy select stocks.
THE S&P 100 (OEX) INDEX; DAILY CHART:
The S&P 100 (OEX) turned bearish with the break below 720, which is now key overhead resistance. 700 is key near support, then 690. As with SPX, I am looking for a rally early in the week, but don't anticipate OEX rebounding back above 708 to 712.
While 700 may hold for a while as support especially on a closing basis, I expect that we'll see a further retreat later and lower lows then see to date. The major indexes are oversold short-term. Friday was probably overdone, but this sharp break suggests that more weakness will develop over time.
DOW 30 (INDU) AVERAGE; DAILY CHART:
The Dow 30 (INDU) Average was struggling to keep a rally going and, as I said last week, to "gain traction above 14000" and sure enough if you can't take em up, they'll come down on enough bearish news; plus, everyone panic running for the same exit at the same time. The break of 13750 was a key area and momentum snowballed. 14000 is the pivotal major resistance and I doubt that we'll see that level again anytime soon. Key lower resistance is at 13800.
13400 is next support. My maximum downside objective in INDU remains as 14300 currently. My typo last week was that this area was my maximum upside objective; ah, you knew what I meant. Sorry.
Well, we're not only oversold on the 21-hour RSI, but nearly so on the 13-day RSI oscillator. The typical pattern will be for intermittent rallies once the RSI gets 'fully' in the oversold zone as shown above.
NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:
As I noted last week, my upside target for the Nasdaq Composite (COMP) Index at 2835 was met within 1 point. Not bad, wish I could get that close more often! The sideways trend of the highs was the tip off for building a top. The bearish break then came when the index fell under the low end of the prior week's trading range, or to below 2755.
The close on the low is bearish and would suggest immediate downside follow through, but that pattern is tempered by it being 'emotional' Friday and I anticipate at least a short-term rebound setting up Monday-Tuesday. Once market participants are bitten by tech mania, they in turn don't want to surrender their grip.
2750 is near resistance and a close back above the 21-day moving average would be mildly bullish, more so if there was some more upside follow through the next day or least a steady close and ability for COMP to hold above this key trading average.
Near support now is at 2700, then around 2650 after that.
NASDAQ 100 (NDX) DAILY CHART:
I anticipated that there would be increasing selling and lack of buying above 2200 in the Nasdaq 100 Index (NDX) and NDX kept getting up near that number but couldn't gain enough traction to go through it. The sideways movement of the past several days was a sure tip off that NDX was building a top. The major indexes rarely have 'spike' highs, unlike what is seen often at major lows; 'congestion' patterns at tops are almost always the norm in stocks, unlike say the commodities markets which will often have spike-highs, followed by reversals.
While I also said last Saturday that I wasn't looking (yet) to trade against the strong trend that had been in effect for some time coming into last week, the double top made around 2200 was a definite 'go' signal for puts.
Near support is noted below at 2128 and near resistance not much higher, at 2143. We'll see how the bulls and bears battle this one out over the coming 1-2 weeks, but over the next 1-2 trading sessions, I'd look an attempt to rally these stocks.
On balance, I anticipate the path of LEAST resistance over the next few days to be down. Next lower support looks like it comes in around 2089-2090, with the support below this area at 2060 and then fairly major support at 2030-2035. Major resistance, if I didn't spell it out, is at 2195-2200.
NDX has plenty of room so to speak to decline before the index is anywhere near an oversold condition again. This doesn't mean that NDX will be weaker than the S&P, but it we could reach a point where the S&P rallies, but the Nasdaq doesn't follow through as much.
RUSSELL 2000 (RUT) DAILY CHART:
I thought that there was some chance that the Russell 2000 Index (RUT) could make it all the way back to retest its prior high at 856, but all such bets were off if 830 was pierced. Sure enough it was, and RUT fell to trendline support in the 800 area. We'll see if the trendline holds; it may near-term. A downside penetration of 800 support would set up a move to 773-770, where I've noted next lower support. 760 is a next lower support.
Immediate overhead resistance is at 803, then at 815; 820 to 823 looks like the current key/pivotal resistance; a close above 823-825 would be bullish if this held up the next day.
Good Trading Success!
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NOTES ON MY TRADING GUIDELINES AND SUGGESTIONS
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.