Option Investor
Index Wrap

MARKET CONTINUES ONWARD AND UPWARD

HAVING TROUBLE PRINTING?
Printer friendly version

THE BOTTOM LINE:
I wrote my Trader's Corner article the other day (OI 5/1 Daily) on what I saw as the most bullish technical patterns and indicators that were a counterbalance to the quite bearish current bearish 'fundamentals'; e.g., employment data, consumer outlook surveys, earnings, etc. The current economic backdrop is one thing and the tendency for the market to price stocks based on the outlook several months out is another. The recent resurgence in stocks is an attempt to forecast future earnings trends and what lies ahead, not what is happening this month and next.

I wrote in the aforementioned Trader's Corner, and you can review that online by clicking here, that there were at least 4 bullish chart/indicator patterns that I could point to:
1.) Long-term bullish chart considerations
2.) Formation of two common chart bottom patterns
3.) Last bearish sentiment extreme occurring around the start of the last up 'leg'
4.) Long-term weekly Dow theory chart patterns involving the Dow 30 (INDU) and the Dow Transports (TRAN)

I've talked about point #1 before in this column, which reflects the fact that the S&P 500 (SPX) and the Nasdaq 100 (NDX) on a weekly chart basis, on their last lows, rebounded from multiyear up trendlines, suggesting that the long-term trend remains up.

#2 point: formation of a "W" type bottom pattern developed with SPX and a "V" bottom pattern is seen with NDX, which is especially apparent when using a 'line' (close-only) chart view on the daily chart.

I'll review point #3 in my S&P 100 (OEX) commentary below.

# 4 - Some Dow Theory considerations
Something worth commenting on again here, as the weekly close is finalized and first is shown the weekly chart of the Dow Averages; i.e., the Dow 30 (INDU) and the Dow (20) Transportation stock average.

Dow theory is still proving its value today. The two Dow averages are snapshots of the manufacturing stocks (the Dow 30 Industrials) and the biggest companies that ship those goods (the 20 Dow Transportation stocks: symbol TRAN). INDU includes more service companies now and they create services not tangible goods.

If shipping slows, this will tend to show up in the TRAN average and it will top out first or simply not follow the INDU to a new high, which was the case in October of last year when the Dow went to a new closing high, whereas TRAN was languishing well below its prior high. A 'diverging' pattern like this can forecast a recession and I would say this Dow Theory sell signal did a good forecasting job.

Conversely, we may see a pick up in shipments first due to inventories being worked off and this may send TRAN to a new high well before the same is seen in INDU. This could be an early sign of a resurging market.

That TRAN has been on an upward tear off its bottom and this recent resurgence hasn't been widely noted in TRAN, but it's now not that far below its all-time weekly closing high. High fuel costs or not, something is happening here. Maybe, TRAN stocks are not doing as badly as you would think from the current negative economic news and savvy investors might be seeing/forecasting an earnings pick up later this year in TRAN. There is buzz about airline takeovers sending select airlines higher, but this influence isn't likely to be THE biggest factor.

Moving from the very long-term chart picture to that of the short-term hourly chart of the Dow, I would note that 'trading-range' patterns that shift to more strongly trending markets, means that certain indicators will stop 'working' as an trading decision input; in this case, the use of hourly charts and focus on extremes in the Relative Strength Index (RSI) indicator.

I had been marveling really at how well it HAD been working to buy calls during the occurrence of an 'oversold' reading with the 21-hour RSI and to buy puts when the RSI hit an 'overbought' extreme, as seen below.

UNTIL, that is, to around mid-April, when such a high extreme was followed by only a relatively minor pullback, after which INDU has continued to move steadily higher. Hey, it was great while it lasted!

Now, the RSI readings on a DAILY chart basis are at or near typical overbought levels. Stay tuned on what that will mean as to perhaps signaling a substantial (downside) correction.

I'll save further commentary for the individual index charts below.

QUESTIONS/COMMENTS:
Please e-mail me at Click here to email Leigh Stevens Support [at] OptionInvestor.com with 'Leigh Stevens' in the Subject line.

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:
On Thursday of this past week, the S&P 500 (SPX) achieved a decisive upside penetration of its 1400 key resistance. Next resistance now is in the 1423 to 1435 area as I noted last week, with these levels representing the 62 and 66% retracement levels of the December-March down leg.

The chart continues to show a bullish pattern. The question now is whether there will be a close above 1435, followed by the ability for SPX to continue on higher in the face of the beginnings of an overbought condition as measured by the 13-day RSI.

The significance of a retracement that goes beyond 2/3rds or 66% of the prior down leg, is that the history of many such similar retracements in stocks and the indexes, is one of often going on to a 100 per cent retracement of the prior decline. This is how many double tops set up. The 1435 area also has significance of being the December 'breakdown' point and is an area that we can assume could have a substantial supply of stock for sale.

Very near support can be assumed at prior resistance, at 1395-1400; next support is in the 1374 area, then down around 1324, at the last downswing low.

Bottom formations are often of the Head and Shoulders type or form a 'W' or 'V' pattern. With SPX, the pattern is a "W" bottom pattern, even though the two legs ending in the low end of the 'W' formation are not exact double bottom lows as they often are, but the two lows in question are close and the pattern clearly forms a W.

SPX has now arrived at the low end of readings of 65 to 70 in the 13-day RSI (see above) that begin the typical 'overbought' zone. Only in strong bull markets has there been a tendency for the 13-day RSI to climb above 70. What this indicator suggests at the level it's at currently, assuming this market remains in an overall bear market cycle, is that negative shocks or re-ignition of bearish angst could send prices down sharply and is a characteristic of 'overbought' periods. Be cautious about over-staying in calls.

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

The S&P 100 (OEX) Index pierced initial technical resistance at 648-650 this past week, leaving OEX's next key test of potential resistances at its 62 to 66% retracement levels at 662 and 668. A weekly close above 668 would complete a bullish turnaround and suggest OEX potential back to the 700 area and above.

Near support implied by the 21-day moving average is 634-635, with the next key support down at 610.

As I noted in my Trader's Corner article of the other day, if we only focused on the last sentiment extreme in my 'CPRATIO' readings, taking it as a 'buy signal' as noted on the lower portion of the OEX chart below, the market is still acting on its last trade signal (a buy) with no countervailing 'sell signal' yet to occur.

SENTIMENT:
I took it as bullish, in a contrarian sense, that bullish sentiment actually dipped on Friday amidst a continued strong uptrend per the ratio of daily equities call volume compared to CBOE equities put volume; see the 'CPRATIO' line above. If bullishness doesn't get extreme, it suggests that this market could keep moving higher.

If bullishness, as reflected in the CPRATIO line, shoots up to 2 or higher (daily equities call volume double or more that of puts) a tradable top has usually followed within 1-5 trading days.

DOW 30 (INDU) AVERAGE; DAILY CHART:

The Dow 30 (INDU) not only knocked on the doorstep of key resistance at 13000 but managed a weekly close above this level this past week. INDU seemed to have faltered at bit at the 66% or 2/3rds retracement level at 13066. If the 62-66% retracement levels are calculated from the OCTOBER top at 14198 to the early-March low instead, 13220-13342 becomes a key technical resistance area, as noted on the chart below.

INDU may struggle some to hold above the 13000 level as it's a likely area where further selling may come in AND where the market approaches an intermediate overbought level as suggested by the 13-day RSI.

Conversely, if INDU can stay mostly above 13050, then further upside potential will look promising. Such a further advance may happen AFTER a correction, such as back to near support implied by the 21-day average, currently in the 12700 area.

Next lower technical support, below the 21-day average, is at 12270, at the last downswing low.

NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

The Nasdaq Composite (COMP) Index had now retraced more than 50% of its last big down leg so it's getting to be a healthy rally. The last retracement levels of some importance (other than a round-trip 100 percent retracement back to the 2727-2735 December highs) is 2506 and 2535, the 62 and 66 percent retracement levels, respectively.

In the 2535 area, COMP is also at the low end of the November-December trading range and a significant amount of stock may get offered in this area, so such a move implies potentially formidable resistance/selling pressures.

Near support is at 2405-2400, then at 2380-2370, with major support at the 2260 prior downswing low.

NASDAQ 100 (NDX) DAILY CHART:

On Thursday's big advance, the Nasdaq 100 (NDX) Index pierced technical resistance I talked about last week in the 1960 area and then charged up close to the 1980-1982 resistance I also wrote about last time. The Friday opening near 2000 however, brought in significant selling however and NDX closed out the week in its 1980 resistance area, but not above it.

The 2000 level is an obvious psychological resistance and benchmark, but I've noted a next key resistance as 2025. Generally, if NDX can hold the 2000 area it does increase the odds that the index could climb back to 2141-2147 and retest those prior highs. This outcome also seems unlikely given that the RSI is starting to edge into its typical overbought area. A sideways to lower correction seems most likely to occur ahead of a challenge to the December highs, if that is going to occur at all.

I also noted last week that "A rally above 1940, especially on a closing basis, would suggest that upside momentum was renewing itself, sidelining some selling, with potential then for NDX to tack on another 20 to as much as 40 points." Well, NDX did get to 1980 (1940 + 40).

Near support is in the 1915-1912 area, with next support coming in around 1870, with pivotal support at 1850; if 1850 was pierced it would suggest potential for a retreat to and retest of the prior 1776 low.

NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:

On very little volume, the Nasdaq 100 tracking stock (QQQQ) daily chart keeps chugging higher. The recent rally in QQQQ hasn't brought in a lot of buyers. Arbitrage with the underlying NDX index will keep the stock in lockstep. But the volume numbers don't suggest that there are major buyers out there. This may fit with the cautious level of bullish sentiment seen among options traders. Hey, a perfect case for a continued advance! Well, maybe.

QQQQ ran up through resistance in the 48 area and even briefly got above 48.75 resistance as it rallied above 49 briefly. If the stock can stay above 47.75, it has a shot at making it up to what may prove to be much tougher resistance around 50. I'd short the stock if it got to 50 in this coming week, with a buy stop at 50.5 and looking for a 2-3 point drop, back into the 48 to 47 zone.

Near support is in the 46 area, with next technical support down at 44-43.7.

RUSSELL 2000 (RUT) DAILY CHART:

The Russell 2000 Index (RUT) has followed the rest of the market higher but it barely saw a weekly gain and the index seems to be a reluctant participant in the overall advance. A move to and slightly through the prior 731 high seemed to have brought in enough selling to overwhelm what buying interest existed. I'd maintain that key near resistance is in the 730-735 area, with next resistance at 740, extending up to 747.

If you're long RUT calls, you should figure that this index looks like the most likely candidate for a correction. Moreover, of all the indexes, RUT seems like the most tempting choice for some put buying.

Near support is in the 700 area, extending down to 685.

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.

Index Wrap Archives