Option Investor
Index Trader

Some Upside Reversals

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THE BOTTOM LINE:

Index Traders last week will recall that I suggested that the market was near at least an interim bottom and enough of a rebound could follow to suggest that holders of puts be on ALERT to cover.

I followed up on Thursday with my Trader's Corner (TC) piece about 'bellwether' stocks, indexes, indicators and patterns that were key in forecasting the recent rebound. Of course, fundamentally it was news on oil price declines and some other factors, but the market also always has bellwethers that tip us off ahead of time to a possible CHANGE in the fundamentals.

Bellwethers I discussed in the aforementioned Thursday TC article included:
1.) Stocks
* Dow and S&P relevant: Bellwether stock GE seemed to find a bottom in the week ending 6/27
* Nasdaq relevant: Bellwether Intel Corp (INTC) started 'basing' beginning during the 2nd week in July and On Balance Volume (OBV) turned strongly up, suggesting the stock was starting to be accumulated again.

2.) Indexes
* The Dow Transportation Average (TRAN) bottomed in the week ending 7/4; TRAN was ahead of the Dow (INDU).
* The Semiconductor sector Index (SOX) 'based' just under 340, a prior well-defined 'line' of support established from January to March. SOX then broke out to the upside just ahead of the Nasdaq.
* The Oil sector Index (OIX) gave back 2/3rds of its prior advance, a retracement amount (unless OIX drops back to its major up trendline at 755) that suggests rally potential; OIX is also now very oversold. While the Financials outweigh Oils, an oil stock rally could fuel an extension of this past week's S&P rebound.

3.) Indicators
* A very key indicator, my equities daily call to put volume ratio hit its 'oversold-extreme bearishness'
reading a week ago Friday, suggesting strong (upside) reversal potential within 1-5 days.
* A number of the indexes saw their daily and weekly Relative Strength Index (RSI) indicators, on a 13 to 21-day to 8 to 13-week basis, finally reach 'fully' oversold extremes, suggesting a PROPENSITY to rally.

4.) Patterns
* As has been common at significant (i.e., tradable) reversal points, there were some key double bottom lows that looked like they were 'setting up' (especially OEX, on a weekly chart basis) and bullish price/RSI divergences, which were especially apparent in the Dow 30 (INDU) and the Nasdaq Composite (COMP).

For more on 'bellwethers', see my aforementioned Thursday Trader's Corner article by clicking here.

There are 3 weekly charts that I find of interest that I'll finish up my 'bottom line' commentary with that show patterns suggesting that the market may have made a significant or tradable bottom here and that the major indexes could gain some further upside traction ahead.

The S&P 500 (SPX) made an approximate double bottom this past week at 1200; this relative to its June '06 low at 1219. The S&P 100 (OEX) made an EXACT double bottom low potentially as measured on a weekly close basis and highlighted on the OEX weekly line chart below.

The recent weekly closing low was accompanied by a fully oversold reading on a 13-week (quarterly) basis per the RSI indicator. OEX has the potential to rally some more no doubt. It may look too 'easy' or too 'obvious' but sometimes technical patterns ARE picture perfect textbook examples. Stay tuned on that!

The Dow 30 (INDU) also traced out a 'classic' chart pattern, that of a key (2-week) upside reversal as there was a new low, followed by a weekly close above the prior week(s) HIGH. The close above the prior high is what makes it a 'key' upside reversal, versus a close simply above the prior Close, which is a garden variety 'upside reversal'.

This kind of bottom is also sometimes called a selling climax or volatility bottom. It also could be termed a 'bear-trap' reversal; the bears were gunning for 10700 and instead may have wound up still short on a weekly close near 11500!

The unusual thing about the Nasdaq Composite (COMP) and Nasdaq 100 (NDX) is that both remain within their long-term UPTREND channels. NDX still is holding above it's long-term up trendline, whereas COMP has held its lower support trendline on a CLOSING basis to date. A couple of dips below such a trendline isn't a big deal, especially if held to 2-3 such dips. COMP has held above its 2155 low of this year, showing a very different chart picture relative to SPX.

QUESTIONS/COMMENTS:
You can e-mail me with any questions or comments at Click here to email Leigh Stevens support@optioninvestor.com Please put "Leigh Stevens" in the Subject line.

MARKET NEWS and INFLUENCES:
Other index and sector closes, recaps of market influences like earnings, company news, related market events, government reports and activities, etc. are found in the Option Investor 'Market Wrap' section.

** MAJOR STOCK INDEX TECHNICAL COMMENTARIES **

S&P 500 (SPX); DAILY CHART:

The S&P 500 (SPX) Index may have turned the corner from the 1-way downtrend and achieve further upside progress ahead. The chart remains bearish on an intermediate-term basis. It's a favorable sign that buying interest came in around and not far under June 2006 lows in the 1217 area in SPX.

1200 was a 'natural' support area and the S&P stocks did see some short covering around this index level. 1200 could be the bottom for awhile if not a 'final' low (seems doubtful). Next key support is at 1170.

A close under 1200 not reversed in the following 1-2 days would maintain a bearish chart, whereas currently short-term momentum has turned up. An hourly close above 1260, then a daily close above 1273-1277 would reverse the short-term trend from down to up. Next resistance (above 1273-1277) is at 1312. 1320 is resistance implied by a fibonacci 50% retracement (of the last downswing) and 1350 is resistance suggested by the fibonacci 62% retracement level.

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

I like trading the S&P 100 (OEX) Index when it has periods of acting fairly 'technically'; a recent example being the rebound from the low end of the trendline highlighted on the daily chart below, which was also in the area of its summer '06 lows, which was then a key bottom.

555 is near support, then down at 542. Near resistance implied by the 21-day moving average is around 581 and just a hair's breadth above the Friday close. I've noted next resistance at 608-609 on the chart.

A key indicator got bullish a week ago when daily equities put volume on the CBOE was approximately equal to that day's call volume as seen in the most recent green up arrow on the 'CPRATIO' portion of the chart. Seems too simple to be true, yes? However, it doesn't happen all the much and it's quite a good forecasting tool and gets me tuning in closely for price action that ALSO suggests formation of a bottom.

Favorable signals from technical indicators come most reliably when there is a price pattern (e.g., a rebound from the area of a prior low) and other indicators that also point toward trend reversal potential such as I noted already with the very 'oversold' RSI readings seen recently.

Maybe this most recent rally will fall apart, but as long as bullishness doesn't also shoot up a lot in terms of the CBOE equities call to put volume ratio I use, I'm along for the ride with a few light call purchases bought on the recent dip below 559 in OEX.

DOW 30 (INDU) AVERAGE; DAILY CHART:

The Dow 30 (INDU) had a key upside reversal in terms of the weekly chart (noted in my initial 'bottom line' comments) and the daily chart had some favorables also, especially the upside breakout above INDU's down trendline and the close above resistance implied by the 21-day average. A bullish backdrop to this recent rebound was the bullish price/RSI divergence that set up.

Along with too many others, I was anticipating a possible test of major support in the 10700 area. So, of course, it didn't happen! Well the Dow was VERY oversold when it got to 11000, which was also seen as a support and which put INDU very far under its 200-day average at 1395. The Dow was due for a rally and the major index that had gotten stretched the furthest snapped back the fastest and farthest.

Near resistance is at prior low seen at 11732; support, once pierced, often 'becoming' resistance later on. Next resistance is at 12000 and that's about the highest upside potential I see currently for the Dow and is in the area of a 50% retracement of the mid-May to mid-July decline.

NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

The Nasdaq Composite (COMP) Index bounced strongly from the area of prior earlier year lows as highlighted on the daily chart below. The rebound was also deflected initially at resistance implied by the 21-day moving average, putting COMP back down near the top of its recent trading range.

I anticipate that the index will work higher after some backing and filling and maybe a pullback to near support in the 2250 area. Near resistance is at 2315-2325. Next resistance is in the 2365 area and then extends up to 2390-2420, a zone highlighted on the daily chart below.

Some tech earnings disappointments with Microsoft and saint Google (GOOG) led to a divergent trend on Friday, which was the way I had been seeing it with oversold extremes in the S&P and Dow leading to a good-sized rally in that market when oil had its inevitable (downside) correction.

Key support in COMP begins in the 2200 area and extends down to the 2170-2155 zone. I pointed out already that the Composite had a bullish price/RSI divergence that was a backdrop to the recent rally, as highlighted in the recent price and RSI trendlines sloping in opposite directions. A reading in the 30 area in the 13-day RSI suggested that COMP was quite oversold also.

NASDAQ 100 (NDX) DAILY CHART:

The Nasdaq 100 (NDX) Index in terms of its bounce from a prior low, then a minor pullback from resistance at the key 21-day average, is pretty much a copy of the recent pattern in the broader COMP index. The key difference, in a show of stronger Nas 100 relative strength, is that NDX hasn't retraced its entire prior advance; the index has mostly managed to stay above 1800, a retracement of 2/3rds of its March-May run up.

I noted last week: "As long as the index can maintain closes above 1800 I see potential for a rally, such as back to the 1900 area and higher; e.g., to around 1950." There were two consecutive closes below 1800, with the first such close leading to a next day sell off to 1760. However, the index came back relatively strongly by the end of that day, with Wednesday then bringing a minor breakout above NDX's down trendline.

Where to next? I anticipate that NDX can climb above 1856, to above its 21-day average. A close above the next resistance at 1900 may be tougher; tougher still to make it back to 1950.

Support is in the 1800 to 1790 area, then around 1785 and is next noted at the recent 1761 low. Major support begins at 1700 and extends to 1670, at the early-March bottom.

NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:

The Nasdaq 100 tracking stock (QQQQ) has rallied from support in the 43.70 area, with the one break to an intraday low at 43.3. Resistance has come in on rallies toward 45.7-46, the top end of the recent trading range. A close above 45.65, then 46.0 is needed to turn the short-term trend higher. Next resistance is at 46.7-46.9.

Near support lies in the 44 area, then at 43.7 and 43.3. Major support begins at 42.0

There could be some backing and filling, but the recent sideways trend in the Nasdaq 100 tracking stock, as with the underlying NDX index of course, looks to me more like 'basing' action for another rally attempt. I don't currently see potential to much more than back up to around 47 however.

RUSSELL 2000 (RUT) DAILY CHART:

The Russell 2000 Index (RUT) in follow the leader fashion did manage to break out above congestion/resistance at 680-684 and head up toward pivotal next resistance at 700. Above 700, a significant amount of stock should be for sale in the 717-720 area.

A close above 717-720, not reversed the next day, would be bullish for RUT, suggesting potential back to the 741 to 747 area which would be a more bullish outcome than I see in the current chart pattern.

Near support is in the 680, with next support at 660 and very key support at the prior lows and the low end of the multimonth trading range, at 647 to 643.

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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