Option Investor
Index Trader

Strong Bottom Formations Lead to Strong Rallies

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THE BOTTOM LINE:

I wasn't able to update last weekend due to technical problems I was having with my notebook PC while away from home base. I missed my usual Trader's Corner article from a week ago Thursday, but managed to get back in action this past Thursday.

I was predominately bullish on my last Index Trader update from 2 weeks back and even more so on in my Thursday "Trader's Corner". I'll repeat some of that commentary (on 'rectangle bottoms') here. You can go to the full (Trader's Corner) article yourself online also by clicking here.

In the aforementioned article I took note of the 5 technical patterns that Dr. Andrew Lo's research at MIT pointed to as having above average predictive significance in terms of how the trend unfolds after these patterns. Those 5 patterns are the:

1. Rectangle bottom
2. Head and Shoulders top
3. Double top
4. Rectangle top
5. Broadening Bottom formation

The bottom pattern in the S&P 500 (SPX) is the more common V-bottom type; this formation was also significant for suggesting a bottom was developing or in place. Heres the SPX daily chart as of the Thursday close:

All that was needed to 'prove' the bottom so to speak was a move above the highlighted 'line' of resistance seen above, but that outcome was fairly well predicted (to me anyway) by the pattern.

So, along comes Friday, a total 'random' event (sure!) and the updated SPX daily chart looks like this of course:

What I ESPECIALLY took notice of was the 'rectangle bottom' that was shaping up in the market-leading Nasdaq 100 (NDX). Not only was this bottom pattern of a higher 'order' of predictive value (per Dr. Lo and my past experience), but the rectangle pattern has a 'measuring' implication for a next upside objective for the move.

Next is the NDX daily chart I showed in my Thursday column so it reflects the index only through Thursday. I noted the following about the NDX chart then:

"There was a breakout above the top end of the implied NDX rectangle yesterday (Wednesday), followed by a pullback to the top end of the box like pattern today (Thursday). If there is a valid breakout that has occurred, what was resistance (the top of the box) ought to now 'become' support. Stay tuned on that!

The measuring implications of a breakout above an apparent rectangle bottom are a 'minimum' one (the conventional interpretation) seen if there's a move ahead equal to distance 'A' and a 'maximum' one, suggested by a move back to retest the 2056 high and equal to distance 'B'."

The next development in the chart is reflected next, where everything (comments, etc) about my graph is the same EXCEPT that NDX reflects Friday's major rally:

A long segue-way intro here saying that I'm STILL BULLISH based on the charts and the market is getting more interesting. Individual stock index commentaries follow below. This coming Friday is expiration of index options, so there may be some volatility related to unwinding.

E-MAILS NOT ANSWERED...
I noted last time I wrote this column I think that our (Option Investor) support desk was forwarding e-mails for me to an outdated (for nearly a year!) no longer good e-mail address. I don't know if any of you noticed that e-mails that don't get delivered don't so reliably 'bounce' back, indicating that there is no such (e-mail) address. Seems like that is more and more the case and I don't know why really. The notification of a bad address used to help me stay current with people. Anyway, the following is NOW true:

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

FUNDAMENTAL 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) could be bottoming for a move higher, such as back to the 1320 area or even 1350. The dominant or longer-term chart pattern is bearish. I wanted to be long calls since and after the tip of the V-type bottom was made in the 1200 area; on a risk to reward basis the outlook was very favorable at that juncture. I think it's still favorable to be long calls and short puts, just so it's understood that the further upside potential is getting more limited.

Key near resistance is at 1320, representing a fibonacci 50% retracement of the last downswing. Next SPX resistance comes in the 1350 area and that's about the best upside I see for this current move. Longer-term, I don't know. Fortunately I don't have to think 'long-term' as in a portfolio situation. In the S&P I like the major oil stocks again however, as the CBOE Oil Index (OIX) is back down to support implied by its long-term (multiyear) up trendline.

Pivotal near support is at 1260, with next technical support in the 1235 area.

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

The S&P 100 (OEX) Index has been trending higher ever since the one bullish call to put volume reading highlighted on my 'sentiment' indicator below, at the green UP arrow. How good is this indicator or what! I don't put much stock in moving averages/moving average crossovers of this ratio in terms of timing entry or exit on trades; the 5-day moving average I display is to give a bit broader take on the trend in the actions of options players.

While it looks like it still ok to hold calls, and buying on the pullback to the low end of the broad downtrend channel offered a fantastic opportunity on a risk to reward basis, I don't want to lose sight of fact that the major trend is still down and bearish. Keeping this in mind makes for a still cautious attitude; as you know there has been a lot of volatility in recent weeks with all the many cross currents.

I can see potential back up the 610 area and possibly OEX will make a run to the low-620 area. Fairly tough resistance begins around 640.

Very near support is at 596, at the line of prior recent resistance. 580-581 is the pivotal technical support. 'Pivotal' implies that a close below the key 21-day moving average, not reversed (back to the upside) the following day, would reverse the short-term trend to down. A 'confirmation' of a renewed downtrend would look conclusive on a two consecutive day close below 570. 550 is major support.

DOW 30 (INDU) AVERAGE; DAILY CHART:

The Dow 30 (INDU) remains the weak sister (brother?) of the major market indexes. INDU has rallied recently of course, pulled up by the broader market, but the INDU advance has to be seen as being within a dominant downtrend.

I can envision a continuation of the recent advance to the 12000 area but not much more than that currently. A weekly close over 12000 would be bullish, suggesting potential for a move to still higher levels, perhaps to the 12300 area, maybe even to near 12500 which is major technical resistance currently.

Near support is anticipated around 11400, below this in the low-11200 area, extending down to 11125, at the late-July downswing low. Major support begins at 11000 and extends to the 10800 area.

NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

If there's a place to be it's in the tech stocks and the Nasdaq Composite (COMP) Index had a powerful surge this past week. After a decisive upside penetration of near resistance in the 2350-2352 area, there was one pullback to this area which was had 'become' technical support, giving a further opportunity to pick up some calls in your favorite tech stock mover or in the awesome Nas 100.

COMP probably will begin to encounter near-term resistance in the 2420 area, with stronger technical resistance around 2480. Major resistance lies at the prior double top at 2550.

Near support is in the 2300 area, then at 2280-2270. Major support is at 2200.

NASDAQ 100 (NDX) DAILY CHART:

The Nasdaq 100 (NDX) Index projects to 1950-1957 and could get back to at or near 2000, which was the prior 'breakdown' point. The overall chart remains somewhat mixed but the long-term weekly NDX chart uptrend remains intact. Most importantly to index option traders, NDX has had substantial price swings and directional trends BOTH up and down for weeks, not days, unlike say the Dow 30. Once NDX broke out above its well-defined multiweek 1785-1870 price range, it wasn't rocket science to predict that the index was going to run to the upside.

'Rectangle' bottoms tend to have a good record of predicting a good-sized move in the direction of the breakout as the shorts scramble to cover when the index shoots above resistance that's been in place for awhile and the bulls come in less fearful and in a buying mood. In the new global economy, tech has been one of the brighter spots in earnings trends. My recent 'technical' troubles in my trading software were just solved by a new Dell Notebook PC and I'm impressed with how much power and performance it has. Technology is one of THE markets for the future as demonstrated by the powerful aforementioned long-term uptrend in the tech biggies.

Near NDX support is at 1870, with pivotal technical support at 1840, and major support beginning in the low-1800 area.

NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:

It's been a relatively low volume rally in the Nasdaq 100 tracking stock (QQQQ), but I have a new theory on volume as it relates to this key tracking stock. Less volume means less conviction and like low bullish 'sentiment' offers a contrary indicator; i.e., tends to be bullish.

I wrote last two weeks ago that I was projecting a move in the Q's to the 47 area. It now looks like QQQQ could move still higher, but I don't see huge upside before stronger selling interest comes into play, especially if the stock gets back up to 49.

Near resistance is at 48, with tougher resistance likely in the 49 area, which was a prior breakdown point. Near support is at 45.25, with next support coming in at 44.25-44.0. Major support is at 43.

RUSSELL 2000 (RUT) DAILY CHART:

The Russell 2000 Index (RUT) is mixed in its pattern and best resembles a broad trading range market. Buying at the low end of the range on the last dip under 660 was a winning trade and it looks like there is more upside ahead, perhaps back to the 760 area, or the top end of RUT's broad range.

The fibonacci 55-day moving average continues to be a good trading guide as to the trend. The average initially acted as resistance (note the red arrow) and when RUT finally managed more than at 1-day close above this key average, it defined a key area of technical support.

Near resistance is in the 740 area, then at 760-763, the area of the prior top. Pivotal near support is in the 712 area then in the 702 to 694 zone.

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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