Option Investor
Index Trader

Madness of Crowds and Stampeding Bears

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THE BOTTOM LINE:
Or is it the bulls that normally 'stampede'? Bears charge when smelling blood or danger I believe but I myself have only faced the Wall Street kind.

A couple of key aspects to this current market meltdown that I wrote about last week, were that I thought that certain indicator extremes would be seen before prices started bottoming out. The PRICE level at which even an interim or temporary bottom would form in such a 'waterfall' decline is very hard to project. I thought then (last week) that we would be looking at possible test of lows seen back in 2004 and '05. NOT! The S&P 500 (SPX), down 200 points on the week, is instead getting close to hitting it's 2002 low.

I've noted for awhile now that the major indexes are as oversold as they've been in decades on a weekly chart long-term basis, as highlighted above (yellow circle) with the SPX 13-week Relative Strength Index (RSI).

In an over the cliff waterfall decline like this and a major panic like not seen in decades, prior lows as possible support levels give way like a knife through soft butter. To offset the unknowns regarding what price levels might signal buying interest and a bottom, I rely on some key technical type INDICATORS (RSI and 'sentiment') as far as 'signaling' the conditions where the major indexes are ripe for a turnaround.

Both key conditions were met finally this past week; in one (my extreme bearish 'sentiment' indicator), only on Thursday (and then again on Friday) as traders finally got as bearish appears warranted by the market free fall. The conditions suggesting the market is ripe for stabilization and a potential bottom will be discussed as part of my commentaries with the major index charts below. Paraphrasing from LAST WEEK:

"In terms of charts and indicators, there are things I anticipate relative to a next bottom:

** Almost certainly, trader sentiment is going to get MORE bearish than it is now in terms of call to put readings; i.e., the ratio of total daily equities call volume relative to total daily put volume.

** ...indicators like RSI, on a DAILY chart basis, are going to get 'fully' oversold just as the WEEKLY chart RSI is showing already..."

Those holding index puts need to assess the possibility that the major indexes WILL stop their free fall at some point (maybe it's started) and are due for a rebound such as was seen after the sharply lower Friday opening. Even if rally attempts are short-lived, most of profit in index puts may be realized by now.

The panic phase is not quite the end of major bear markets. After panic comes a surrender or disinterested phase where investors just don't want to hear about stocks, don't want to look at them and don't want to open their statements. We're seeing some of this now to a greater extent than last week. This phase tends to go on for a lengthily period but tends to end the panic free-fall stage.

SHORT SELLING RESTRICTION LIFTED THURSDAY
The most notable example of renewed shorting appeared to occur with Morgan Stanley and in the insurance sector. Insurance stocks tend to hold the highest quality stocks, but even the best of them go down with a sinking ship. As Charles Dow used to say, the rising or falling tide lifts or drops ALL boats.

My commentary will by necessity be concise and to the point (less long-winded?) than might be the case if it were not that I am writing this between breaks in a seminar I'm participating in this weekend. I am forgoing the pool, the outings on the green and all that, in order to try to make a little bit of sense out of the current madness. I was going to skip my column all together, but duty calls!

QUESTIONS/COMMENTS:
Please e-mail me with any questions or comments at Click here to email Leigh Stevens support@optioninvestor.com and 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:

A projection out into the future of the current or past rate-of-change in prices (i.e., a trajectory of price 'momentum') is what a trendline is. As of the close on Thursday, the S&P 500 (SPX) had even fallen under its prior most negative prior rate of downward momentum, as measured by its rate of decline in June-July. This is represented by SPX having pierced the downward red (dashed) trendline highlighted below. This move finally put the 13-DAY RSI into a 'fully' oversold condition which is one of indicator events that I thought would occur BEFORE a bottom was seen, even if only an interim one.

I noted last week that the 13-day RSI had not gotten fully oversold, unlike the extreme seen in the weekly chart as of the prior week already. Now however, the 13-day RSI is 'fully' oversold as highlighted at the yellow circle on the lower portion of the chart. Because it was so unusual to see the prior mismatch in oversold indicators between the weekly and daily chart RSI indicators it was also a key reason why I thought last week that the market had significantly more to go on the downside. In a market of 'extremes', EVERYTHING (all indicators) will get extreme. I can't point to an exact principle at work here, just something that experience suggests to me.

I've noted near resistance on the daily SPX chart at 1020 to 1050. Potential support begins around 840, extending to 800. I'm not showing it on the chart, but SPX support should also be found at 775. Multiple lows in the July 2002 to March 2003 occurred in the 800-775 price zone and suggests support in this area.

S&P 100 (OEX) INDEX; DAILY CHART

The other 'extreme' (besides in the 13-day RSI) that I expected to see before the market bottomed is highlighted on the lower portion of the S&P 100 (OEX) chart below, which is the bearish 'oversold' extreme on my trader sentiment indicator. The market will tend to prolong declines UNTIL there is day or cluster of days when CBOE daily equities put volume equals or exceeds daily call volume.

This recent market saw a very steep decline before traders got convinced that the market was not going to rally 'any day now' and to start betting on further downside potential. We can't of course assume that all put activity is buying, since shorting puts is also a way to bet on the underlying stocks being at or near a bottom. Nevertheless, such declines in the CPRATIO line ratio has proven over many years to be a contrary indicator, suggesting that the major indexes are close to a bottom; e.g., within 1-5 days after such daily extremes, which is reinforced by the drop in the 5-day moving average into the same 'oversold' zone.

Support is in the 400 area, extending down to 385 at the green up arrow. Resistance is at 480, then at 520.

DOW 30 (INDU) AVERAGE; DAILY CHART

You'll see again on the Dow 30 Average (INDU) how the recent downside acceleration has taken prices even under the prior rate of decline or downside momentum as highlighted by the red down trendline. This is another way of looking at how oversold this market and INDU is.

Near resistance is at the aforementioned (down) trendline, at 9000, then at 9600 and finally at 10000, which will likely to prove to be fairly major resistance, this level having reversed its role as (previous) 'major' support.

Near support/buying interest was seen in the 8000 area, with next support probably coming in around 7500.

NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

The Nasdaq Composite Index (COMP) hasn't fallen quite so far below what I would normally see as 'support' implied by the lower end of its downtrend channel. COMP hasn't gotten as oversold in terms of the 13-day RSI as at its late-June/early-July bottom and Nasdaq stocks may see the best initial buying interest in terms of when portfolio managers and individuals get up some conviction again on stock prospects.

In terms of prior historical lows at least going back to the region where COMP bottomed in 2003, I can't point to potential support based on the long-term weekly charts (not shown) until around 1350 to 1300 and that is still some distance lower. I doubt that tech stocks are going to get pushed down that far but I didn't think they would get this far either! It's only a guess as to where COMP turns around price wise.

Resistance is easier to measure: at 1800, then at 1900.

NASDAQ 100 (NDX) DAILY CHART:

The Nasdaq 100 (NDX) has gotten very oversold relative to ITS last significant bottom. If there was one index call to play in a probe of the long side, NDX looks like it could be the best play for a bounce.

I've noted support at 1100, but I think INITIAL support has already been successfully tested at 1200. Major support is at 1000.

Near resistance is in the area of the recent downside gap, around 1440, with next likely resistance coming in at 1500.

RUSSELL 2000 (RUT) DAILY CHART:

Support in the Russell 2000 (RUT) developed in the 470 area late this past week. I've noted next support down in the low-400 area. Needless to say, RUT is also very oversold, which at least implies favorable 'conditions' for a rally in this group of stocks. Oversold or not, there still has to be a significant number of buyers willing to take some money from under the mattress and exchange that green for stock. While the major big-cap stocks are still suspect, there may be some decent buying interest in RUT.

Resistance comes in at 600, then even stronger resistance is implied by the line of prior support at 650; support, once broken, 'becoming' resistance later on.

GOOD TRADING SUCCESS! BE CAREFUL OUT THERE!!

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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