The past week, following last week's bullish reversal, was looking like it was going to finish flat but Friday's rally gave us a strong weekly candle to give the bulls a bullish candlestick pattern. But while the week finished strong it wasn't enough to keep the month from being the worst January since 2009, which of sparks discussion about the January barometer.

Week's Indexes


Review of Major Stock Indexes

Helping to spark the rally on Friday was a global equity rally that started in Asia following Japan's decision to drop their key interest rate in negative territory. The feeling is that this could get the Fed to at least back off on its desire to raise rates and it might force them to think more seriously about lowering rates as the race to the bottom in currency devaluations continues.

At the moment the Fed's actions have only helped the U.S. dollar stay stronger while others devalue their currencies (the dollar rose to a 5-month high vs. the yen on Friday), which in turn causes the importation of deflation as imported products are cheaper. By raising interest rates, and just talking about raising rates, the Fed is actually helping deflation take hold, which is exactly the opposite of what they want to achieve. It's just one more example of how flawed their economic models are.

The blue chip indexes finished the week with about a +2% gain but unfortunately that wasn't enough to prevent January's loss of more than -5% from being the worst month since last August and the worst January since 2009. The Nasdaq finished down nearly -8% and the RUT finished down -8.8%. The banks got hit harder, down -12.6%, and the biotechs, which have been the star performers the past few years, got taken out behind the woodshed and were shown little mercy, down -24%. January was also the most volatile January since 2008 but that January led to a choppy rally into May before the bottom fell out. Many traders are hoping we'll see at least something similar (without the bottom falling out).

Friday's advance-decline line and volume were very strong, almost capitulation kind of strong (10:1 up vs. down), such as was seen on August 27th. The next day saw only a minor intraday high and then started the choppy pullback into the September 29th lows. It appeared to be an end-of-month run and that leaves a question market as to whether it was real buying interest or more of a manipulated rally. While advancing volume strongly exceeded down volume, the total volume was only slightly stronger than average. The bulls need to see follow through with strong volume and daily closes near the top of the day's range. If we see that in the next few days then we'll have a much stronger signal that new highs are likely coming, which would have us looking at pullbacks as buying opportunities. But at the moment the bearish pattern is the more likely one, which says the bounce will be reversed and prices will drop lower.

As far as Friday's rally, most of the large hedge funds, the ones with the ability to move the stock market around, especially during the overnight session, receive much of their fees based on assets under management (AUM). Isn't it interesting that one of the biggest rally days of the month was the last day of the month. Purely coincidental I'm sure. If the funds were doing some buying just to boost the prices as much as possible for month-end close they might not be willing to hold onto that inventory next week, which is another reason follow-through buying is important for the bulls at this point.


A Look At the Charts

In last weekend's wrap, following the sharp reversal off the January 20th low, I had shown a depiction for a pullback from Friday's high and then another leg up into the end of this past week to create a larger a-b-c bounce correction to the decline. We got more of a choppy sideways consolidation instead of a deeper pullback and then Friday gave us the next leg up. Now it's time to figure out where the bounce could be headed.

I want to look at upside targets because the trade setup (the higher-probability one) is for a reversal back down and to new lows and the setup for the reversal is looking like it could happen on Monday. This fits both a price and time window for a reversal (February 1) and I like the setup for what should be a nice trade. I'm not looking for much lower than the January 20th lows before we're set up for another bounce correction so we're definitely looking at trading, not sell and hold (and certainly buy and hold should be banished from your dictionary).

I'll start the weekend review with the Dow's weekly chart and then zoom in to see how it should set up on Monday and what our next downside target will be (to help evaluate risk vs. reward).


Dow Industrials, INDU, Weekly chart

Because the January low for the Dow did not drop below last August's low, I can still consider a potentially bullish pattern, shown with the light green dashed lines on the chart below. This pattern calls for a large-range sideways consolidation into the summer before starting another rally that will take us to new highs. I believe the higher-probability pattern calls for a stair-step move lower into the fall, something like what I have depicted in bold red. Assuming we'll get another leg down from the current bounce, I see the potential for a drop to price-level support at 15340-15370 (February 2014 and August 2015 lows). From there another bounce correction before heading lower into April, followed by another larger bounce correction and then lower into the fall (this is the stair-step pattern lower I keep mentioning). From the low in the fall, assuming it plays out as depicted, we'd have a good setup for a large corrective rally into early 2017 before the bears really attack this market.


Dow Industrials, INDU, Daily chart

Friday's rally had the Dow closing above its 20-dma at 16361, which is a bullish sign. There is upside potential to the bottom of a previously broken down-channel for the initial decline from December, near 16800, maybe even up to price-level S/R near 16900. But there is a price projection and Fib retracement pointing to 16550-16600 as a good target zone to watch for the top to its bounce. If reached and rolls over from there I think it would be a very good setup to trade the short side.

Key Levels for INDU:
-- bullish above 16,900
-- bearish below 15,863


Dow Industrials, INDU, 60-min chart

The 16550-16600 target zone for the Dow is shown on the 60-min chart below. Two equal legs up for an a-b-c bounce correction off the January 20th low points to 16550. A 50% retracement of the leg down from December 29th is at 16600. If the Dow rallies above that target zone then I'd watch for a rally to 16800-16900. But for now the setup looks good for the completion of the bounce correction on Monday and then down for the rest of the week and into the next.


S&P 500, SPX, Daily chart

As you'll see for all the indexes, the patterns look the same and the expectation for the coming week is the same. SPX is now close to back-testing the bottom of its previously broken parallel down-channel for the initial decline from November-December. It's currently near 1950 and the 50% retracement of its decline from December 29th is near 1949. But two equal legs for its bounce off the January 20th low points to 1969 so that's a higher potential than for the Dow. Either the Dow will hold back SPX or SPX will drag the Dow higher so keep an eye on both to help gauge where resistance will be. Look for intraday bearish divergences to help identify where the top could occur. But if SPX can rally above 1970 I'd look for a move up to price-level S/R near 1992. Above 1993 would change the price pattern from bearish to bullish since it would be an overlap of the December 14th low (a rule violation for the bearish EW count).

Key Levels for SPX:
-- bullish above 1993
-- bearish below 1867


S&P 100, OEX, Daily chart

Take the titles and price scales off these charts and it would be hard to identify which one was which. The OEX chart below is a spitting image of the SPX chart above. A 50% retracement of its decline from December 29th is near 870 and two equal legs up for its bounce off the January 20th low is near 878 so that's our upside target zone. The bottom of its previously broken down-channel is near 881 and therefore 878-881 is clearly a possibility before the sellers return. Above 890 (the December 14th low) would change the pattern to bullish.

Key Levels for OEX:
-- bullish above 890
-- bearish below 835


Nasdaq Composite, COMPQ, Daily chart

The techs have been relatively weaker than the blue chips (a somewhat defensive posture) and for the Nasdaq the 2nd leg of the a-b-c bounce off the January 20th low might only make it up to 62% of the 1st leg, a common projection in a weak move. That projection is near 4619, not much above Friday's high near 4614, which is also about where the 20-dma will be located on Monday. So there might not be much left to the upside for the techs. However, if the blue chips do rally some more on Monday we'll likely see the techs head higher as well. If they continue to lag the blue chips then they'll likely lead the market to the downside following the reversal.

Key Levels for COMPQ:
-- bullish above 4872
-- bearish below 4450


Nasdaq-100, NDX, Daily chart

NDX finished on Friday slightly above its 20-dma so it's slightly stronger than the Nasdaq in this regard. The 62% projection for its 2nd leg of the bounce off the January 29th low is at 4282, only slightly above Friday's high at 4279 and a 50% retracement is near 4348. That gives us a couple of levels to watch on Monday to see where the rally might top out. The pattern does not turn bullish until it can rally above its December 14th low near 4478 so there's a lot of work for the bulls to do to make that happen.

Key Levels for NDX:
-- bullish above 4478
-- bearish below 4112


Russell-2000, RUT, Daily chart

The RUT was the stronger index on Friday, up +3.2%, and it took price up near potentially strong resistance at 1036-1040 by closing at its high near 1035. On January 13th it sold off sharply and broke its uptrend line from March 2009 - October 2011 (you can see the big red candle when it happened). On Friday the big white candle brought the RUT back up to the broken trend line and it's a setup for a back-test to be followed by a bearish kiss goodbye. Only slightly higher, near 1037, is the top of a parallel down-channel for the decline from December. This channel is an EW channel created by drawing a trend line from the 1st wave through the 3rd wave and then attaching a parallel line to the 2nd wave -- it often acts as a good guide for where the 4th wave (the bounce off the January 20th low) will stop. And then above 1037 is price-level S/R (its October 2014 low) at 1040, which could also be a back-test to be followed by a selloff. We have a bearish setup here but if the buyers keep going on Monday then I see upside potential to 1062 (two equal legs up from January 20th) and then price-level S/R near 1080. An intraday break above 1040 followed by a close below Friday's high (1035.38) would be a sell signal.

Key Levels for RUT:
-- bullish above 1040
-- bearish below 996


SPDR S&P 500 Trust, SPY, Daily chart

The SPY daily chart below shows the strong spike back up after pushing the lower BB lower, like it did in August, and how it has now reached the middle of the band (the 20-dma). Upside potential by the BB is the top of the band, currently near 202 and coming down fast, but you can see in the past how many times a rebound off the lower band resulted in just a poke above the 20-dma before rolling back over and I suspect we'll see the same thing. You can also see that the MFI is back up near the 50 line and how often it reversed from that level. Bulls would obviously like to see the MFI climb above 50, which would support seeing SPY rise up to the top of its BB. Otherwise the short-term relief of oversold conditions should lead to a continuation lower.


Powershares QQQ Trust, QQQ, Daily chart

The picture is the same for QQQ -- it rebounded off the lower BB and has made it up to the middle of the band. The Williams %R has a little more upside potential before hitting the upper line (-10) before reaching overbought but there's no guarantee it will get there. At the moment it at least has some bullish potential for follow-through buying on Monday. You can see the volume on both the SPY above and QQQ below that neither could be considered especially strong volume even though we had a 90% up day.


Summary

All the price patterns look the same and from an EW perspective it's a clear setup for another leg down if we're to get a 5-wave move down from the December 2nd highs. The bounce off the January 20th lows fits well as an a-b-c 4th wave correction and Monday is looking good for a reversal back down. It's looking like we could see the indexes work their way a little higher on Monday but it could fail at any time and therefore I consider the long side the riskier side. There's still more work for the bulls to do before they can negate the bearish pattern.

Assuming we'll get another leg down to complete a 5-wave move down from December 2nd, it might result in only a minor new low, or a test of the January 20th lows, and then start another bounce correction. So I'm only looking for a trade on the short side, which could take us into mid-February. That would be a setup for a bounce into opex week but obviously that potential will have to be evaluated if and when we get the low into mid-month. That's the setup and now we'll see if the market has something different in mind.

Trade safe, have a good week and good luck with your trading. I'll be back with you next weekend.

Keene H. Little, CMT

Technicians look ahead. Fundamentalists look backward. The true language of the market is technical. - Joe Granville