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A Trade and Trend Checklist, Part 2

For my trade and trend checklist, I'm using the Acronym "POVS" ('Pops' with a "V"), for the first letter of each word, to remind myself to check the following:

Pattern; i.e., price or chart pattern
Overbought/Oversold
Volume
Sentiment

The above are the major chart/indicator aspects I check before making a trade AND for my ongoing evaluation as to whether to stay in any option I'm holding.

I'll carry on a bit more on "Pattern" by seeing how patterns mentioned in my Trader's Corner of a week ago were influences.
[ To see the previous article, click here ]


PATTERNS -
These are such things as formation of a double top or bottom, a deflection or rebound from a down or up trendline (respectively), a return to a previously broken trendline that may now have an opposite influence, a return to the top or bottom end of a likely trading range, etc.

I suggested two major chart aspects relating to Index patterns that could/would likely be influences on the rebound occurring in the S&P indices and in the Nasdaq.

In the daily chart of the S&P 500 (SPX) and S&P 100 (OEX), it was what would happen on a return to the previously broken up trendline. Support areas, once pierced (broken) tend to "become" resistance later on and vice versa (resistance "becomes" support). So, the question was would the trendlines in question act as deflections to the rally going on in the indices?

In the daily chart of the Dow 30 (INDU), the pattern was simply a rebound to a down (resistance) trendline - in the INDU weekly chart it was a return to the previously broken up trendline that was of interest.

THE RELEVANT CHARTS -

The S&P 500 Index (SPX) stopped short and then appeared to reverse after intersecting from what was the prior up trendline (had you kept it on the chart extended to the right). I marked key resistance in my 2/6 Sunday Index Trader column as being at 1205, which was the SPX high so far this week.

This 1205 figure came from just seeing where the intersection would be on this trendline extended out as seen below, not from any prior chart point like a prior top or anything -


By the way, regarding questions I've gotten on the location of my Index Trader articles - you need only go to the Web site, not the e-mailed Newsletter and click on "Index Trader" up top.

The S&P 100 (OEX) chart below shows the same return to ITS previously broken up trendline. This, by way of showing how the same pattern tends to be repeated on similar indexes - but, not always. Sometimes the Dow chart shows a different pattern.


I'll come back to a comment on overbought/oversold and my "Sentiment" indicator later on.

The Dow 30 (INDU) as shown on its daily chart below, did NOT come back to a previously broken up trendline, merely to its down trendline - very straightforward as INDU often is in its pattern.


Note that the above down trendline in the daily Dow chart cuts THROUGH one day's intraday price range. This is an example of the optimal way that I usually draw trendlines which touch the greatest number of highs and greatest number of lows - how "internal trendlines" are constructed. The market is not so mechanical as to always draw trendlines mechanically. Rather, they help up see the dominant trend direction and rate of change up or down.

On the WEEKLY Dow 30 (INDU) chart below, it was interesting to note that the weekly highs of late-August/early January were deflected by the previously broken up trendline.

What does this pattern yield of practical use to traders now? It does suggest that the most recent rally might not go very far as that prior top could have marked the high for some time to come - such an outcome is a tendency when you see this formation. Not for nothing, did someone call this the kiss-of-death trendline. Time will tell on what further rally potential there is.

NASDAQ and RALLIES TO A PRIOR (DOWNSIDE) GAP -
With the Nasdaq Composite (COMP), the pattern that I was seeing as significant was the downside gap that formed on an overnight sell off in January. A daily chart gap is where the next day's high doesn't reach the prior day's low - a "gap" then exists. This is an area where there was "unfulfilled" selling. Traders would have sold in this area but couldn't, instead having to sell at lower levels -

The Nasdaq Composite rallied to above this gap area - the gap did not act as resistance. The saying is that gaps get "filled" - but sometimes not MORE than that, as this area may be stubborn resistance for some period of time. You may have noticed that the Nasdaq 100 (NDX) trades the most "technically". We need compare the two charts - the Composite and Nasdaq 100.


A note on Oscillator Overbought/Oversold readings - as seen in the RSI Indicator above (the number 2 in my "POVS" checklist), January's low occurred right at the level that is usually considered to mark an oversold condition in the Nasdaq.

This was not the most reliable "signal" for a bottom as there was nothing in the pattern that might confirm a bottom there. But the oversold reading did signal the exact (down) swing low.

NASDAQ 100 (NDX) -
It's chart's gap DID act as resistance: as soon as the gap area was nearly "filled in" (by a move to near the high end of it), a sharp downside move occurred within a day as can be seen below -

Gaps sometimes don't get filled in completely, contrary to the saying that they do. The more significant is the resistance, the more they tend NOT to.


Another technical aspect you may recall me discussing is the tendency for the 21-day moving average to tell us where the Index trend is going. If a rally takes an Index back to ABOVE the 21-day average, this is often telling us that the rally is going to continue. If the same average acts as resistance, it says that the trend may still be down, and a further downswing take the Index to the lower trading band (green line on the chart above).

You may have also heard me say that I like to see two CONSECUTIVE days where the close is above or below some support or resistance point of significance - this because of the tendency, especially in Stock Index futures, for stop-loss orders to be elected (activated) and for the resulting buying or selling to take the Index (or stock) only temporarily over the point.

Zooming in on the Nasdaq 100 (NDX) chart below shows us that there were NOT such two consecutive days with closes above the 21-day average. This is another example of a pattern not showing up that you would like to have - to stay long NDX calls in this case. This pattern made me at least want to exit calls at this point. It would have possibly got me into puts - at this point I could exit with a small loss if the rally DID develop further.


As the NDX goes of course, so goes QQQQ - but with the tracking stock it was even more apparent (at dashed blue line) what was the previous "breakdown" point. A return to a breakdown point (or breakout point in the case of a bottom), especially in a stock, indicates a place of potential distribution, an area where there will be a significant amount of stock for sale - hence, resistance.


VOLUME - notice how daily trading volume in the Q's fell off on the high point of the rebound. Volume should "confirm" the price pattern. If the price is going up, the trend in volume ought to be the same.

SENTIMENT -
I'm going to mention "Sentiment" here, but write more about my Call to Put Indicator next time. The following S&P 100 (OEX) chart is the same one as seen above -


If you have found your way to my Index Trader column found as a section up top on the Option Investor WEB site (not the e-mail Newsletter), I indicated that I found the last low in the S&P suspect in that sentiment did not give a reading that I usually associate with a "final" bottom. This is the lower-most indicator on the S&P 100 (OEX) chart above.

My Call to Put Sentiment Indicator made its last peak (noted with the red down arrow) on 2/7, two days ahead of today's reversal. This indicator tends to peak, or bottom, 1-5 trading days before a reversal. So, it was right on "schedule"!

The goal is to see Patterns and Indicators "confirm" each other by at least two key technical aspects, of Pattern, Overbought/oversold, Volume or Sentiment, suggest a similar thing. We assume a trend will continue until it reverses. Highlighting the potential or likelihood of an UPCOMING reversal is very valuable to option traders.

Option traders benefit the most from ANTICIPATING a reversal, before option premiums get inflated after a (trend) reversal is already apparent or suspected.

Please send any technical and Index-related questions for possible use in my next Trader's Corner article to Contact Support with 'Leigh Stevens' in the Subject line.

Good Trading Success!!
 

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