OIN SUBSCRIBER QUESTION:
My question is do you use longer term charts, like weeklies, to help you decide what the overall direction of the market is? If so, what indicators do you recommend and what settings?
Then I switched to weekly settings and I thought "Not so fast Bucko, this market is still in upswing mode. Reminded me of your recent comments about the market not being particularly friendly to bearish trades. Hmmmm... Thanks for your insights.
Conversely, an ability for OEX to close, and then stay, above 570 is bullish; but I would give the Index a bit more leeway and take a bullish trading stance if the Index closes above 572, and then holds this area on balance after that.
572 represents the 2/3rds or 66% retracement of the March April decline. An advance of more than 2/3rds of the last down swing, suggest that the Index may go on to advance back to the area of the prior high (585) or beyond, to a new high. Stay tuned on that! Next is an OEX chart showing the retracements ....
I would also point out what I think is the significance of bellwether S&P (and Dow) stock General Electric (GE) holding at and above 36.50, the top end of a lengthily trading range or 'rectangle' formation, and a well-defined line of prior resistance. A close below 36.5 would be an ancillary sign of a possible pullback in OEX as well as in bellwether GE.
And, on the concept of "bellwether" stocks, sectors and other related indices see an ONLINE prior explanation by clicking here.
But I DIGRESS from my answer on the question, a bad habit!
Regarding the use of WEEKLY charts:
On weekly charts, such as in the OEX (S&P 100), I tend to rely mostly on interpretations of the chart patterns and relevant trendlines. As far as INDICATORS, I do also look at the Relative Strength Index (length setting, 8) on an 8-week basis to gauge how overbought or oversold the market might be. I like using the Fibonacci number sequence and 'length' settings of 5,8,13 and 21. [For daily charts, I use 13 & 21 mostly; sometimes 5 for very short-term trading.] For weekly charts, I use an RSI measuring 8 (sometimes 13) weeks, as is seen in the chart below.
As far as the patterns, OEX has broken out above its very long-term down trendline, but has not yet achieved a decisive upside penetration back into its (weekly) uptrend channel. It's hugging the line so to speak, but is starting to trade just (back) into its prior uptrend channel; a mild bullish plus if this pattern continues and if OEX works higher from (you guessed it!) 570-572.
Now, there is a fair amount of use of the MACD indicator, a measure of price momentum, on weekly charts. In fact, this indicator was formulated especially for use on WEEKLY charts.
I don't use the MACD Indicator as much as some. Momentum can be seen on price charts and gauged well if not better by trendlines I think, but the MACD can be a confirming indicator. The MACD is about to achieve a bullish (upside) crossover if the trend doesn't falter around recent highs and the OEX continues to work higher on a weekly closing basis.
Someone asked me (and I was looking at it myself) about what would constitute a REVERSAL of the recent strong up trend. The concept of what constitutes a reversal pattern, and especially a so-called "key" reversal is a topic in and of itself and useful for trading in many instances.
Some reversal patterns are formed in only 1-2 sessions of whatever time duration (e.g., hourly, daily, weekly) being watched. You may hear the term "key" upside or downside reversals used for these situations. Sometimes a price 'spike', where the high or low for the bar is noticeably above or below the close, warns of a trend reversal.
Certain candlestick patterns that form in one session are anticipated to mark a trend reversal; e.g., the "hanging man" or "hammer". At the opposite extreme are patterns that form over an extended duration such as are described in technical analysis as "broadening" tops or bottoms.
The discussion here is of the type called key reversals on a bar (or candlestick) chart, measuring the High, Low and Close (HLC); or, commonly, containing the Open as well (OHLC charts).
A strong sign of a trend reversal and which is often the start of a intermediate or long-term trend change is the formation of 1 or 2-day key reversals. By the way, the definition of a key reversal is only loosely defined in technical analysis.
A common definition of what is usually called a reversal up day or reversal down day is as follows (sometimes also loosely called "'key' reversal up" or "'key' reversal down" days). I use as examples what are typically the most significant or at least talked about reversal time frame, those seen on a DAILY chart:
1. Reversal up day a day where there is a lower intraday low than the prior day, followed by a close above the prior days CLOSE. Such days are fairly common and I resist calling this set of conditions, a "key" reversal in fact, there is no agreed upon textbook definition of what exactly makes a reversal a key reversal. I learned it one way, others another way.
2. Reversal down day a day where there is higher high than the prior day, followed by close that is below the prior days close.
What I consider to be a more significant and what makes a reversal a KEY reversal, either up or down, is this definition:
1. Key Upside reversal a day (or hour, week, etc) where there is a lower low than the prior "bar" or prior two bars AND the close is above the high of the prior bar or the prior 2 trading periods.
Since I use examples on the daily charts, I'll start to substitute 'day' for 'bar'; just keep in mind that the SAME reversal patterns occur on intraday charts like 15, 30 or 60 minutes, AND on weekly and monthly charts.
2. Downside key reversal day: a day where there is a higher intraday high than the prior day (same as the above "reversal down" definition) OR prior 2-days AND the CLOSE is below the prior days LOW (a 1-day key reversal down) or, of the prior 2-days (a 2-day key reversal down).
The key reversal term does tend to be applied most often to a daily time frame or daily chart.
The pattern of a move to new low, followed by an upside reversal and a CLOSE that is above the prior day's HIGH happened recently in the S&P indices, and the S&P 500 (SPX) daily chart is shown below...
The fact the last LOW here was substantially below the prior day's low is reinforcing for the upside key reversal. Of course, as well, SPX made an approximate double bottom. The two pattern types together made it a very potent indication that the market had bottomed.
Significant tops and significant bottoms are emotional events and are often extreme. Selling accelerates as more and more traders and investors dump stock, UNTIL there it (the selling) gets 'exhausted'. Short-term traders sense this and start covering short positions and there is a rapid rebound.
The Nasdaq did not also have a "key" reversal, only the common reversal pattern: a lower low, in this case substantially, followed by a close above the prior day's close as seen in the Nasdaq 100 (NDX) chart below ...
The circled day was a more common variety 1-day (upside) "reversal". However, the fact that the intraday low as SUBSTANTIALLY lower than the day before and in fact was a new LOW for the move, is also highly significant.
Such a "spike" down to a new low (a 'spike' low) as seen above which was followed by an immediate upside rebound, also fits the pattern of a "bear trap" reversal; i.e., a new low for the move, followed by an immediate substantial upside reversal. [The reverse pattern is a "bull trap" reversal: a new high for the move, followed by an immediate fall.]
And, as always...
LOOK FOR MULTIPLE SIGNS OF A BOTTOM OR TOP
The above pattern seen in NDX had a low that was at the lower end of its downtrend price CHANNEL, which adds significance to what happened in the subsequent reversal also.
As well, it seemed that a bullish price/RSI DIVERGENCE occurred, as the daily Relative Strength Index (RSI) established a pattern of trending higher, unlike the lower intraday lows.
Of course it's also true that the RSI measures the CLOSING level of the Index versus what we're seeing in a chart above, that shows intraday price swings. In a way the RSI divergence seen in the above daily chart is just another way of viewing a price trend that reversed from down to up.
LOOK AT OTHER TIME FRAMES
So, in the case above of a possible bullish Price/RSI divergence, is a bullish Price/RSI divergence apparent on the hourly chart?
I use an Hourly CLOSE-ONLY or 'line' chart below of the same period when the Nas 100 (NDX) Index was bottoming as seen above in the daily chart.
Since the RSI does its indicator calculation based on the close of a bar (e.g., hourly, daily, weekly, etc.), the line chart is a key one to look at. The RSI indicator below has a longer 'length' setting than I usually look at (21), at 34. 34 being the next higher number in the Fibonacci number sequence of adding the two prior numbers to get the next higher one: 1,2,3,5,8,13,21,34, etc.
And, a clear-cut bullish HOURLY Price/RSI divergence is seen in this next chart ...
Looking at other patterns, indicators and time frames is simply part of the 'check list' so to speak, that can be run through for 'confirmation' of key, or simple, reversal patterns.
Reversals of trends are very important to an option trader as spotting reversals means that you have the most confidence possible, at least as supplied by technical analysis, that you are getting into a NEW trend and, EARLY in that trend.
Good Trading Success!