Option Investor
Trader's Corner

More on Retracements

HAVING TROUBLE PRINTING?
Printer friendly version

Again your recent market analysis and projections of support and resistance levels on the OEX have been right on the mark.
While playing with my OEX chart after reading your update of 9/4/05 I had in the back of my mind your comment regarding the SPX and Comp that they ". . . retraced approximately 62 (COMP) to 66 percent of the prior advance. This amount is about as far as retracements go, unless they going to retrace 100 percent of the prior move."
Just for grins I put a retracement on the OEX from its high of approximately 3/2000 to its low 7/2002. Out pops a 38% recovery level from that "bottom" at approximately 562, a number prominent in OEX trading action for nearly a year now.
Seems to fit too closely to be a coincidence. Is this significant? Can you offer any insights to the implications of the OEX recovering to the 62% retracement level of its all-time high?
BACKGROUND NOTE:
The reference made is to my last (9/4) INDEX TRADER commentary, which can be seen on the OIN website by clicking here.

A note on my INDEX TRADER commentary: I write this once a week, on the weekend and summarize the week and project what I think will happen in the days ahead as far as the major Indexes (e.g., OEX, NDX, etc.) When you get your weekend Option Investor NEWSLETTER, there is a link to my Index Trader column at the top of the Newsletter; you can click on that and go to my column online. Or, just go at anytime to the OIN website and click on the "Index Trader" section. My midweek 'update' on where I think the market is headed is most often part of my Wednesday Trader's Corner column. (I keep intending to write a midweek Index Trader update, but haven't been finding the time yet.)

RESPONSE:
Well, first of all, never being entirely 'satisfied' with whether my market timing advice has been the most useful to OIN Subscribers, I did inject a note of caution ahead of the Tuesday (9/6) market open about the possibility that the Indexes could dip another time; down toward recent lows, but this would be an opportunity to buy calls. I was reasonably certain that the major indices had bottomed and had said so the week before.

There were many factors making up this (my) technical viewpoint. One significant factor was the percentage of the prior advance that got RETRACED at recent lows, especially in the indexes that were 'leading' on the last advance: the S&P 500 (SPX) and the Nasdaq Composite (COMP). More on that further on; as well as an answer to your retracement question on the S&P 100 (OEX).

While others explain and expound on the market influencing 'news' and market 'fundamentals', I find that everything that I need to know is in the charts. It's not that a market-savvy practitioner of 'technical' analysis thinks that the market is NOT driven by the outlooks for the economy, earnings and the like, only that the current outlook is best REFLECTED in price and volume activity. Since the market is driven by reoccurring market cycles and market outlook (psychology), there are reoccurring patterns that tend to happen. One of these (reoccurring patterns) involves percent retracements.

Percentage retracements of a prior advance are calculated from the last (downswing) low up to the highest high and projecting lines that reflect price levels representing 38% (sometimes also 33%), 50 percent and 62% of that distance; in addition, I also calculate a line that represents a 66% retracement or 2/3rds of the prior price swing.

When a decline falls to more than a 38% retracement, figure that the index or stock will give back (retrace) one-half of the prior price swing. If prices slip still further, figure that the fall will be another eighth (12%) more, or very possibly reaching a 66% retracement.

S&P 500 (SPX) HOURLY CHART:

If a retracement of a prior move goes more than 2/3rds, past experience with retracements will suggest the possibility that there will be a return to the prior low; or to the prior high, in the case of a 100% retracement of a prior decline. Since the fall shown in the SPX hourly chart was a bit UNDER the lowest retracement line shown (66%), heres a closer view and a bit more on the patterns:

'EXPANDED' S&P 500 (SPX) HOURLY CHART:
There was some 'slippage' below the lower retracement of 66%, but you also note on the expanded hourly chart below, that all but two of the hourly closes were above this line; and, the two hourly closes BELOW the line, were quite close to the line. My 'way' of technical analysis is to look at the DOMINANT pattern. We are measuring the predominant trend, not the absolutes, which are often the result of 'stops' being triggered; however, buying resurfaced soon enough in the case of SPX.

Just to add another note on PATTERNS, the move above the well-defined (hourly) down trendline above, was the technical (upside) 'breakout'. This was followed by a consolidation that traced out a bull flag pattern. It is a bullish consolidation and, once prices move above the upper end of the downward sloping flag or the upper trendline, there is usually a strong further advance.

NASDAQ COMPOSITE (COMP) HOURLY CHART:

The Nasdaq Composite (COMP) hourly chart is shown below, with what would be the 50, 62 and 66 percents of the prior advance. There was not point in showing the 38% retracement as that was substantially exceeded early in the decline. There was ONE hourly low that touched or reached the level representing the 62% retracement. From there, the Index rallied quickly, which was bullish.

I would also just note that I used the LAST low to figure my retracement levels; there was a lower low before the last COMP low which is off to the left (before) of the early-July low in the chart below. Some might use the lowest low and figure the retracement lines based on that. I usually use the last low. Most charting applications calculate retracements. If measuring retracements in a decline off a top, point first to the prior low, then to the top. If measuring a retracement of a prior downswing, point first to the last low, then the prior top.

If I were going to look at what would constitute the retracements in this latest advance, relative to the last DECLINE, I would see that the 62-66% retracement (of the last downswing) falls in the 2180 area. If the current rally is going to falter, anticipate it happening in this area. Otherwise, look for ANOTHER move up to the 2220 area, in a 'retest' of the prior top.

And, as an added note on patterns, involving technical indicators relative to price, the interest aspect in the COMP chart above is the long period when the hourly ('length' = 21) RSI was trending higher, while the index was falling. This is a bullish 'divergence', as RSI slopes UP, contrary to the direction of the price trend. What it tells you is to GET READY, for a trend reversal; usually a sharp and strong reversal. As soon as there is a breakout above the down trendline, you want to be in calls.

If you can't watch the market intraday (hey, I WORK at a 'day job' too!), you could have bought some Nasdaq 100 (NDX) calls when the 62% retracement occurred in the Composite (entry for the 8/30 opening at 1551.3 and set a mental or actual 'stop'/exit point just under the 66% retracement line relative to the COMPOSITE. Since the Composite was leading NDX, I would tend to trade 'off from' or based on the Composite.

Divide the NDX close by the COMP to see what one NDX point would equal in NDX. To set a stop in NDX calls equal to 2103 in the Composite, 3 points or just under its 66% retracement at 2106: multiple .736 X 2103 = 1549.8; setting a 1549 (or 1550) stop in NDX calls would have kept you in NDX calls through the recent NDX intraday low at 1551.4; today's NDX close = 1599.8. Yes, I work with 'close' tolerances in trading. [One of the most striking things I noticed in watching my first Pro football game was how precise their running patterns were and how narrow the distances between the pass receiver and potential interceptors.]

But, (as usual) I digress!!

The observation noted was first of all about the 562 level in the S&P 100 (OEX), representing a 38% retracement of the distance covered in the decline from the all-time high (in March 2000) around 846 to the July 2002 low around 385. The 560 has been, more or less, significant in the OEX for the past year or so. This was the area of the highs back in the first half of 2004; then, with the exception of a few weeks in April to mid-May, was the approximate low end of the 560-580 trading range that OEX has been in from the late-fall of 2004.

I would say that 580-582, the top end of this price range, on up to 590 is the next key resistance, as noted on the weekly OEX chart below. 560-562 is a reoccurring level as you say, and represents a 'minimal' 38% retracement of the major previous decline. It may be that the longer that OEX can hold above 562, the more likelihood that the index will achieve a 50 percent retracement by advancing to the 618 area.

As to the question of what are ... "any insights to the implications of the OEX recovering to the 62% retracement level of its all-time high?" ... I don't have an answer. An eventual move to the 672 area, representing a 62% retracement might coincide with some major resistance.
After such an enormous run up to the 2000 top, I would not anticipate more than such a 50 percent retracement; i.e., to the 618 area. I doubt that OEX can get much above 600. It doesn't look like we're seeing a set up prior to the resumption of a long-term bull market, but time will tell on this.
THE LOGARITHMIC SCALE:
The other thing we need look at is the retracements on the long-term charts using the 'SEMI-LOG' (logarithmic) price scale, more appropriate to major price swings. (The semi-log scale shows equal distances for equal PERCENT moves, rather than equal PRICE moves as in the usual 'arithmetic' price scale.)
Using the Semi-log scale on the OEX chart below, some even more interesting aspects show up relative to retracements; 570 is a key level, representing the 50% retracement. 570 was the area of the rally high (at the red down arrow) in early-2004. The pullback following this peak was exactly back to the 38% retracement line (at the green up arrow).

A 62% retracement, using the Semi-log scale, is to 628. It would interesting to see a break out above 600, but that ended 28-30 points higher. This might mark a 'final' top; this, assuming that OEX can hold at or above 570 over the latter part of this year.
IMPORTANT NOTE:
Please send any technical and Index-related questions for possible use in my next Trader's Corner article to support@optioninvestor.com with 'Leigh Stevens' in the Subject line.

** Good Trading Success! **
 

Trader's Corner Archives