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Trendlines

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I was absent from this space last week, due to an attack of the killer flu bugs. Well, maybe I shouldn't make any kind of joke regarding a 'killer' flu, as there are some much worse ones that may be out there now or in the future, than the one that laid me low for a couple of days.

As I was wondering this morning what illuminating topic I might write about, hopefully to take my mind off why I wasn't short this market!, I was 'saved' (as to a relevant topic for discussion), by an OIN SUBSCRIBER QUESTION that came in:

"What do you see now in the trend and do you consider that the market is now in a down trend? Also, what do the charts show you about oil prices, and gold too which has been really strong lately?"

RESPONSE:
Those who follow my work no that I tend to define trend direction more than anything by the use of TRENDLINES.

And, in those terms and looking first at the S&P 500 (SPX) daily chart, the index has broken down under its multimonth downtrend line; it looks like it might be headed to the 1200 area again.

If SPX reached this area and staged a rebound it would set up a potential double bottom low and could start rallying again. Trendlines don't tell us everything about where the market is going, trendlines can be pierced and the market come back later. It's just more rare.

Other technical aspects are 'trigger' points that relate to trend, and also can show changes in near-term/trading momentum. I especially tend to rely on the 21-day moving average. I noted in my weekend (9/17) 'INDEX TRADER' commentary [see online by clicking here],
** production note: 'click here' URL = http://www.optioninvestor.com/page/oin/commentary/iwrap/2005/09-17.html>that I would stay with October Index calls bought near recent lows UNLESS the 21-day moving average was pierced; especially on a closing basis. The next day's opening was time to exit calls!
I don't stay in an option unless on the 'right' side of trend.

The most definitive chart aspect for the intermediate trend and used on DAILY charts, are the relevant up or down trendlines:

Today's S&P close under the May Aug uptrend line suggested that its likely the index will fall further. The prior lows become a next possible target or objective.

The SPX rally failure shy of the highs was a warning that the uptrend was losing momentum, but the rally could have gotten going after a minor pullback or consolidation. This possibility becomes much less when a major index falls under its 21-day average.

The trendline break shown in the SPX chart above suggests more than a 'pullback' or minor retracement, rather, another down 'leg' ahead. A down LEG is a move equal to, or greater than, the last downswing; i.e., from 1245 to 1200 or 45 points. It's sometimes the case for a second leg down to be as much as 1.6 times the first; suggesting a target to 1170 for example. By the way, am not predicting this kind of downside unless there is a close under 1200 and not reversed the next day.

HOURLY AND DAILY CHARTS

It's important to look at trendlines on charts in timeframes 'above' and 'below' the daily chart time interval. My favorite intraday time frame that is finer detail than daily, is hourly. Hourly chart trendlines show you shorter-term trend reversals. Weekly chart trendlines, a time frame above daily, shows the long-term or major trend.

Hourly chart trendlines are very useful for the option trader trading trends of shorter duration, over a few days, rather than 2-3 weeks, or longer.

DRAWING TRENDLINES:
You need only two highs or lows to tentatively establish a down or up trendline. The first trendline shown on the hourly chart below, began by drawing a straight line between two hourly highs. The next high after that (the 3rd point) came right up to that line and gave what we most desire in trendlines, which is 3 or more points. The following rally high again touched the hourly down trendline. An upside reversal occurred by the thrust up above the down trendline at the (2nd red) down arrow.

Up trendlines were constructed on the next rally, the steepest of which (Trendline 1 or T1), was pierced and suggesting to exit calls. I was trading the active S&P 100 (OEX) options based on the SPX as the broader '500' group was leading the big cap NYSE stocks. I tend to 'trade off from' the leading index in that market segment; so, I wouldn't trade the Nasdaq 100 (NDX) based on the trendline breaks or breakouts related to SPX.

The second trendline (T2) also got pierced. When the prior low as also penetrated, this was a 'final' confirming chart indication that at least the short-term trend had reversed.

DRAWING AND RE-DRAWING TRENDLINES:
There is a necessity to re-draw trendlines. For example, the first low in SPX that held at 1225 and seen in the hourly chart above was the second low used to construct my hourly up trendline. The subsequent pullback around 9/15 fell under that line and I re-drew it using THAT low. The next price break took prices below this trendline and was a second 'confirming' break of upside momentum and any up trendlines.

'INTERNAL' OR 'BEST-FIT' TRENDLINES:
Internal trendlines can cut through a bar as these kind of 'best-fit' trendlines connect the MOST number of highs or lows. The long-term weekly chart up trendline is a case in point. You notice on the lower left, that the trendline begins in an area where it cuts through one weekly bar; i.e., the range between the weekly high and low that particular week.

The weekly up trendline in the chart below, drawn through the cluster of lows made in the early-2003, then connected to the cluster of mid-2005 weekly lows, conveys the dominant trend. A simple way to think of a trendline is that it shows the dominant RATE OF PRICE CHANGE or momentum.

The key point to make about this trendline relating to where we are NOW is major trendline support is suggested in the 1200 area, which was also the area of the last low. 1200 becomes the 'make or break' area so to speak, as far as the trend.

There is another consideration when looking at very long-term (weekly or monthly) charts, where there has been a big run up or run down in prices. Check the trendline using the logarithmic scale, which draws equal PERCENT changes to be an equal distance.

The so-called 'semi-log' or 'log' scale is different than the way we usually see price charts displayed, in the arithmetic scale, where equal PRICE moves have the SAME length.

An internal up trendline connects even more weekly lows by using the semi-log scale on the weekly chart below. It suggests that the long-term chart and trend picture starts to turn bearish if there is much more of a drop from today's low.

EVEN SIMILAR, INDEXES OR MARKETS HAVE DIFFERENT TRENDLINES
The S&P 100 (OEX) daily chart below, while bearish given the sharp two-day break and its closes near or AT the lows. But, its daily up trendline has not yet been pierced. It would take a move below 560 for that to happen. I think a daily close under 560 would suggest that the prior, late-August, lows were not going to become support again. Those lows, around 556 bear watching, but with a close under 560, I will not be holding my breath expecting a double bottom at 556.

There is another aspect to trendlines that the OEX shows that the S&P 500 does not. A down (again, an internal/best fit) trendline that suggested declining or falling momentum. An OEX chart trendline showed this aspect, whereas the SPX chart did not. Once there was a high not exceeded the next day, there were some points to construct an internal trendline.

Notice that the prior highs in the OEX chart that were ABOVE the down trendline in the chart above, did not have a close above this line. These are little things to look for. The big picture thing we're looking at is that there is a PATTERN of DECLINING HIGHS.

BEWARE OF TRENDLINES THAT APPROACH A VERTICAL SLOPE
You asked about gold prices and it looks like the Gold and Silver Index (XAU) could top again in the 112-113 area. The subscriber question was about GOLD. I don't tend to 'trust' these gold rallies that go straight up. They then tend to come STRAIGHT DOWN.

OIL PRICES?

Well, the OIL STOCK (OIX) Index looks like it is going to the moon, but as with the XAU chart above, I think the rate of increase is getting a little 'scary'. If I had to be an option, I'd rather be in puts with this latest acceleration. Especially so, if we go on to look at the crude futures chart.

This chart 'strings' together the nearby futures contacts to get a longer-chart view. And, that view, that pattern, suggests that $70 may be the top of its uptrend channel. Again, the straight up move is seen. Again, this current runaway up trend is probably not sustainable. I'd start to look for prices to come back down on balance.

PLEASE 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! **
 

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