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Prioritzing Patterns

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Before I get into this topic, which is about how a technical analyst like I was at PaineWebber (now UBS) or a technically-oriented trader like I am now, might view patterns that could suggest different OUTCOMES for the current trend. This is an especially important consideration when the market is appears that it 'might' be at a low or might be at a tradable top.

Before I launch into that, let me back up and share one OIN SUBSCRIBER QUESTION that I answered after I wrote about some aspects of TRENDLINES in my last Trader's Corner (9/21) article
[click here to view online]. I'll ADD a bit more on the subject.

"I have this question: why is it logical to apply the charting techniques to a commodity (oil)? People buy stocks to get a reward based on future earnings, which are predictable and about which there is a lot of data and many data trackers. Surprises cause upside or downside. I can see where oil, copper, nickel, etc. could operate that way in the "perfect" environment. Maybe the 1950's.

But now oil demand is about to permenantly outstrip supply. It doesn't seem logical to apply terms like "support" or "resistence" to this. Oil is going to $100, at least. It's like oxygen; you couldn't do a trend line on that if you were in a small sealed room with 100 other people, once the first guy had trouble breathing. I'm a long way from an expert in these things, but what's wrong with my view?"

RESPONSE:
Well, charting techniques work as well on commodities as stocks as there are many supply and demand considerations. My point is that oil will have substantial up and down price swings, as you can see on the nearest oil futures chart. It looks like it's at the top of its (price) range for now.

While I happen to agree with your longer-range assessment, I also tend to take a short to intermediate-term view, especially as this is a 'trading' site. There is nothing 'wrong' with your analysis in my opinion, we are merely looking at two different aspects of this market. Good question and observation. Thanks.

CONTINUING SOME COMMENTS ON TRENDLINES:

The point I was making last week was to beware when trendlines start getting toward a vertical slope, or nearly so. In other words when I trend is just going straight up; or, straight down for that matter. It's somewhat less true for markets in free fall as everyone is selling at once and this kind of (more straight-down) slope can go on longer.

I was referring to the price of oil as reflected secondarily in the CBOE Oil Price Index (OIX). You can see in its weekly chart below how the trendline drawn up through the weekly lows is going up at a very steep angle. This kind of trend, no matter what the underlying supply and demand characteristics are, has high risk of a sharp correction.

Market trends discount ahead. The OIX Index is reflecting high oil prices for probably 6 months out. As soon as more supply is released or comes back on line, how many traders are going to take profits and sell? How many willing buyers will there be at such lofty prices?

By the way, the 8-week RSI is not 'confirming' the latest high, so I'm doubly wary: that the steepness of the price rise won't go on much longer before a correction sets in AND that the market is now going up on LESS relative strength.

The foregoing are some of the considerations that reflect such VERY steep trendline slopes. No market goes straight up or straight down forever

TThe nearby Oil futures contract price series, as reflected in the chart below, is also telling. There are levels where commodities markets find resistance:

GOLD prices are another example of markets that tend to race up and then race back down again. These price swings/trends trace out very steep trendlines. Such very steep, nearly vertical trendlines are often characteristic of the more volatile commodities and, in some markets, high-beta stocks, especially Nasdaq and especially tech. br>
Gold (and silver) prices, as reflected in the PHLX Gold and
SSilver Index (XAU), have been trading in a fairly predictable range. When the 8-week RSI has gotten up toward the 70 'overbought' area, it's been close to a top. However, the main point I'm making is a warning about a top from the relative steepness of the trendlines on the weekly chart.

CONFLICTING PATTERNS AT POSSIBLE TOPS/BOTTOMS:br> I'm of the opinion that the market is at or near a bottom, based on the fact either that recent Index lows held at or above prior swing lows and that the lows held up trendlines; or, are forming them by the pattern of the lows of the past few days.

On the other hand, I see some patterns that make me less sure of this view. For example, the last sharp decline, followed by a back and forth narrow price consolidation could have traced out a bear flag, suggesting another downswing ahead with an objective to around 547 at the lowermost dashed line, which is back around the May lows.

AAnd, what about the pattern often seen with the indexes, like with the S&P 100 (OEX) below, where there is a tendency for OEX to reach the lower envelope line when it breaks, then can't get back above, the 21-day moving average. Moreover, tradable bottoms often come when the Index get 'fully' oversold as reflected in the RSI getting down to that lowermost line.

So, what to give priority to? And others will find THEIR favorite indicator that suggests caution and that it may be that there is another shot down coming here. Certainly there are danger signals looming out there in the economy and with consumer sentiment. br>
Well, the basic 'ranking' of patterns or individual technical aspects goes like this, in terms of most important to lesser importance:

1. Was a potential top or bottom made at or near a prior significant high or low? Yes, in the case of OEX above and with the Dow 30 (INDU) below. In fact, INDU has, so far, formed a double bottom low. I rank a potential double bottom most important as a sign of a tradable bottom as in leading me to buy calls.

2. Did a well-defined and multimonth trendline define support or resistance? Yes, in the case of OEX above and 'sort of' in the case of INDU below.

BBy 'sort of' I mean that the Dow has so far predominately held its trendline, as there was only one close below it. One close above or below a trendline, even where there were INTRADAY highs above it or intraday lows below it in the case of the INDU up trendline still maintains an uptrend.

3. Possible bearish or bullish 'flag' patterns, indicators like moving averages, moving average envelopes, overbought/oversold indicators, etc. are SECONDARY patterns that rank third, even a distant third, to patterns involving price and markings that are 'derived' from prior lows/highs like trendlines. br>
Patterns like 'flags' don't come into play as predictors UNTIL and unless the low end of the flag is pierced. In the case of the possible bear flags outlined above, only such a break suggests another downswing ahead, sometimes a substantial one.

In the Nasdaq 100 Index (NDX) chart shown below, there are two strong indications for a possible bottom:
1.) The double bottom low + 2.) the way lows are climbing, and
"defining', an up trendline.

Could there be a break of the trendline and a move down toward my lower envelope line? Or, a move back to a PRIOR low like the early-July bottom around 1500? Of course. But, if you want an edge in trading you pretty much are forced to prioritize and be ready to act AHEAD of the crowd. If there is a POTENTIAL double bottom low and if that low also rebounds from the likely relevant trendline, it's enough to make a trade on that. br>
An alternative way is to wait for the index or stock to gain enough upside momentum to break out above resistance and so on. The reason I don't favor that is that I don't have the neat device of the prior low to tell me where to exit my bet on the upside. That is, exit if there is a break of the prior low in the case of calls. Exit puts when prices pierce a prior high in the case of a possible/probable top.

Do I like bottoms where EVERYTHING lines up? E.g., a double or triple bottom, bounce from the dominant up trendline, oversold as can be, very BEARISH SENTIMENT, very low volume at the low, prices getting 3-4 percent under the 21-day moving average, a picture perfect 'wave' pattern, etc. YES!! But, how often do I see everything line up, both PRICE and (secondary) INDICATOR patterns: NOT OFTEN.

To have enough to go on and go in on a trade, PRICE patterns are number one and then some.

** CALLING ALL OIN SUBSCRIBERS: **
PPlease send any technical and Index-related questions for possible use in my next Trader's Corner article to Click here to email Leigh Stevens Support [at] OptionInvestor.com with 'Leigh Stevens' in the Subject line.

** Good Trading Success! **

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