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Following the Lewder; and Everything Else

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I wrote in my Index Trader article this past weekend that I saw limited downside remaining in the market. To view, click HERE.

I wasn't a screaming bull but I didn't see that the market was going to get pushed all that much lower. I thought that the S&P 500 (SPX) could yet drop to the 1270 area. But it also looked like the S&P 100 (OEX) had solid support down around 580, suggesting that SPX wouldn't even get that low. The OEX Monday low was 580.6, versus today's close at 592.

An OIN Subscriber then wrote me saying that since I use TRENDLINE analysis a lot and SPX was trading well under the up trendline I was working with on the daily chart, didn't I think that their might not be a steeper decline in the market coming?

On Monday in fact the OEX did follow SPX to a close under ITS up trendline. There were some OTHER factors however. OEX had not yet sold down under a cluster of prior lows around 580. There is a kind of 'ranking' of technical factors that comes into play here.

In poker or bridge, certain combinations or suits 'trump' others. In technical analysis, a stock or index's ability to stay at or above its last significant downswing low ranking as a more significant event than a trendline break. Prices can break trendlines and then come back, whereas this tends not to happen as much with a break below a prior low; with downside penetration of prior lows previous buyers in that area do more selling than is the case with trendline breaks which many money managers do not follow that much anyway.

The other thing is it's important to see what's happening in OTHER important time frames, especially on the weekly chart and we'll look at that in a moment in the case of SPX piercing its well-defined up trendline on the daily chart.

Another minor factor is my 2-day rule on trendline breaks. Since "trendlines are 'made' to be broken" and because traders and floor brokers 'run' stops under important trendlines but only briefly, I look to see what happens the NEXT day with trendline breaks. Trendlines ARE important tools to suggest when a trend may be changing but, as I often say, I like to see TWO consecutive days of prices trading under a trendline before I'm ready to believe a new trend is underway. A case in point:

There was a 1-day close the OEX up trendline on Monday, but the next day saw a Open that was above the prior close, and in bullish technical action, there was never a low that under the prior day's close after that. In candlestick charting, they consider the open and close to the 'real' body or area to focus on. The intraday lows and highs above, and below the close, are not considered to be especially significant. Charles Dow only really considered the Close to be important.

I use intraday lows and intraday highs on bar charts and use them to construct trendlines, but I also draw trendlines, as can be seen above, that bisect or go through SOME intraday highs or lows, which is consistent with the use of trendlines that are looking for the PREDOMINANT cluster of highs or lows, especially when there are only no or only one Close above or below the trendline I'm working with.

I'll show one other chart before I get to my MAIN point about following the LEAD index, not unlike 'following the money' which we saw in the Watergate investigation and many others. This point relates to checking to see if daily chart trendlines 'confirm' hourly trendline breaks and if a daily chart trendline break is ALSO seen in a next higher order time scale, namely WEEKLY.

In the S&P 500 daily chart below, which is often but not ALWAYS the 'lead' index in the blue chip, mostly NYSE traded stocks, there is a very well-defined up trendline (more so than the OEX) with a fair number of intraday lows that 'define' this up trendline. The downside penetration of this trendline seemed significant but not as significant as a break of the cluster of prior lows in the 1270-1270 area would have been, as noted at the green up arrow.

Moreover, you'll note that lows were predominately forming in the same area; under the trendline to be sure but a look at the this, or the hourly chart (not shown) would suggest that SPX was finding support above 1280. Tuesday's strong rebound in SPX on a the common 'reversal day' of Tuesday or Thursday, wasn't too surprising.

The bullish rebound above was especially NOT surprising given the still quite bullish WEEKLY chart pattern, which is where examination of the next higher order time frame is useful.

An 'external' trendline is what is most commonly known as a 'trendline' and it connects 2-3 or more of the lowest lows in the case of an UP trendline [and 2-3 or more (the more the better) of the highest highs in a down trendline]. There is an important weekly low in 2003 and 2-3 weekly lows last year (2005) that define this conventional trendline.

Even more useful and more reliable usually is an 'internal' trendline that connects the MOST number of lows (or highs). A very strong SPX bullish picture in the weekly chart below is suggested by use of the weekly internal up trendline as seen in my next chart:

The substantial rebound in this week's price action so far in SPX tends to confirm a still-strong bullish pattern as the rebound was right from the internal up trendline in the chart above.

As long as SPX stays above 1245-1250 a long-term bull market or trend is still suggested by WEEKLY chart considerations.

There is another thing that could lead you to discount the trendline break in the daily SPX chart and this involves the question of what sectors and what index has been LEADING the overall market higher in recent weeks.

# 1, the Nasdaq market has been leading. #2, within the popular NYSE related indexes, the DOW 30 (INDU) has been leading the S&P. The technical picture in the recent decline is quite different when you look at the INDU daily chart.

The Dow held right at ITS well-defined up trendline in a picture-perfect fashion so to speak. The was one close just under the line, but only by a hairs breath and the low the next morning was right at the trendline and INDU rallied strongly from there.

So, it's important to always look at what sector or major index is leading the market to see what pattern presents itself there within each market, Nasdaq or the NYSE.

I also pointed out how the Nasdaq had been leading the market higher in the weeks prior to this most recent correction. Its recent decline held and rebounded from, its up trendline without even a single close under it. The fact that the up trendline we're looking at here is a 'best fit' or 'internal' up trendline is seen in the 3 instances where intraday lows poked briefly under this line.

You can also see that the 3 lows that dipped under the (internal) up trendline in the daily COMP chart above were all 'extreme' days with those lows well under the cluster of prior lows around that day. This type action is fairly typical of the emotional nature of bottoms. So called 'bear trap reversals' and key upside reversals are in fact defined by a sharp final decline under the prior day(s) low, followed by a strong rebound.

I mentioned in the start of my rant here that its important to look at EVERYTHING going on that influences the market; and, to go beneath and beyond common explanations or expectations. John Murphy, who I toiled with for a time at Merrill Lynch, has developed the topic of INTERMARKET analysis, or the analysis of other markets to understand how say the stock market is going to perform.

It's been puzzling that sharply rising oil prices have not been more of a damper on this market, especially this week:

While I think that if energy prices rise high enough, eventually they'll prove to have more of a dragging effect on the stock market then is currently true as consumers feel the pinch. [Not me as much for those of us with the oh so numerous now (on the 'left coast' anyway) Prius hybrid.]

However, along with these record high oil prices (not yet in inflation adjusted terms) you also start to realize how much the big oil companies account for in the S&P capitalization weighted index as THEIR profits go through the roof. So, we see the oil sector leading the S&P indices higher with a very strong advance, such as reflected in the CBOE Oil Index (OIX) weekly chart below. What is sauce for the goose is goose for the gander or something like that!

** E-MAIL QUESTIONS/COMMENTS **
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MY INDEX TRADER COLUMN:
This Wednesday Trader's Corner article also serves as an adjunct to my weekend 'Index Trader' column. In the article you're reading here I typically also do a brief midweek update of my in-depth weekend column.

You will normally see a web LINK to the Index Trader at the top of your weekend Option Investor Daily e-mail. Moreover, my Index Trader can always be found by going directly to the OptionInvestor.com web site and clinking on the Index Trader section at top.

** Good Trading Success! **
 

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