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Trader's Corner

Gauging If a Bottom Has Formed

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This column will repeat some of the ideas I wrote about last week in my 6/14 Trader's Corner when I sent what I thought was my most recently written article but failed to notice I attached my 1-4-06 article rather than the correct 6-14-06 column. OPPS!

My oversight was corrected on the web site issue for Wednesday (6/14) the next day but your e-mail version looked pretty strange with my Jan 4th comments along with my June 14th charts. My last week Trader's Corner ("Capitulation") is seen by clicking here:

The term 'capitulation' refers to the final stage of these relentless type free fall declines such as was seen into the 6/13-6/14 low. Capitulation is a final emotional selling phase where the greatest number of still-bullish investors and traders feel that stocks are NEVER going to stop going down. Bulls can capitulate (to the Bears) at bottoms and vice versa with bears giving in to the bullish impulses at tops.

Since the market is so driven ultimately by investor psychology and expectations, capitulation can be a powerful cathartic event often associated with market bottoms and stabilizing prices. When everyone who is a potential seller finally dumps stock, selling pressure dries up and even limited buying causes a sharp rebound.

Charles Dow talked about the same emotional state of mind of a final panic selling. Last week I listened to an analyst on one of the market wrap shows talking about bottoms coming with a final 'accidental event', or some final bit of news that causes the last selling wave for awhile; after this news comes out, traders figure the worst is over.

MARKET 'SENTIMENT'
For a gauge of capitulation, I most often rely on my equities call to put daily volume indicator for the CBOE. I look for a simple ONE-DAY reading that suggests put volumes are close to equaling call volume. This event tends to reflect that same type emotional trigger as discussed above.

However, there was only what is a common 'capitulation' type reading in my call to put volume ratio back in early-June (6/2), as seen in the following chart of the S&P 100 (OEX). A bearish 'sentiment' extreme associate with bullish capitulation is seen in heavy put volume relative to daily call volume; put volume becomes close to being equal to call volume; i.e., near 1. This is seen last on the lower indicator on 6/2 as I noted.

By the way, the OEX rebound into today's High backed off from resistance implied by the 200-day moving average (initial support on the way down) and at the down trendline.

Sometimes the market will reach a bottom, rebound back to resistance, but then drop back to the area of the prior lows or even dip under the prior low. This then becomes where there is then a 1-day or more extreme in my 'sentiment' indicator; i.e., a big jump in put volume relative to call activity with the two getting close to being equal.

DOUBLE BOTTOMS
A retreat to a prior low is another way to gauge a milder form of 'capitulation'. Investors decide that they just arent going to buy unless a key major index or the indexes in general get back to some important prior low. The Nasdaq 100 (NDX) has now retraced all of its gains made since its October bottom.

If you had been observing some of the key Nasdaq biggies (big cap stocks), it was apparent by last week that many were finding some supporting buying interest. The key example of a retreat to a prior bottom marking the end of a decline in at least one of the major stock indexes is seen in the Nasdaq 100 (NDX) chart below.

Today's close above its 21-day moving average (as well as the breakout above a bull 'flag' pattern) was bullish and suggests a possible move to the low-1600 area or higher. Today's action also suggests that anyone who bought calls around the prior October low made a low risk trade by setting an call exit or stop to be triggered at just under that prior low in the index. Relative to that risk, the 'reward' potential still looks good.

BULLISH PRICE/RSI 'DIVERGENCES'

You can also see on the Relative Strength Index (RSI) above how the last low in NDX, was accompanied by a HIGHER reading in the RSI, which is considered to be a bullish divergent action. New lows accompanied by an already RISING trend in the RSI is suggesting rising 'relative' strength. This bullish divergence AND the potential double bottom made for a highly attractive option trade, although an upside reversal didn't look 'proven' so to speak until the upside surge of the following days.

It's my particular trading style to try and ANTICIPATE significant tradable lows. And it helps in not having to 'stay glued to the tube' or watching the market every minute. I myself have other business activities besides trading and just watching the markets, although I had many years of that too.

Buy at prior lows if prices appear to stabilize in that area. You don't have to wait for the first big upside surge, when premiums on calls rapidly inflate. Like the triple rule in real estate re location, anticipate, anticipate, anticipate.

RETRACEMENTS

I also like to buy the 50 percent and the 62-66% retracements, of a prior big advance. The S&P 500 (SPX) retraced 2/3rds or 66% of its last big run up. Once a retracement of a prior move gets to be more than 2/3rds, there is the strong possibility that the price will fall back to the area of the previous low as was the case in NDX.

TOTAL NYSE AND NASDAQ UPSIDE VOLUME

Quite frequently at major lows, a 10-day moving average of total daily NYSE and NASDAQ Up or Advancing Volume will retreat to at or a bit under 300 million; or, to around 600 million shares in other instances. When this the 'line' then turns up from these areas, look for a rally to follow.

The 300-600 million share levels is the 'zone' I look for; as it happened, NASDAQ fell first to a 10-day Up Volume average of 300 million shares, followed by a short-lived Index rally, although tradable in calls. Then the recent bottom and a lower low, was accompanied by a dip in the 10-day NASDAQ UP Volume average of 600 million shares, as seen in the chart below of the Nasdaq Composite Index (COMP).

Why, UP Volume? This is the measure of volume where there was buying on up ticks and nearly always is a gauge of the willingness to 'pay up' for stocks. You nearly always see a declining trend in Advancing/Up volume numbers as the market is in a declining/down trend. When this volume trend turns around after certain reoccurring 'baseline' amounts are reached, it's a good indication that buying interest has returned.

Nothing comparable exists as a volume type 'indicator' at tops, such as with Declining Volume on a 10-day moving average basis.

BUY REBOUNDS TO/FROM A LONG-TERM TRENDLINE

You have to look at all the major indexes to see the possible range of the various technical events that are suggestive of a significant bottom, offering a high potential index trader.

If you have been following and tracking the Russell 2000 (RUT), this index has been trading back and forth within a broad uptrend price channel. It's recent low reached a longstanding RUT up trendline, suggesting this was a good buying area, as can be seen in the chart below.


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