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Trader's Corner

When Long-Term Trends Reverse

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THE major consideration that got me into technical analysis as a separate and additional study to study of market fundamentals (e.g., economic growth trends, earnings trends, etc.) was that I lacked 'objective criteria' for when to get out of a position. This is another way of saying that I had no clear cut criteria for when a trend reversed from up to down, down to up.

This was when I was trading the futures markets more than stocks, so it was not that I had no concern about having a time-limited position. Of course options present even more of a challenge due to amount of built in time premium, which is a more subjective evaluation and 'premium' given to the seller of the option, than is true of the 'carrying charge' premium of physical commodities or even financials like bond and stock futures.

I've heard so many stories (and I remember my own!) of people that road a big tech stock position from hugely profitable, relative to their cost basis, to a fraction of what the stock or stock portfolio was worth in 2000. This was because they 'believed' in the tech 'revolution' or believed in the individual company's 'story'; i.e., their business model, their earnings potential, etc. There is nearly always a 'belief' involved, rather than simple ignorance, not knowing what to do, etc.

Well maybe you didn't have the trendlines there but you'll likely remember the GO-GO period of the late-1990s into the early-2000 top. Consistent with 'objective criteria' for when the major trend started to reverse, was the downside penetration of the steeper up trendline. A sharp price break followed. A fortune making time to buy Nasdaq stock puts!

After prices stabilized and rebounded after the first big break, a number of weekly lows then defined the next lower (less steep) trendline. You can see 1-week's sharp fall under this trendline, but only one, until a couple of months later when the lowest of the 3 trendlines also gave way. This line was constructed with our 'minimum' of 2 points, but ended up only pointed to areas of resistance at the weekly highs for a few weeks.

So, the first 'technical' method I started paying close attention to involved trendlines. For example, when an up or down trendline got pierced, especially a long-standing one. I learned to look not only at 'external' trendlines but at 'internal' or 'best-fit' trendlines.

External trendlines are straight lines that connect only a minimum of 2 (3 is best) or more of the lowest lows or the highest highs. An internal, best-fit, trendline connects the MOST number of highs or lows and may cut through some bars (of a bar or candlestick chart). External trendlines are pretty much the only thing you'll see used with Point & Figure charts; e.g., from Jeff Bailey's Monday 7/10 Market Wrap commentary.

This Wednesday Trader's Corner article also serves as an adjunct to my weekend 'Index Trader' column, an online (only) section at the Option Investor.com web site.

I wrote in my weekend Index Trader ("What Market?") that the Nasdaq and NYSE Markets as represented by the Nasdaq Composite (COMP) and S&P 500 (SPX) respectively, were diverging more than usual. Both markets have been having some trouble gaining upside traction, but it's especially true of the Nasdaq. If you took out the oil, gold and other commodity related (e.g., ADM) stocks out of the S&P Index, it would look to be struggling too.

In my Wednesday Trader's Corner articles I typically also work in a technical midweek update to my weekend Index Trader. Especially so when I can demonstrate the relevant technical/trader tools discussed here. My most recent Index Trader can be seen by clicking here.

The long-term up trendline on the Nasdaq has been decisively pierced or 'broken' with the decline of recent weeks, as seen on the weekly COMP chart below. The broken up trendline is an internal/best fit trendline, showing the angular ascending trend; trendlines show the percentage rate of price increase or decrease over time, without putting a (percentage) number on it.

When internal dynamics (fundamentals) change, the angle becomes less steep and price momentum slows. Traders have discovered that momentum or trend changes keep going until a new equilibrium or trendline is established.

The SECOND OBJECTIVE RULE FOR TREND CHANGES has nothing to do with trendlines. A major uptrend shifts from up to down when the last major (downswing) low is exceeded. Charles Dow would say that only the Close matters.

I look at breaks of both the prior Close and the Low above. The key prior weekly Close is 2065. A Friday close under 2065 in COMP could be the confirmation so to speak of a shift in the major Nasdaq trend from up to down. A further fall below 2025 would be a second confirming event.

There is another consideration in the Nasdaq weekly chart above. The 8-week RSI is showing an 'oversold' extreme, suggesting that a second down leg would more likely come, if it comes at all, after an oversold type rebound; e.g., back up to 2200, maybe even 2300. 'Oversold' or 'overbought' are secondary technical indicators, but worth paying attention to for possible short-term upside reversals back above up trendlines on the DAILY charts.

The S&P 500 (SPX) had fallen under both its long-term internal and external up trendlines. The recent rebound brought recent weekly highs right up to the trendline at the red arrow as seen in the weekly SPX chart below. Prior support and prior support TRENDLINES, once broken, often defines resistance later on (resistance also often 'becomes' later support).

1245 is key must hold support on a weekly CLOSING basis for SPX. There has been so far one weekly close at this level, but prices rebounded in the following week.

The Dow Industrials (INDU) seems to be trying to hold above it's dominant long-term up trendline and recent dips under the support trendline have been followed by rallies.

A weekly INDU Close below 10,950 would be under its up trendline and suggest that this narrow selection of blue chip stocks was now also losing upside momentum:

While the week is not over for the Nasdaq 100 (NDX), the midweek trend here is not looking good. BOTH my 'objective' criteria for a trend REVERSAL from up to down: 1.) a break of the long-term up trendline and a 2.) Weekly CLOSE (stay tuned for that on Friday!) under not only the prior weekly Closing low at 1544 but under the prior line of weekly lows per the level line on the chart below.

If we get further weakness into the end of this week, could this be 'confirming' a bear market ahead, at least in Tech? Maybe so, although it's not completely accurate to say that Nasdaq equals just technology stocks.

I'd like to point to the bottom of the next chart, this one is DAILY and of the S&P 100 (OEX). Those of you who follow my Index commentaries will note that I've been saying for some time that the only thing I HAVE NOT been seeing that I tend to see at tradable bottoms is a build up in bearishness.

Finally, the earnings to date for Q2, the many earnings 'warnings', slowing housing, relentless rise in oil prices, the threat of more rate hikes, etc. seems to have sunk in and traders have picked up their put activity considerably. And resulting in a falling ratio of CBOE daily equities call volume relative to put volumes, and resulting in the start of a bearish outlook in the extreme as seen in the lowermost of my indicators above.

Trendline breaks are EARLY warnings of 'trouble in River City' or slowing momentum. Sentiment doesn't usually LEAD momentum as much as FOLLOW momentum. Why this is the case is another story for another time. Thanks for your e-mails, but they are too FEW, meaning I would like to hear from you!

Please send any technical and Index-related questions for answer in Trader's Corner articles 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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