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Trader's Corner

Follow Up on Technical Bottom Indications

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From my OI SUBSCRIBER mailbag came the following e-mail:

"It seemed that your charts in your weekend Index column were out of date, but you predicted a new low would be made and it happened today. What did you see in price action so far that might confirm the things you said last week that would suggest a tradable bottom? I bought some calls today after the strong rally coming off a new low something I've heard from you before as bullish."

I didn't notice until the day after I wrote on Saturday that I was missing the last two days of this past week's price data. My software stopped updating and I was jetlagged (in Spain) without Friday's date in my mind. Shows what happens when you're not trading that week! Fortunately, I was concentrated on seeing the PATTERN being traced out and thinking that we had NOT seen a final low. As to a low for this correction, it MAY have come today. I'll give my take on some of the technical aspects that could suggest that that's the case.

As you can see I don't have any good ideas of my own that a Subscriber doesn't put in my head! Please send any technical and Index-related questions for answer in any of my articles to Click here to email Leigh Stevens Support [at] OptionInvestor.com with 'Leigh Stevens' in the Subject line.

The following chart is from my LAST WEEK'S Trader's Corner column so yes, THIS chart reflects the close as of 3/7 and is for illustration of a pattern I was looking to develop from that time forward. I'll follow this with the same Index (SPX) chart, reflecting prices through TODAY:


I thought a next low might carry the S&P 500 (as seen below) toward the 1340 area or lower, but today's low in SPX looks like it be a bottom and low point for this current move. Sometimes the second downswing will equal a move that is MORE than the first decline. This would be the 'classic' A-B-C corrective wave pattern in (Elliott) wave terms, but the PATTERN is consistent: a first decline, a rebound that retraces at least half of the first downswing, followed by another sharp decline that carries prices to a lower low; typically on technical selling and preset 'stops' or exit points, particularly in the index futures contract.

Some other things that tend to occur at bottoms could include the following (technical) aspects and are updates from my Trader's Corner article of last Wednesday (3/7) and which can be seen by going back to that day's Option Investor (OI) Newsletter or by clicking here.

As can be seen in the SPX chart above, this occurred at a significant prior low from early-November. This is not the 'most' significant past low but it is distinct and occurred before the market had another upside run of a few weeks. Interesting, the recent rebound high occurred in the area of a cluster of prior lows in Dec-Jan. before SPX took off again. Prior lows can offer support. Prior lows that are pierced, can 'become' resistance later on. Sorry, I am mostly focusing on significant prior lows as later support. Looking at another Index chart, or a market 'Average' in the case of the Dow 30 (INDU) as it's a price-weighted average not an index:

This wasn't my primary point, but notice how the rebound off the first low carried back to the area of some prior lows around 12,337 in the Dow Industrial Average. My primary point is what I noted in my Index Trader column of Saturday (3/10) where I was looking for major support in INDU in the 12,000 area. The even 10 and 100 levels in stocks and other lower priced indexes/sector indices; or the 1,000 levels in the case of the Dow Jones, are often very significant as support or resistance.

The other significant aspect of the 12000 area is that it is the approximate area where INDU retraced 38 percent of its last big run up, from July '06 to the February '07 peak. In a strong market or in a strong advance, a fibonacci 38% retracement is about as much as will be seen. In a more normal trend, one simply rising (or falling) at a more modest rate over time, its somewhat more common to see a one-half/50 percent retracement or even to see a retracement of the prior move equal to 62-66 percent.

The other pattern seen in the Dow, as outlined above, is a so-called bearish rising wedge pattern, which is the pie shaped upward sloping triangle. This is basically where buyers and sellers get enough in balance so that the price swings narrow in and the distance between rally peaks and pullback lows covers less and less ground; this is a type of 'compression'. Compression in an Index or a stock is usually followed by EXPANSION and the next price swing carries significantly further than the preceding back and forth movement, usually in a reverse direction. [A downward sloping wedge pattern often suggests a substantial bullish upside reversal ahead.]

The note I made on the chart above about the upward sloping wedge is there is also a 'measuring' implication for a corrective move as being to at least back to the start of the wedge pattern. This has been seen already, which is another small indication that the market may have seen its low already.


Overbought/oversold type indicators like the Relative Strength Index (RSI) usually don't provide traders with a lot of help in making entry and exit decisions when there is a VERY strong trend with only limited or shallow corrections. This is because in an uptrend for example, the market gets 'overbought' in terms of these type indicators and stays that way; or, at least, doesn't get 'oversold' for very long periods.

However, given the sharpness of the recent break, I fully expected the lead S&P Index (the 500) to get 'fully' oversold again, not only on a daily chart basis but on a weekly chart basis. Going back to the same S&P 500 (SPX) chart seen above, I could point out the following about the RSI, at least on a 13-day basis. I tend to use a 'length' setting of 13 (a fibonacci number in the fibonacci number series from 5 to 8, 13, 21, etc.

As can be seen from the (13-day) RSI above, we got at least ONE 'oversold' reading in the RSI. In a bull market and I assume that this market is still in a bull mode (unless it starts Closing under SPX 1300), we wouldn't normally see a series of dips into 'oversold' readings; i.e., below 30. The weekly chart can be the most telling in terms of overbought/oversold indications in a strongly trending market. On weekly charts I most often use a length setting of "8". Sometimes 13, but my most common selection is 8 on weekly charts. (21 for hourly charts always.)

Using the longer-range Weekly chart for the same SPX Index shown below, I've applied the RSI with a setting of 8, to measure the rate of change up or down for a 2-month time frame. You'll see with the weekly RSI indicator that this recent pullback put the RSI down to 40. While the classic definition and common 'default' setting for suggesting an oversold condition is 30, its necessary to adjust this level line upward in a strong bull market trend; e.g., to 35 t0 40.

On the way I've 'defined' the oversold zone for the weekly Relative Strength Index above, the recent weekly close registered an 'oversold' situation and something of a 'minimum' to me in suggesting that SPX may have reached a tradable low. While in a strongly upward trending market, there tends to be an 'early', often quite premature, oversold extreme; as suggested by the RSI chart highlighted above. An 'early' oversold reading in a strong bull market trend is not often the case with readings on the low end of this indicator. Of course, if SPX fell back to its long-term weekly up trendline seen above, most likely there would be an even lower extreme in the RSI indicator, perhaps even on a 13-week basis.

I made the point last week also that I anticipated ANOTHER low in bullish sentiment per my indicator and seen next with the S&P 100 (OEX) chart.


"Often, the first low of a big correction like we've seen will be preceded by at least a 1-day bearish extreme in sentiment or the outlook for the market ahead, which I measure as occurring when total volume of CBOE equities calls is down to 1.1 times (or less) of the total put volume traded that day. This is seen graphically in my (CBOE) equities call to put daily volume ratio seen above noted at the green up arrow. As soon as the lower extreme in this ratio occurred, the next day brought a tradable low and the beginning of this recent rebound.

The sharpness of the recent correction and the fact that my sentiment indicator has rebounded quickly, suggests to me that there will be another low, perhaps a lower one, that is showing an 'oversold extreme' in this indicator. Stay tuned on that!"

Well, it's time to TUNE INTO this indicator again a week later and see how option traders as a group are go very good at picking reversals, but in a CONTRARIAN sense! If they are overly bearish, a market bottom often follows within 1-5 trading days. Overly bullish for long enough: look for a top.

Before skipping down to the bottom of this chart of the S&P 100 (OEX), I would just note that the yellow circle indicated a trendline that I thought in my weekend comments might mark a next significant support in the 625 area. Hey, all you need is a ruler, straight edge or an opened up matchbook!

Well, I'll be darned indeed, the ratio of total daily CBOE volume for equities option calls relative to daily put volume was under the 1.1 level that typically suggests that an upside reversal should be 1-5 days away. It was 1-day in this most recent instance and 1-day in the instance before yesterday's reading; these readings are noted at the green up arrows on the "CPRATIO" indicator above. Not much more to say about this. I bought OEX calls on a 'sentiment' basis, the fact of the fall to 625 and likely trendline support, as well as an oversold condition showing on the 21-hour, 13-day and 8-week RSI. Well, it's one thing to buy em and another to wind up with a profit, but so far so good.

People define them in different ways, but I usually define a 'key' upside reversal as a move to a decisive new low, followed by a Close that is above the prior 1-2 days HIGH. Others define key or a just plain upside 'reversal' pattern as a move to a decisive new low, followed by a close that is above the prior 1-2 days Closing level(s); e.g., a 1-day upside reversal. The pattern seen above with OEX or below with the Nasdaq Composite (COMP) below qualifies as a 1-day upside reversal in these terms. The key reversal, a Close above the prior day's High, is more rare.

There is another way to define upside (or downside) reversals as bull or bear 'trap' reversals, as defined by my old friend Jack Schwager. This is an interesting/insightful way to look at a reversal pattern. In a bear trap reversal ('traps' the bears so to speak), there is a move to decisive new low, followed by an immediate (same hour, same day, same week, etc.) upside reversal that soars above (at least) the prior day's Close. [A bull trap reversal is the opposite: after a period of rising prices, a move to a decisive new high is followed by a fairly immediate collapse in prices.]

The bull trap (upside) reversal seen in the COMP chart above is typical of all the indices. The fact that today's COMP low exactly equaled a 38 percent retracement was another powerful factor in suggesting that a ride on the call side of Nasdaq could have a good risk to reward equation; e.g., 'risking' to just under the prior Nasdaq 100 (NDX) low at 1710 (and a minor double bottom) for NDX calls, just under 42 in QQQQ or to just below 760 in the Russell 2000 (RUT) in terms of call purchases.


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.

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