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Technical 'Underpinnings'

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Since I got out of most of my calls and don't want to buy more and I won't short (buy puts) this market absent a (price) reversal pattern on the major indexes; or, a double top; or, indication of stalling at technical objectives or resistances; I have been letting the bulls fight it out for the last hurrahs! It's mostly a Dow rally. They used to talk about the 'solitary walk of the Dow', where extreme strength in the Dow 30 (INDU) somewhat masks the fact that the rally leaders might be thinning out a little. At least 'value' is thinning out.

INDU is an arithmetic average, price weighted and only 30 stocks so they can take it most anywhere they want and there was talk of 14000 in the Dow before this market got to the end of this particular run. By 'they' I mean the big institutional money players that are dominating at least this rally phase and which now includes a LOT of hedge fund money. The little guy is not jumping into this market in a big way, at least by what I can see and what I hear. Individual investors had been favoring the small to mid cap stocks, at least in the last two (market) cycles and if you look at the Russell 2000 (RUT) it's not participating in this most recent spurt higher. Nor, is the S&P 500 or the NYSE Composite just lately, at least not the way the Dow is.

And, of course it's expiration this week and a recent speculation in my Index Trader weekend column is how I assumed that stocks would have an upward bias into this expiration. What started me on this particular Trader's Corner were recent e-mails asking me where I think this market is going to; or, how long can this rally go on?

In the absence of a prior high, it's hard to judge of course, except that at 1553 the S&P 500 would finally match its all-time peak from 2000 and that area could act as a major lid on the market no doubt. The top end of the Dow's broad weekly chart uptrend channel could be an area that could be calculated as a tough technical resistance area; here's one source of the idea of the Dow reaching 14000. The New York Composite Index went into new high ground much longer ago than the Dow (early-2005 versus October 2006), so there's not a lot to go on there.

We see the tech heavy Nasdaq lagging too, along with the Russell (RUT). Usually the laggards will slow first in a rally or on a decline, suggesting that the strong sectors only have so long to go before a correction sets in.

SINCE INQUIRING MINDS WANT TO KNOW, I'LL RUN DOWN SOME OF THE TECHNICAL FACTORS I SEE CURRENTLY.
This seems a lot more interesting that anything else I could write about, at least in the absence of other Subscriber questions. Hey, these kind of run ups are exciting and historic. On average, year in and year out, the market doesn't 'trend' strongly in one direction or the other more than about a third of the time; at most. I mean where counter-trend moves are less than 5-10 percent.

As to my last article relating my outlook for the market, my weekend INDEX TRADER column can be seen by clicking here.

TECHNICAL RESISTANCES?

I mentioned the level (1553) where the S&P 500 (SPX) would or could reach its old high. A prior high or low is the best benchmark of course for possible resistance (or support), and it's not a long way from where SPX went out today at 1514, representing a further gain of what, 2 and a half percent. So, 1553 in SPX bears watching if and when it gets to that area.

In terms of the Dow chart, with the Dow being as usual the center of attention (by the casual media), the weekly chart price channel I mentioned, where the top end of it might offer another type of technical resistance, is outlined in my first chart:

The beginnings of this price channel goes back to the bottom seen in mid-2002; I just can't show that much price history on the screen here.
Potential resistance implied by the top end of this channel is shown at the red (down) arrow. Can prices bust out above the upper trendline, yes certainly only it's unlikely; not only for a reason related to the fact that price channels do so often pinpoint the outer limits of the back and forth prices swings in a broad trend. Working against a move through the upper channel shown here in INDU, is the overbought condition suggested by the Relative Strength Index shown under the price chart.

As you can see above, the RSI doesn't often get more 'overbought' than it showing now. There is nothing 'magical' about this. It's more to do with probabilities. As option traders we play probabilities all the time. We bet that certain options will finish out of the money. That OEX will end up by May expiration neither above X, nor below Y. The last time that the Dow's 8-week RSI was higher than where it is currently (assuming the weekly close was also today's close) was the last time that INDU traded to the TOP end of the broad uptrend channel seen on the weekly chart above; i.e., early 2004 when this RSI hit a peak reading of 84. By the way the correction that followed wasn't enormous in investment terms, from around 10745 down to 9700, but I'll take a few hundred point price swing in DJX options anytime I can get it.

This all somewhat begs the question of why I didn't just go heavily into DJX calls and make the ASSUMPTION that INDU was going to next make a run to its upper channel line. Not a bad question that! I bought the slower plodding OEX calls and left some points on the table; but I always get out 'too soon' in that I don't like the last bit of these races to the moon where the turbulence can get rough! You play the percentages in the way that fits your trading style.

MORE ON TREND STRENGTH, AND 'RESISTANCES' IN NEW HIGH GROUND:

This chart of the S&P 100 (OEX) has been in strong and prolonged uptrend of course. One way to see that is that any price dips stay, at most just 'touch', the 21-day moving average. There is also a point to be made about a different type of potential technical 'resistance' here. Not a return to a prior high, not move to one end of the price channel an index has been traveling in, but a return to the prior trend trajectory that it was on during the past strongest rate of upward momentum. One way to measure the rate of change higher or lower is by use of simple trendlines. When a trendline is pierced, as occurred in late-February when OEX broke its up trendline dating from July, very often the rebound will be back TO but not ABOVE that previously 'broken' trendline, which would be at the red down arrow seen below:

Assuming OEX continues its present advance and the index reaches the low-700 area where the (previously broken) trendline intersects currently, AND if there's signs of a reversal in that area, this (and the overbought condition) would suggest a tradable top was at hand. These are some factors. Another type of 'overbought' is suggested when bullish sentiment reaches certain extremes, at least as measured by my indicator.


SENTIMENT:
This model of trader sentiment is simplicity itself. Look a the CBOE EQUITIES call volume and put volume daily and divide calls BY puts. In an uptrend, when this call to put ratio equals 2 or more (calls double puts), especially when there are clusters of 2-3 such readings, be afraid, be very afraid. Well, VERY cautious any way if you are counting your profits by bullish trading strategies.

Speaking of clusters, I look for as many 'clusters' of patterns and indicators that suggest the market is getting toward a possible top. However, confirmation is always a good idea as runaway moves can well, keep RUNNING! 'Confirmation' is a pattern like a move up to a new high, especially to some technical resistances like I've been speculating on, FOLLOWED by a sharp pullback, especially to a close that is under the prior day or prior 2-days LOW.

WATCH LAGGING INDEXES:

Other technical aspects to watch when you are assessing the technical underpinnings and strength of a bull, or bear, market trend is to not just focus on what leaders are doing but how are the laggards are doing also. A case in point with the indexes is the tech-heavy Nasdaq or the mid to small cap growth segment of the market represented by the Russell 2000 Index (RUT).

The rebound in the Nasdaq Composite (COMP) today did see COMP close above its pivotal 21-day trading average, which is a bullish plus along with its rally from the area of its late-Feb. top in the 2530 area; prior resistance 'becoming' support.

The OVERARCHING technical consideration at the moment is that the Index has fallen below its up trendline and has a rounding top formation. Both the line of the rounding top and the pierced trendline, suggest key resistance at the red down arrow on the COMP chart below; i.e., the intersection of the previously broken trendline and where prices would break through the rounding top. The circular line of a rounding top can be seen as another type of technical resistance, not unlike that of a trendline.


Lastly, I mentioned the Russell 2000 (sym: RUT) as a lagging index, and its chart is the last one assessing some of the technical aspects of the overall market. The RUT price/chart pattern is that of a possible 'rectangle' top. Key technical support has yet to give way, but RUT bears watching for possibly the next important index to start into a downtrend after possibly the Nasdaq. It's vulnerable. RUT has already had two apparent rally 'failures' at ITS previously broken up trendline; a harbinger of things to come? It's unlikely that that the Dow will keep going up for weeks more while other important groups of stocks are unable to gain traction.

DIVERGENCES:

Prices of the Russell Index have been going sideways, while the RSI is trending down, creating a type of price/oscillator 'divergence'. Oscillators are the Relative Strength Index (RSI) and Stochastics type of technical indicators that measure price MOMENTUM, as well as (commonly) 'overbought' and 'oversold' conditions. Their respective 'trend'lines should go in the SAME direction and not in divergent directions. Diverging suggests some likelihood of trend reversals; e.g., an up trend becomes a sideways trend, a sideways trend becomes a downtrend/correction.

** E-MAIL QUESTIONS/COMMENTS **
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.

GOOD TRADING SUCCESS!
 

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