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Trader's Corner

Trend and Retracements

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A SUBSCRIBER E-MAIL asked for my comment on the trend and how deep this correction might go: "I wonder if you think the major trend in the market has turned? Am thinking of the stocks I hold in my investment account not so much short-term. TRading wise have some OEX index puts -time to cover?"

I've written once or twice recently in this space about seeing potential resistance in terms of the upper end of broad weekly uptrend channels and the same weekly charts are a good way to look at where a correction would be more than a 'correction' (to the dominant uptrend) and where a major trend reversal would occur.

If a trend is a series of higher rally highs and higher pullback lows, then the major trend in the S&P 500 (SPX) is intact as long as we don't see SPX fall under its last big correction low at 1363.9. This would also correspond currently with support implied by the low end of the weekly chart uptrend channel seen below.

While the major trend remains up, this same uptrend channel seen below also suggests that the Index may have tough going again if prices rebound to the area of recent highs; which is also the level of the prior all-time high. I would anticipate another rally back up toward the high end of this bullish channel but the index may again hit significant selling pressures there, especially if this coincided with the seasonally difficult Sept-Oct timeframe. Would I let go of my long-term stock holdings? Maybe some, especially any laggards, the reverse of what many investors tend to do by selling their stocks with the biggest gains.

As to the other part of the question: whether it's time to exit or take profits on S&P 100 (OEX) puts? Based on the weekly uptrend channel in this index, I suggested in my weekend Index Trader's column that significant support and buying interest ought to be seen in the 670 area in OEX, at the low end of its uptrend channel; at least the way I had constructed the lower 'internal' up trendline, intersecting the greatest number of lows. This play, covering OEX puts today around 670, looked pretty good at the close near 682.

The theory of retracements or I should say the theory of 'fibonacci' retracement levels, holds that in an up or down trend, counter-trend retracements often tend to be held to around 38 percent in a strong trend, or to about one-half or 50 percent, or a bit more (62%), in a moderate up or down trend. A strong up trend is seen with an uptrend line that is quite steep, such as seen in the S&P over recent months. A moderate angle of ascent is more common and here we tend to see corrections contained at 50% to around 62% of the prior advance from trough to peak.

There is another factor, related to TIME. If an index or stock has not seen a counter-trend move in a lengthily period, corrections will tend toward 50 to 62 percent also as they 'correct' more of an extreme overbought condition. The S&P 500 (SPX) rebounded today after an almost exact 62% retracement of its early-March to early-July advance. Once the 38 percent retracement level is exceeded in a pullback, look for a 50 percent retracement and when 50% is exceeded, retracement considerations suggest looking for a price target to a fibonacci target-level of 62%.

If such retracements (implying potential support) of a prior advance, such as seen above in SPX, also coincides with a level that is within .5 of 3 percent above or 3 percent below one of the major INDEXES' 21-day moving average, this can also suggest that a move may be 'overdone', in this case to the downside and the index may 'snap' back like a rubber band stretched too far.

Today's SPX low dipped below its 3.5 percent moving average envelope line and a 'snap back' rally did develop. Its the major stock indexes that tend to trade reliably in the 3-4% range above/below their 21-day moving averages; stocks have a much great variability and the 21-day is not necessarily the key moving average to track.

Just as the S&P 500 had led the market higher, the same index had a deeper retracement than the big-cap S&P 100 (OEX) seen below, where the retracement to date has held at around 50% of the March-July advance.

Also and not surprisingly, a tendency to rally today in the major indexes is coinciding with a high level of put buying as suggested by my CBOE call to put volume ratio indicator (CPRATIO) seen above. When put volume gets close to equaling daily equities call volume, this indicator falls toward the lower line that suggests an 'oversold' or an extreme bearish outlook by traders.

An index or stock that only sees a 'minimal' 38 percent retracement or a relatively shallow correction, is demonstrating still-substantial buying interest on the pullback. Sellers are not dumping the 30 Dow stocks in mass and buyers are there to bid on the stocks on dips.

Moreover, with the Dow 30 (INDU), there has been only one isolated Close to date below support suggested by the low end of its trading range of the past two months. There was a brief dip under the 13,200 'support' implied by a 38 percent fibonacci retracement again today, but a rebound then developed from the intraday low. If 13,200 gives way in subsequent days, then a next retracement target is to around 13,000, or a 50% give back of the prior advance. Stay tuned on that!

The Nasdaq 100 (NDX) also saw just under a 'minimal' 38% retracement of its prior advance, and then also rebounded today. NDX fell to 3.5 percent under its 21-day moving average suggesting that at least a short-term snap back rally shouldn't be a surprise. With the NDX, the long-term weekly chart is also of interest and the one that I will close with:

Major or significant resistance was suggested with the advance to the upper end of its weekly uptrend channel; and, minor support is suggested now in the 1900 area as noted by the green up arrow at the rising up trendline. If 1900 gives way, a deeper retracement should follow. 1885 would represent a 50 percent retracement; 1844 is a 62% retracement of the move from the 1711 low to the recent 2060 peak. I tend to keep retracements levels on my chart and I suggest it for all as important areas to keep track of in corrections.

Lastly, with downside retracements that EXCEED 62 percent, with 'leeway' to 66% (2/3rds) of the prior advance, the next 'retracement' to consider (beyond 62-66 percent) is a retracement of 100 percent of the prior move; i.e., a 'round trip' back to the last significant low. This is where double bottoms sometimes set up.


Please send any technical and Index-related questions for my answer or feedback to Click here to email Leigh Stevens support@optioninvestor.com with my name ('Leigh Stevens') in the Subject line.

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