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Trader's Corner

Finding Support; and 'Key Reversals'

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NOTE: Today's column was mostly written yesterday (Wednesday). A funny thing happened to this article on its way to you via the Wed 1/23 Option Investor Daily as my column got misplaced by the folks that put the OI Daily together, due to a technical snafu. Its necessary for me to mention this because my price charts further on reflect yesterday's (1/23) close. Since these charts are illustrating points about this recent bottom, it was not necessary for me to redo them just because they don't reflect TODAY'S close. I have redone my comments regarding days/dates.

First, just to pick up on what I wrote about last week in this space about the STAGES of a bear market, where stage #1 is 'distribution', as more savvy insiders start selling stock to the 'trend following' fund managers and the public and stage #2 is 'panic selling'. Well it appears that stage #2 ended yesterday. Yet to come, and stage #3 doesn't always follow, just usually, is the 'discouragement' stage #3; i.e., a longer phase of discouraged liquidation as time goes on without much encouraging news and where rallies don't carry that far or for that long.

I also just would pick up on the point made on the 'December Low' indicator. This is where the Dow falls below its December closing low of 13167 in Jan-March (Q1). The average further decline in 26 of the last 27 occurrences of violation of the December closing low (this is #28) averaged a further 10.1 percent decline before a bottom was made. Such a further 10.1% decline would equal an INDU close of 11838.

While the Dow closed yesterday at 12270, it reached 11645 at the Tuesday low, and a bit lower yesterday, which puts INDU well under the average decline if viewed on an intraday, rather than on a closing, basis. While the Dow is close to having realized the average decline based on what happened in years past when there was a drop (in Jan-Mch) below the December low, the 10.1% average is made up of declines that were greater than this and less than 10,1%. Still it gives us an idea of the fact that its possible the worst is behind us in terms of a price decline.

Unfortunately, even if the absolute low has been seen (with the possibility of a second low in the same area; i.e., a double bottom), the period ahead may require picking your trades carefully in indexes and stock options especially on the buy side, as we could see a lengthily and frustrating period ahead where the indexes go more sideways then strongly up and without big volatility swings (typical of bear market stage #3), which is not the greatest environment for big trading opportunities. That's OK unless you a broker or floor trader who gets paid on a per transaction basis!

Fortunately, the Fed and Bernanke in particular got a fire lit under them and did that major emergency rate cute Tuesday. Good that the Fed can act so swiftly. Not always true however of Congress and the President, although news came today of an agreement. Its a bit of an eye opener to look at the historical record of when recessions (determined well after the onset usually) ended, relative to when federal government stimulus packages were enacted. I ran across the following table below; the footnotes simply refer to the name of the noble-sounding act that got passed.

You'll notice that often the recession ended either before or right around the time the anti-recession package got passed and went into effect. An interesting record don't you think? And raises the question: what's the point? Well, since psychology plays a big part in these things (and is a major interest of mine), maybe government action helped change the tone and reluctance to go ahead with spending and hiring plans for businesses.

But I digress a bit. So much excitement Tuesday and Wednesday, it's enough to get your head spinning if you were watching the blow by blow this week or even anxiously checking in when you could snatch a moment from other work.

WHEN TRENDLINES DEFINE SUPPORT

The second point of this article is about how some key indexes found technical support in the recent price free-fall. There were two key charts that I highlighted in most recent (Saturday) Index Trader column. This article can be seen by clicking here if interested, but I am also going to show similar charts again.

I have been anticipating possible technical support to develop, if it was going to materialize, at the low ends of major WEEKLY chart uptrend channels in the Dow 30 (INDU) and the Nasdaq 100 (NDX). WHY them? For one thing, as of this past weekend, unlike the other major indexes, INDU and NDX had NOT pierced the low end of their long-term uptrend channels. Besides this and more important really, INDU tends to trade very 'technically'; e.g., the Dow tends more than many of the other indexes to form reliable support and resistance trendlines.

As to the Nas 100, NDX was the strongest index in recent months and had been until Tues-Wednesday resisting the decline more than the S&P and Dow for sure. IF NDX didn't hold long-term support, no other index was likely to maintain any long-term support trendline. Always look at what's been leading a rally and see how it fares on the decline, especially in the 'capitulation' phase of the 'panic selling' stage I talked about above.

I have the Dow long-term weekly chart in two versions: its bar or OHLC (Open, High, Low, Close) chart and (2) a 'line' or close-only chart.

The standard bar chart would suggest of course a major downside penetration of INDU long-term support up trendline yesterday. But, it's important to note where there is an intraday, or in this case, intraweek, penetration of a trendline versus how prices end up at the CLOSE. Japanese traders considered lows or highs below or above the range between the Open and the Close to be of relative un-importance, which is why Candlestick charts consider the true (fat)'body' as the price range from Open to Close and the highs and lows outside of that, shown in a narrow width, the 'shadow'; i.e., lacking true significance. I don't really agree with that in charting but I get their point too.

For trading purposes, yesterday's strong intraday turnaround, after the big spike below INDU's long-term support line, did give some clue that the sell off had run its course--and a lot of stops! Better evidence for a price low, not just based on the price action feel or TONE, was provided by following NDX's action; more on that in a minute.

Looking next at the Dow (close-only) line chart makes it appear quite accurately that INDU has found, to date anyway, technical support at the low end of its multiyear uptrend channel. Of course, you had little to go on trading wise yesterday in just 'hoping' that INDU was going to have a rebound back up to its weekly support trendline.

You might have also noticed that CBOE equities call volume picked up considerably Tuesday relative to put volume, as compared to last week.
Market timing can't always be perfect of course and traders were guessing or feeling that this sell off was coming close to being at a final 'extreme' or final low for awhile (the capitulation I mentioned) so they started accumulating some calls. I covered most of my puts on Friday. Would I have rather done that yesterday on that major decline? Of course, but I play the averages so to speak, which doesn't take into account the crazy panic extremes that COULD occur.

The really interesting NDX chart picture is next and I wasn't necessarily convinced that the Nasdaq 100 would finally get all the way down to its long-term support up trendline, but when it did and prices started to rebound, I wasn't going to waste any time in buying NDX calls. This is not just to say that I 'trust' trendlines all the time, but for sure buying near the trendline gave me a close by 'risk' point by placing my exiting stop just a bit under the trendline.

Of course the 'trendline' strategy didn't work so well in timing Dow Index call purchases as INDU went so far under its trendline INTRADAY, but: two things here, NDX was the KEY index and it was a HUGE sell off to finally get the index to this potential support area. I had been targeting the 1700 area for some time in NDX and was willing to wait to see if it finally got there. I wasn't completely alone in that! (The reference to 'Today's Low' below refers to the where prices were as of the 1/23 closing date of this chart.)

KEY REVERSALS AND OTHER BOTTOMING INDICATIONS

A daily 'key upside reversal' is where in a decline, prices fall to a new intraday low but Close ABOVE the prior day's High. Some consider it enough if there's a new low followed by a close above the prior day's close. The more stringent pattern I'm suggesting was apparent in the S&P. Not so in the Dow and the Russell 2000 (RUT) as they did not quite fall to a new low. The Nasdaq Composite didn't quite make it back above its high of Tuesday and the Nas 100 didn't quite close above its Tuesday close either. The Nasdaq indexes certainly had sharp 'spike' down lows and came back a long way from those lows yesterday even though they didn't achieve the key reversal definition.

Besides the daily S&P 100 (OEX) chart below showing a KEY UPSIDE REVERSAL (new Low for the move, followed by a Close above the previous day's High), a principal way I measure 'oversold' is how far a major index gets below its 21-day moving average on a percentage basis.

As I've highlighted below, we have to go back to the first major low in 2002 to find an envelope percentage extreme as great as today, when OEX fell to 9.5% below its 21-day average. We need to go back to the second 2002 low forming a double bottom low in OEX, to see where prices touched my second lowest 7.5% 'envelope' line. The important point is that this sell off was really getting extreme and buying that OEX dip under 600 in OEX was relatively low risk in terms of the snap back potential. This was coupled with what I noted about the NDX chart support AND the bearish 'sentiment' extreme seen last week. You can imagine, in a panic especially, that there is NO floor under prices, but there always IS a floor.

The chart notations above reflect price/indicator action as of the Wednesday (1/23) close.

As many if not most of you know, a single reading or multiple readings of the 'CPRATIO' (seen above) below 1.1 suggests that a significant upside reversal is not far off, specifically within 1-5 trading days. In a bear market trend 'CPRATIO' will often have a close cluster of days that register below the 'oversold-extreme bearishness' line; moreover, in a steep decline the 5-day average will ALSO typically reach the oversold line seen above.

The fact that call activity picked up at the beginning of the week (Tuesday) such that this indicator popped back above the oversold level, I took as mildly bullish, since it suggested a movement toward greater call activity; i.e., Tuesday daily equities call volume was 1.3 times put volume. Traders were starting to probe the long side of the market even in the face of a downside panic type market; the strong Fed action helped of course!

GOOD TRADING SUCCESS!
 

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