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Current Short and Longer-Term Pattern Interpretations

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I wrote last time (in the Wednesday 4/2 OI Daily) about some short and long-term INDICATOR patterns that can provide potential clues as to how stocks might fare in the period ahead. Today I want to concentrate on some short and long-term chart PATTERNS; things like 'flag' patterns, rounding bottoms and trend channels. If those terms are all Greek to you, that's why I'm here; i.e., to try to read some of the 'technical' tea leaves and how indicators and pattern recognition could help you make trading decisions. There are plenty of 'fundamental' factors to chew over and probably too many conflicting ones!

Before I get into the main topic of certain chart patterns I'm seeing currently, I'll briefly revisit one shorter-term indicator (from last week) that has been quite accurate this year in predicting areas where the major market indexes were topping out or bottoming. That indicator is the Relative Strength Index or 'RSI' applied to the hourly charts and using a 'length' setting of 21, a fibonacci number.

When RSI has gotten to between 60 and 60, the current bearish market has had trouble making further headway; 60-65 or above, has marked an 'overbought' area. Conversely, RSI readings down in the 30 to 35 area have defined a place where the major market indexes have been 'oversold' and having potential for a good-sized rebound.

As I wrote about in my weekend 'Index Trader' column, seen online at the Option Investor web site, there have been some short and longer-term chart patterns suggesting that this market could climb higher. Working against that notion was the early-April overbought readings as measured on a 21-hour basis in the major indexes; 21 hours of RSI calculations represents what occurs in about 3 days of trading.

The hourly Dow chart seen below reached overbought extremes at the red down arrows seen on the RSI portion of the graph. Moreover, at the last upside extreme in RSI, there was also a classic bearish 'divergence' between price action and the (RSI) indicator; i.e., as prices continued higher after the first INDU hourly peak, while RSI did not follow suit. The diverging slopes of the two trendlines tell the story.

As of today, the sideways to lower move had 'worked off' the overbought extreme as can be seen in the falling RSI line. The RSI doesn't have to fall to the oversold zone to suggest a rally (like today's) can happen, but an overbought condition does tend to suggest rally attempts will get capped by selling, as least that has been the case in the weak 2008 market.

Shifting to a focus on a chart pattern, the upside 'gap' area occurring between 3/31 and 4/1 also represents an area of potential or presumed support on pullbacks, as was apparent in yesterday's hourly lows. An indicator (RSI) can suggest one thing, possible tough going on further rally attempts and a gap pattern can tell us another, as in showing areas of support on pullbacks. Some other chart patterns also suggest bullish potential ahead.

The RSI indicator suggesting a recent hourly 'overbought' extreme and the hourly chart pattern suggesting that the Nasdaq Composite (COMP) could be finding support in the (upside) chart 'gap' area, is seen below. It's the same indicator and chart pattern, so there's not more for me to say about this chart except that it's fairly consistent with the Dow and S&P charts.

CHART PATTERNS SUGGESTING FURTHER UPSIDE POTENTIAL

SHORT-TERM: FLAG PATTERNS

You don't see this pattern in the stock indexes all that much, not nearly as much as in some stocks and widely in the futures markets (e.g., bond futures, oil, etc.), but a sharp rally, followed by a consolidation over a FEW days with a limited pullback from the high of the sharp rally, is called a bull flag pattern. The sharp run up is the 'flagpole', the pullback shallow (limited to about a third of the flagpole run up) and a sideways move of a few days typically traces out a 'flag' type formation. Hey, imagination helps!

The usual resolution of this pattern is a breakout above the top end of the flag (the 12700 area) and a next move that tends to tack on a further advance that is at least equal to the first spurt higher as measured from the top of the 'flag'. This upside projection for the bull flag pattern outlined below would suggest that a decisive upside penetration of 12700 would have the further potential of a move to the 13000 area.

A bull flag pattern is most often resolved in a FEW DAYS after the initial run up. If this doesn't happen and prices start falling below the low end of the flag (around 12500 in INDU), this pattern breaks down or devolves into a simple TOP.

INTERMEDIATE TO LONG-TERM CHART PATTERNS:

You'll see above in the Dow 30 (INDU) daily chart that I've traced out what could be a 'rounding bottom' pattern, sometimes referred to as a 'saucer' bottom. This pattern has a fairly good record of predicting the formation of an intermediate to longer-term bottom AS LONG AS subsequent pullbacks don't start breaking below the circular line; e.g., currently suggesting INDU support in the 12000 area.

If the Dow falls back to lower than 12000 or wherever the intersection of the circular line is at the time, this suggests that a bullish rounding bottom is not a valid chart interpretation. If prices retreated under Dow 12000, technically I'd then be looking to see if a decline held at or above the prior (11732) low. If a decline stopped AT the prior low, there's the possibility of a double bottom. It's not that patterns don't have predictive value. They do. But if a bullish pattern is negated, it confirms renewed bearish selling pressures.

There is a somewhat different pattern unfolding with the Nasdaq Composite daily chart seen next. There is not the same near-term bull flag pattern suggested for the Dow chart, but bullish potential IS seen in the stair-step climb of the higher (pullback) lows tracing out an up trendline currently and with one key pullback rebounding from support implied by the 21-day moving average. However, continuation of a further bullish chart is not 'proven' until and unless COMP pierces its prior highs at 2376 and then 2419. A downside penetration of 2300 would also suggest renewed selling pressures and a retreat of potential buyers.

The same rounding or saucer type bottom is traced out into the (unknown) future on the COMP daily chart above, but it is a 'flatter' circle, more broadly rounded. And there is yet to be a better 'definition' of the rounding formation. Better definition of a rounding bottom might take the form of another retreat to the low end of the circle, followed by another rebound; e.g., COMP retreats to 2200 around the middle of May and then rallies again vigorously. I've often seen the potential involved for a longer-term bottom (or top) in an index or stock when the rounding pattern unfolds. The rounding top is the reverse of the rounding bottom and forms an umbrella shape.

A broad rounding bottom formation is strikingly different than a 'V' shaped bottom or a (inverted 'V') top that goes up to a peak, followed by a steep decline; e.g., the March 2000 Nasdaq 100 (NDX) top especially apparent in the weekly (close-only) line chart. Rounding bottoms are somewhat more common than rounding tops. Buying takes place of a long period typically, whereas selling often gets concentrated as panic sets in.

LONG-TERM CHART (AND INDICATOR) PATTERNS:

I pointed out the still bullish long-term (multiyear) uptrend that remains intact for the S&P 500 (SPX) before, and the Nasdaq 100 (NDX) weekly chart suggests the same pattern and is seen below. Given the potential for rounding bottoms that may continue to evolve in the daily charts I've shown, the notion of being at or near a LONG-TERM bottom gets some added credence. NDX has recently rebounded from its 2002-2006 up trendline. I try to keep this 'objective' long-term chart pattern in mind so to not get locked into thinking that a recession means that stocks are going to be down for months (and years) to come.

If the worse is over in terms of the prospect for earnings, as projected out over the next 6 months or so, the NDX long-term chart may offer some tip off to that. With the current sort of gloom and doom, it's rather amazing to think that the market could still be in a long-term secular (over many cycles) bull market.

I'll finish by noting that the 13-week RSI (13 being another in the fibonacci number series) seen above, got to an 'oversold' level that is about as extreme as it gets before either a good-sized rebound or at least a bottoming type 'basing' (sideways) pattern. The RSI seen above is another indicator aspect to keep in mind, along with the bearish buildup seen in my sentiment indicator (not shown), with both extremes suggestive of a bottom or at least an interim bottom.

QUESTIONS/COMMENTS:
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GOOD TRADING SUCCESS!
 

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