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Trader's Corner

Lately, a 'Golden Timely' Indicator

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Until an OI Subscriber e-mails me with a question or two, I'll keep writing on things that interest me, although I'd rather be sure that these are topics that also interest YOU; I'm doing the best I can in the meantime.

What interests me is always about 'beating' the market and right timing on trades; i.e., trades that make money. It's been so long since the market has been in a more or less reliable trading range, that I'm not used to how fantastically accurate buying and selling the high and low (overbought and oversold) extremes can be for this one 'golden' indicator when applied to hourly charts of the indexes.

I'm talking about the Relative Strength Index (RSI) which is one of the 'oscillator' type (scale is between 0-100) indicators of market momentum. Moreover, I use a 'length' setting of 21, a fibonacci number, so that the RSI uses hourly closes encompassing twenty-one hours, which is of course around 3 days worth of hourly data.

While you in your trading activities may not be taking outright (call and put) positions on the indexes, this timing tool is still very useful, especially when trading 'bellwether' big cap stocks that trade much in lockstep with the overall market, be it the Nasdaq or the NYSE-related indices like the S&P.

I wrote last week about the 21-hour RSI providing a strong sell 'signal' at the recent top and I showed hourly charts of the Dow 30 (INDU) and the Nasdaq Composite to illustrate. I went on to speculate in my weekend Index Trader column that the next oversold extreme in the 21-hour RSI might be a next buy point. I also said some other things that indicated my caution about jumping into calls again too soon, but my prattle was not nearly as accurate as just taking the plunge and buying the recent oversold extreme once again. That PLUS the double bottom in OEX got me in.

You wouldn't think this true in a bear market cycle, but there have been fewer oversold periods, according to this RSI model, than 'overbought' ones. Buying the oversold points have been very profitable. Go figure. The market may be finding an intermediate to longer-term bottom, which is what I suspect from a possible rounding bottom (plus some long-term trendline considerations in SPX and NDX) and illustrated further on with the INDU daily chart. Extreme bearish sentiment has been another bullish backdrop for me in a contrarian sense, but that's another story for another time and which I cover each week in my weekend Index Trader piece.

What we saw in the S&P 100 (OEX) most recently here was a picture perfect double bottom, as seen in the hourly chart, AND another oversold
RSI reading. We've seen only one other such oversold reading in the period shown below, but that prior signal was a good one; although there was a slightly lower OEX low made later on, scary to call holders. That this lower low occurred with a rising RSI kept me in the trade. I did 'loosen' my stop point some.

When the 21-hour RSI has gotten to between 60 and 60 in the major market indexes they have had trouble making further headway; 60-65 or above, has marked a so-called 'overbought' zone at least on a short-term basis. Conversely, RSI readings down in the 30 to 35 area have defined a place where the major market indexes have been 'oversold' and have potential for a rebound of a size to make it worthwhile to trade, especially if you have the fortitude to jump in BEFORE it's apparent to all that the market trend has shifted. This is where exiting stop points are also key.

In the Nasdaq Composite chart below, the most recent low was in the area of or just above its prior low. The upside gap had been 'filled in' which is sometimes an indication that another rally will set up. Besides the second low holding above the prior bottom, the key factor was the dip into the oversold zone. Putting the two aspects together: favorable bottoming (price) pattern and oversold RSI reading, the risk to reward potential in NDX calls (around 1780) was favorable; assuming the use of stop-loss protection of course, such as an exit at 1770.

Of course not everyone can check in to unfolding price action intraday even if what you are following is a slower moving hourly intraday chart and hourly RSI indicator set to a longer setting (21)...sometimes I can't check in that often and have other work commitments. With the use of the 21-hour oscillator however, most often a twice-daily update of prices is enough. It was apparent last night that my hourly RSI was in an oversold area and it was then a matter of seeing if COMP was going to hold 2260. If it did, I was going to base an NDX call buy off of that.

ROUNDING BOTTOM PATTERN CONSIDERATIONS:

The Dow 30 (INDU) daily chart updated from last week (below) has what could be a 'rounding bottom' pattern highlighted. I'm always struck by this chart pattern when I see it, as it's often been a reliable predictor of broad bottoming action. You don't see rounding bottoms all that often, although it more often occurs in stocks than in the commodities markets.

This (rounding) 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 current INDU support in the 12050 area. The tendency for rallies, such as seen today, could be an indication of a market that has bottomed or is bottoming. It would be illuminating to see another pullback to the circular support line seen below, followed by a rebound. Such price action would give some added credence to this chart pattern being a reflection of a market that is finding support and a RISING support at that.

The question becomes: 1.) Are we in trading range market and every rally to the 'line' of resistance that has formed in the 12733-12767 area should be SOLD...OR, 2.) is that line of resistance going to be pierced to the upside. I've found more often than not, that 3 or more highs in the same area is a resistance that will be pierced at some point.

How far any such breakout can carry is another matter. It's possible, based on the 'width' of the base added to the line of resistance and projected upward; upside potential (emphasis on 'potential') might be back to the prior 13780 Dow high. That's a pretty bullish projection given how rallies keep making limited headway. However, pullbacks are modest too, so we'll see won't we.

If the Dow falls back to lower than 12050 or wherever the intersection of the circular line is on out into the future, such action would suggest that a bullish rounding bottom is NOT a valid chart interpretation. If a bullish pattern is negated, it is another demonstration, this one technical, of renewed selling interest.

QUESTIONS/COMMENTS:
Please e-mail Click here to email Leigh Stevens support@optioninvestor.com with 'Leigh Stevens' in the Subject line.

GOOD TRADING SUCCESS!
 

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