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Is it Over?

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I'm not referring to any political campaign or the like, but to the prospects that the 6-week old rally from the mid-March low had run its course. The answer: probably YES.

As John Hussman, a well-respected mutual fund manager, said the other day: "Investors really have no sense of market dynamics if they believe that a recession-linked bear market comprises a single decline of less than 20% followed by a V shaped rebound into a new bull market." He could be right!

The daily chart patterns in the case of the Nasdaq 100 (NDX) does resemble a "V" bottom and the S&P 500 (SPX) that of a similar bottom type pattern, that of a "W" shaped bottom; the "W" pattern simply has one low, followed by a second low later on, made more or less in the same price area.

Market sentiment or outlook, according to my daily equities call to put volume ratio, did get extremely bearish during the 4/9 to 4/15 period. In a contrarian sense, this extreme set the stage for the second leg up in SPX from 1324 up to the recent 1423 high, for a gain of nearly 100 points. However, readings of this type don't necessarily set the stage for new bull markets. A good trading 'signal' yes, a harbinger of a renewed bull market, probably not.

The key to whether a substantial rebound from a deeply oversold condition (as measured on a long-term weekly chart basis) is usually seen in HOW MUCH a recovery rally retraces of the overall decline or the last big down 'leg'. Only if that retracement has gone beyond a 62-66 percent retracement can I be convinced that the rebound is a turnaround and major trend change OR is only a counter-trend rally within a still existing downtrend.


I've written about and use extensively myself in making trading decisions, the so-called 'fibonacci' retracements. I'll go into the Fibonacci number sequence and what that is at the end of this article for those of you who haven't heard this all before or want to review the concept(s).

First is to discuss a general observation made by many traders and investors over many years: a 'weak' recovery in a stock or major market index, will rebound at least 38% of its prior decline; a common, we could say typical or even 'normal', recovery move will retrace about one-half or 50% of its prior decline; a very strong rebound will retrace around 62% to 2/3rds (66%) of a prior decline.

When a stock or index gets very oversold, as measured by the 13-week RSI indicator applied to a weekly chart, it becomes more common to see at least a 50% retracement and a bit more even. A 'bit' more being an 1/8th more (12%) or so. Or 'so' is often just a few percentage points more than 62%, so that it ends up being around a 66% retracement. I'm going to show chart examples of a 'fibonacci' 62% retracement in SPX and the Nasdaq Composite (COMP) to date and a retracement to date of 66%, which is the case with the Dow 30 (INDU).

The rule of thumb on retracements and the reason that they are so useful in trading is that once a 38% retracement is EXCEEDED, we can take as our next upside objective a retracement that would equal a 50% recovery move. If there is more than a 50% retracement, I look for a 62% retracement or a little bit more; i.e., 66%. When a retracement exceeds 66% of the prior decline, then it becomes a reasonable expectation that the rebound could carry all the way back to the prior high; i.e., a 100 percent retracement.

Once one of these retracement levels is reached and the stock or index starts to stall and seem unable to make further upside progress, we have to figure that further upside progress may not happen. Moreover, patterns like a 'key' downside reversal, which is a new high for the move or close to a new high, followed by a Close under the prior day's Low, which is especially telling as a top indication as happened yesterday in COMP.

Now, I have made the bullish technical case and wrote last week in this space about 4 bullish patterns that were associated with an intermediate-term rally or rally prospects; or, even chart patterns that could be construed as making the case that SPX and NDX hit long-term lows at their last major bottoms; i.e., they 'held' their long term up trendlines. I should also note that trendlines can be a little tricky in the sense that they can be drawn with varying degrees of variance and interpretation.

Retracements are quite objective. A starting point is either the all-time high, or the high at the start of the last major down leg, and an end (measuring) point is the absolute low. I generally use the intraday (or intraweek) highs and lows, versus the Close only high or low. A level that is half way (a 50% retracement) between those two points is clear-cut. Either a recovery rally makes it to that point or beyond, or doesn't.

Any anticipation or expectations I might have, or have had, for a major turnaround in the current bear market trend, is absolutely prefaced on the assumption that there will be MORE than a 62% or 2/3rds retracement of the prior decline or down leg at some point; that the market will recover ALL of its prior decline and then eventually go beyond and above that prior top. (A move simply TO the area of a prior high, but not beyond it, becomes of course a double top.)

In the case of the leading current market index, the S&P 500 (SPX) per the chart highlights below, the SPX retracement of the (December to early-March) decline to date has been exactly a fibonacci 62%, which has been followed by several days of sideways to lower movement; yesterday, the index made a 3-day low. Time will tell what's going to happen finally but the retracement pattern suggests that this run up has run its course; only a close above 1423 and the index climbing from there, makes for another analysis.

A related technical indicator that suggests the market may have made at least an interim top is supplied by the recent RSI extreme as seen on the lower portion of the SPX chart above.

As I noted already, when a retracement goes beyond 62%, the most common, slightly higher, retracement is 66% before there's a resumption of the dominant trend. We have to assume that the dominant trend is down until the market starts climbing above a 2/3rds retracement.

The past history of retracements suggests that 13066, the 62 percent retracement level, in the Dow 30 (INDU) is a pivotal point; only a close above it would suggest that the INDU rally keeps going. Near support implied by the 21-day moving average is holding up to date, so stay tuned on how this resolves itself. If I had to bet it would be in Dow Index puts.

My next chart of the Nasdaq Composite (COMP) is similar to SPX in its retracement pattern, although COMP didn't exactly hit the fibonacci 62 percent level but did come close to it. The sideways to lower trend after it did, is suggesting that the index could have reached its rally peak. I don't expect that the market will necessarily fall sharply but could start drifting lower from recent highs.

The retracement theory gives an idea of the key level that COMP must pierce (2506) to suggest that the index could climb still higher, such as (ultimately) back up to its highs in the 2727 area.


You can take your pick:

# 1.) That of an apparent bullish long-term weekly up trendline as seen below with the weekly S&P 500 close-only line chart, shows the recent rebound from this line....OR, see the following chart for a different idea, one that suggests that recent highs could be hitting some long-term resistance.

# 2.) I don't recall seeing this kind of divergence before between the S&P 100 (OEX) and the SPX long-term chart trendline patterns. The two green arrows highlighted on my next and last chart, suggest two areas where OEX rebounded from major chart support implied by this trendline established by 2-3 lows forming a straight line.

A well-known technical analysis principal suggests that support, once broken, 'becomes' resistance later on. If we look at the recent weekly closing high (last week's) it appears that OEX may have stopped climbing precisely at resistance implied by its previously broken up trendline.

Stay tuned on how this tale of two charts works out! Starting with my original premise, it will be an unusual bear market turn if the decline is behind us already.


We owe some debt to Charles Dow for his observations that an intermediate trend often will retrace (give back) around 1/2 of the distance covered by the major or primary trend, before the major trend resumes. There were further refinements on retracements made by W.D. Gann, a famous stock speculator of the early to mid-1900s.

But the origins of one of the most useful retracement theories for stocks and other markets came from someone who lived in the middle ages and was studying the population growth of rabbits.

Leonardo Fibonacci was an Italian mathematician doing such work in the early 1200s. The number sequence that is named after Fibonacci is where each successive number is the SUM of the two PREVIOUS numbers; i.e., 1, 2, 3, 5, 8, 13, 21, 34, 55, 144, etc. Any given number in this sequence is 1.618 times the preceding number and .618 times the following number.

There are some technical indicators whose formulas rely on the Fibonacci number sequence, but the main application is to look at price moves in stocks or index and use the fibonacci retracements of .382 or 38 percent, .50 or 50 percent and .618.

Looking at the number progression of 1, 2, 3, 5, 8, 13, 21, etc. where each succeeding number is the sum of the two before it, there are certain arithmetic relationships that exist: .618 is the percent that each number is OF the next higher number; .382 is the inverse of .618 (100 61.8 = 38.2). Sticking to shorthand, I round off .382 and .618 to an even 38 and 62 percent.

Imagine a stock that in 12 months goes from 10 to 20, up $10 dollars. The stock has had a fantastic double but you think it could go still substantially higher. You wished you had owned it at 10 but still would like to buy it, just cheaper than 20. The stock starts to trade lower. At what level could you hope to buy the stock?

Considering what would constitute the 38, 50 and 62% retracements of the 10 to 20 dollar advance would suggest the following:

1.) If the demand is really strong for the stock, you might not be able to buy it cheaper than 16.25 (.38 of the 10 gain subtracted from the 20 high point)
2.) If the demand was average, you could hope to buy the stock at 15, which is a give-back of .5 or one-half of the 10 point run-up.
3.) If demand turned out to be weak on the way back down from the high point of $20 (e.g., after some news stories about the company die down or change), you might anticipate or wait to see if you could buy the stock at 13.75 (representing a 62% retracement of the ten dollar advance from 10 to 20).

Useful in trading index and individual equity options is to track what would constitute the 38, 50 and 62% retracements, after a short-term to intermediate price swing.

There is a simple pragmatic reason for the popularity of 'fibonacci' retracements. Buying or selling in these retracement areas has often resulted or come close to realizing a buy at a correction low or shorting near the top and end point of a rebound occurring within an a larger decline. Maybe the saying of buy low, sell high, owes something to the common retracements.

You can set most charting applications to calculate retracements ranging from 25, 33, 38, 50, 62 and 66 percent or whatever levels in between, but these are the common retracement levels in use. If a retracement approaches 62%, I also add to my retracements charting tool, a line showing the 66% retracement level. In a correction (fall in price) within a larger uptrend, use of the retracement 'tool' is by first pointing at the low, then the high; in a correction (fall in price), first point at the high, then the low.

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


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