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Q and A: Technical Snapshot

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I got a couple of e-mails from Option Investor subscribers yesterday, one of which had general relevance to a market snapshot using (just) technical analysis. Many shorter-term traders will tend to make trading decisions based on charts and indicators; i.e., 'technically'.

The simple reason for this it that it can be quite hard to predict shorter-term market direction and SHIFTS in shorter-term market direction based mostly on 'fundamental' factors; e.g., what oil prices are doing, latest earnings, what the Fed is doing. So much depends on 'mood' and market sentiment. Why didn't a relatively sharp pullback in oil prices this week lead to more of a rally? Answer: the mood is bearish, as the longer-term oil price trend looks to be higher. If the mood is bearish regarding stocks, a sharp drop in energy prices won't shift the dominant trend at all.

OI Subscriber QUESTION:
"The market must be quite oversold by now, but stocks don't able to recover more than a day or two and them get slammed again. How do you rate the market technically right now?"

RESPONSE:
Well, 'the' market is quite capable of a short-term rally (e.g., 2-3 days), but I rate the chances of a more sustained rally as less likely, based on a couple of considerations. One is whether the market is really as 'oversold' as it can get before there's potential for a substantial rebound. The second is whether a major prior low or major trendline has been re-tested. There is actually a third consideration as to whether bearish sentiment has gotten to the kind of 'extreme' associated with a tradable rally being near at hand.

Another consideration is 'WHICH' market are we talking about. The long-term weekly chart of the Nasdaq Composite (COMP) still has a long-term up trendline (dating from 2002) that hasn't yet been pierced. It's possible that this chart aspect suggests that COMP could remain within a long-term uptrend. The S&P 500 (SPX) has already broken below its long-term up trendline. However, if COMP doesn't go lower than it's been this week, it's still possible that tech is in a heck of long-term bull run still.

Overbought and oversold have to be looked at relative to short, intermediate or long-term time frames. It's a 'relative' concept. My favorite of what are classed as 'momentum oscillators', or indicators that have oversold (or overbought) default definitions, is the RELATIVE Strength Indicator or RSI.

Given that we've been in a multimonth decline, where the decline to date is greater than a 10% decline from the peak, I calculate 'oversold' by whether the long-term RSI measuring 13-weeks (a quarter of a year) is near or under a reading of 30. Seen first is the SPX weekly close-only (line) chart.

You'll note that the major prior weekly closing low at 1236, from 2006, has not been re-tested or reached. I rate it as somewhat unlikely that there will be a sustained rally (e.g., more than 2, perhaps 3, weeks) without a test of this major prior CLOSING low.

If there is rebound once again from the area of this prior 1236 closing low, investors will tend to have more confidence that the S&P stocks as a group may have discounted all the possible bearish news and all possible lowered earnings expectations. Nothing says that this week's INTRADAY low (today!) at 1236.7 can't be a final low for this move, but what would set up a more 'convincing' bottom would be a WEEKLY close near 1236, followed by a rally.

The other INDICATOR aspect to the above weekly SPX line chart is that the index hasn't yet gotten as oversold as at an earlier low of this year (January). Moreover, I'm not comparing what RSI level is fully 'oversold' to what has come in the period shown above. At recent lows the retracement of the 2002-2007 advance is now equal to 40 percent. That is a major, bear-market type, correction. If the correction deepened to 50%, which is not uncommon, SPX would fall to 1173. If the RSI got as oversold as it did toward the end of the 2001-2002 bear market, the 13-week RSI could fall to 20.

NASDAQ PRESENTS A DIFFERENT PICTURE

The Nasdaq Composite (COMP), as viewed on a very long-term weekly chart basis, still has the POTENTIAL of 'holding' its 2002-2007 up trendline. The COMP bar chart below shows that this week's low at 2214 (made Monday) has touched the aforementioned long-term up trendline. If we continue to see COMP weekly lows not much under this week's, the index actually remains within its uptrend channel. However, in terms of how 'oversold' COMP has gotten at significant lows, it has TYPICALLY gotten to a lower RSI reading at MAJOR lows. I am struck by this inconsistency.

Time will tell if this indicator pattern conforms to the prior pattern or whether COMP has a bottom this time that doesn't also see the 13-week RSI down where it's been at most prior major bottoms where sustained rallies followed. Maybe the game is afoot and the stocks that are going to be somewhat recession proof are TECH. Stay tuned on that.

SENTIMENT ISN'T BEARISH ENOUGH FOR A MAJOR BOTTOM?

I've been saying for a while, mostly in my weekend Index Trader column, that the build up of bearish sentiment hasn't yet been 'extreme' enough to suggest a major bottom could be near, at least according to my sentiment indicator. The way I use this indicator is very straight-forward; buy 'signals' are suggested 1-5 days after any SINGLE day when daily CBOE equities put volume is equal, or nearly equal, to that day's equities call volume. NO qualifications to this and NOT measured on a moving average basis.

There is one possible qualification to the above, which is that call to put volume ratio extremes seen on an expiration Friday could be suspect, the result of unwinding not strictly related to trading activities of the aggregate of individual traders.

Given the duration and EXTENT of this decline, I have been anticipating that the next tradable bottom, at least one with rally potential of 5-10 percent, would be preceded by my sentiment indicator getting closer to l or under, per my last chart seen below. I have my sentiment indicator 'set up' with my S&P 100 (OEX) chart, but the CPRATIO indicator represents trader sentiment for the entire market.

Not only would OEX have to sink further to set up a 'test' of its major prior low, but my sentiment indicator also has not yet achieved a solidly 'oversold' bearish extreme. Which of course in an Alice In Wonderland 'contrary opinion' sense would suggest that the market is quite near (e.g., within 1-5 trading days) a bottom with substantial rally potential; 'substantial' bottom = one worth buying calls for more than a 2-3 day trading turn.

QUESTIONS/COMMENTS:
Please e-mail Click here to email Leigh Stevens support@optioninvestor.com with any questions or comments, with 'Leigh Stevens' in the Subject line and it will get forwarded to me for a reply.

GOOD TRADING SUCCESS!
 

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