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Technical Signs of a Bottom

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"...this week's rally is looking pretty strong. Do you think we've seen a bottom?"

There are a number of technical aspects to look for to suggest that a final bottom for a move has been reached. Some of these things are the same as for an interim bottom, but the developments are not necessarily the same.

I'll try to distinguish or separate what suggests a 'final' bottom, versus an interim bottom. Both types of bottoms are of course tradable, especially with all the creative and possible strategies with options. However, an interim bottom will make buying near the lows more important and make it more crucial to exit at a pre-set objective or to exit as soon as an upside rebound is giving signs of fading momentum.

1.) Successful retest of a prior major low
2.) Major oversold condition seen on both daily and weekly charts
3.) Extreme bearishness that does not shift quickly
4.) Greater than a 62-66% retracement of last major downswing
5.) Rallies exceed prior rally highs

This most recent bottom had 2, of 5, of my technical conditions met so far. Point 4, or the extent of the percent retracements of the last major downswings for the major indexes, isn't determined yet. What develops re point 5 isn't known: SPX would have to close above 1300 to exceed its prior major rally high.

Only the S&P 100 (OEX) retested its major prior low from 2002-2003, at 400; I should note that there were two other weekly lows in OEX in '02-'03 that hit 386. The S&P 500 (SPX) for example would have had to reach the 800-775 area; the Nasdaq Composite (COMP) would have had to fall all the way to 1257.

1.) Major oversold condition, at least on daily charts
2.) Extreme bearishness, but such sentiment can shift quickly
3.) Retracements of last downswing average 38 to 50% only
4.) Bullish price/RSI divergences
5.) Rallies struggle to hold about the 21-day moving averages

Of the common signs of a rebound, or interim bottom, 3 of 5 of the conditions have been seen. Bearish sentiment for example reversed too quickly on my indicator to suggest that we're seeing a major reversal to what may be a prolonged bear market. We don't yet know of course if any retracement of the last major downswing will exceed 38, or 50, percent of the prior move. So far, rallies have seemed to have hit resistance implied by the 21-day moving averages.

Three charts will illustrate certain of these points.

In the S&P 500 (SPX) daily chart, you'll see that the 13-day RSI hit an oversold extreme at the first low seen just under 850 (point 1). Bearishness was extreme as will be seen on my next chart (point 2) but shifted to fairly bullish VERY quickly. We don't know the extent of this retracement yet (point 3), but SPX has to rally to 1017 to reach even a 'minimal' 38% retracement.

There was a bullish price/RSI divergence as the second low in the 850 area was on higher relative strength or the RSI (point 4). You'll note that so far on this rally both yesterday and today's highs have stopped right at resistance implied by the 21-day moving average. Stay tuned on how much difficulty SPX has in both exceeding the average and then holding above it.

[Image 1]

In the S&P 100 (OEX) chart below, there was a major retest to date anyway, of prior major support in the 400 area; although in 2002-2003, this area was hit several times and there were two dips below this level but only briefly in each instance. Stay tuned on this, but its the type of chart development that suggests that a major bottom could be in place.

A key technical point as to how transient this recent bottom might be relates to how rapidly my sentiment ('CPRATIO') indictor shifted on yesterday's rally and actually touched the first level of 'overbought-high bullishness' reading at 1.7. This relates to point 2 of signs of an interim bottom only, versus a major bear market bottom where sentiment shifts tend to be slow.

The cluster (3 days) of 'oversold-extreme bearishness' readings was VERY significant in terms of 'signaling' a tradable bottom ahead, but if recent lows were a major bottom, I wouldn't expect to see such a jump of equities call activity so quickly.

[Image 2]

The chart of the Nasdaq Composite (COMP) doesn't add anything fundamentally different to the points made already on my first two S&P charts, but does make for a comparison to Nasdaq. COMP is also approaching a key test of near resistance, both implied by its 21-day moving average AND by the cluster of its prior highs in the 1775 area.

After these two key technical 'tests' will be to see if COMP can climb back to, or beyond, 1866, representing a fibonacci 38% 'minimal' retracement of its last major downswing. A weak bear-market only rally will tend not to go much beyond a minimal such retracement.

[Image 3]


Please send any technical and Index-related questions for possible use in my next Trader's Corner article to Click here to email Leigh Stevens support@optioninvestor.com with 'Leigh Stevens' in the Subject line.

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