Our recent sharp pullback looks like a correction rather than a reversal of the intermediate-term trend. How to figure whether a dip in a bull market is an opportunity for the bulls versus a bearish play on a further decline?

MY E-MAILBAG:

"...last on my mind is whether this recent selloff marks the start of a bigger correction or not? The composite has a long term double top maybe and since tech stocks have been the key play for months, it doesnt look good for my remaining tech stock calls."

MY RESPONSE:

I've been writing this series on Technical Analysis topics for many weeks (I've done 26 articles so far) and while there are some other topics I want to cover, I welcome a change of pace on a real-time, real world topic.

In technical analysis terms or from this perspective, there's just basically one criteria for whether there's a reversal of the intermediate-term trend; i.e., assessment of the 2-3 week to 2-3 months trend, generally as seen on the daily charts. A long-term trend change would involve analysis of the weekly to monthly charts.

In either chart in an uptrend, a Close below the last downswing low suggests an intermediate trend reversal. I add one caveat which is that a Close under the prior intraday or Closing low should last more than a single day. In a bear market situation, an upside reversal is suggested by a (two consecutive day) Close ABOVE the prior upswing high.

There are 2-3 things we want to look at in evaluating whether an existing bull market trend is still intact or there's a trend reversal involved:

1.) Has the prior downswing low been pierced?

2.) What levels of possible technical support are holding?

3.) What other (unrelated to chart/price considerations) technical indicators are suggesting; e.g., bullish/bearish sentiment models; Volatility indexes like VIX.

If we look at my first chart of the daily S&P 500 (SPX), the first question is easy to answer as to any penetration to date of the prior downswing low. NOT yet, as SPX would have to fall below 1275 to pierce its prior significant (downswing) low. That's number 1 in terms of whether this decline is a correction to the existing (bullish) trend or whether it looks like a trend reversal.

The number 2 consideration pertains to what levels of technical support are holding or not. In terms of SPX, the 1300 area is important technically as support is implied by prices holding today at the up trendline; this is the trendline I had on this chart for my Index Wrap commentary written prior to this 3-day sell off. Other potential support could have come in at the 21-day moving average but it didn't. Looking at the next commonly followed moving average length, the 50-day average, this hasn't been tested. So far, I think we're seeing a correction/pullback scenario only.

I also mentioned that a number 3 item on our technical check list so to speak is whether something unusual has developed in a related but not strictly price related indicator, especially with volume, volatility or trader/investor (bullish/bearish) 'sentiment'. Staying with the S&P 500, there's a technical aspect worth noting with the VIX chart of the daily CBOE options volatility levels for the S&P 500.

When looking at spikes in the daily VIX that takes this indicator to 5% or more above its 10-day moving average, there's a history in this bull market anyway, of such spikes in VIX occurring prior to the resumption (or continuation) of rallies; as highlighted with the yellow circles.

This most recent extreme jump in the VIX as seen above, coupled with the index holding a key trendline support, could suggest that this decline has run its course for now. There may be a period of basing type sideways action, but as long as 1275-1300 holds as support in SPX, today or future days with minor dips to/below 1300 may end up as an opportunity in SPX calls; e.g., in the March or April 1300 calls. CBOE volume in March SPX 1305 calls was around 23000 today (2/24). The March 1300 SPX puts were equally active, along with the March 1200 SPX puts; 100+ points out of the money being a real bear bet.

I haven't dealt with the Nasdaq Composite (COMP) yet and its bullish or bearish chart developments. There was a question posed as to a possible long-term double top in the Composite, so next is a weekly long-term COMP chart.

As you can see, COMP has topped out in a same approximate area as it did in October/November 2008. A possible double top indeed. However, it also should be noted that COMP is the only chart that has EQUALED a prior key high. The Nasdaq 100 has exceeded its prior high and the S&P and Dow have not yet neared their prior highs of the same period. Nevertheless, COMP could be a harbinger of a possible major top. COMP, to stick with this index, is certainly about as overbought as it gets in terms of the weekly MACD indicator seen in the lower portion of the chart.

We can't rule out a major top in terms of what COMP is showing us in this picture, but other chart/indicator aspects in the Composite and the other major indexes don't support this idea. Moreover, here comes the rule that 'confirmation' of a reversal in the major trend typically occurs when a previous downswing low is pierced. At a minimum, COMP should fall to below 2460 and eventually to below 2100, to suggest a downside reversal of the major or primary trend.

In answer to whether there's a downside reversal in the tech heavy Nasdaq, the prior downswing low in the Nasdaq Composite (COMP) has NOT been pierced; only a drop below 2677 would suggest an intermediate downside reversal. That's number 1: no reversal of the trend is indicated yet.

Second is to consider what levels of technical support, if any, are holding. COMP pierced its up trendline (gray dotted line) as I had drawn it prior to this week's sell off. If we assume that yesterday and today's lows are two points (of 3 or more) through which we can re-draw COMP's up trendline, there is an emerging up trendline to consider, pending further price action. Moreover, the index has not closed below its key 50-day moving average, so there's some support coming in at and on dips below the 50-day average.

On balance, the chart/technical picture for the Nasdaq Composite is not yet suggesting a downside trend reversal. There is this 'double top' possibility on the weekly long-term chart but it's too soon to call this pattern more than a possible double top. More time is needed to see on this. When there's further price action over coming days to evaluate, then different and further conclusions can be made. What I've given in THIS snapshot in time are key chart/indicator aspects I look at in evaluating a correction scenario versus a possible trend reversal.


GOOD TRADING SUCCESS!