MY MAILBAG:

"I had questions on some of your remarks in your recent Index commentary of Saturday (9/24). I cut and pasted the 3 statements that I wondered about for possible further explanations? I'm somewhat new to technical trading concepts."

MY RESPONSE:

I feel somewhat like a 'stranger in a strange land' myself in terms of understanding this particular phase the market is in using ANY kind of analysis, fundamental or technical!

I'm placing each of MY 3 quotes you refer to separately below so I can better answer each point in turn by number.

(From my 9/24/11 Index Wrap)

1.) "Some technical measures or models are starting to 'work' again such as envelope resistance measures and the 'centered' 21-day moving average alternatively 'acting as' support and resistance."

MOVING AVERAGE + MA 'ENVELOPES' AS INDEX SUPPORT/RESISTANCE

The major market indexes tend to trade within certain parameters above and below a key moving average, namely the 21-day average. '21' is a number in the Fibonacci number series, which is the progression of numbers starting with 1, whereby the sum of the two preceding numbers (starting with 1) equals the next number in the series; i.e., 1, 2, 3, 5, 8, 13, 21, etc. This number progression represents how certain things in nature grow as first discovered in an ancient study of how rabbits, left to their own devices will grow; e.g., from 2 to 3 to 5 to 8 to 13, to 21, etc. If this seems like a crazy concept to apply to trading, it is somewhat. All I can tell you is that using certain Fibonacci 'length' settings in moving averages seem consistently over time to offer best choices in measuring support and resistance at key junctures in the major stock indexes.

I'll examine the 21-day moving average, when used with moving average envelope lines that reflect a certain percentage (that you input) above or below the 21-day moving average. Moving Average Envelopes were was covered in depth in a prior Trader's Corner of mine (8/27/10) which can be read online by clicking HERE. Here I will simply look at how the use of the 21-day average and percentages, ranging from 3 to 5 percent, have provided useful inputs historically, NOT during periods of extreme market swings such as in early to mid-August, but then are bring useful again lately in judging the trend or the possibility of a trend reversals.

When the moving average and envelope lines are 'working', there will be a tendency for 3 possibilities: 1.) the moving average 'acts as' either initial support or resistance; 2.) when prices get to or near the upper envelope line, a correction or slow down of the advance occurs; 3.) the lower envelope line, tends to act as support or an area where a rebound sets up.

The twin or 'double' bottom of 8/9 and 8/22 in the Nasdaq Composite (COMP) took prices to well under 5% below the 21-day average. The subsequent rally took prices to above the average, which continued the bullish chart with subsequent dips below the average never longer than a single day before a rebound (with the average still 'acting as' support) took place.

The recent rally to an intraday high of 2643 was quite near to resistance implied by the upper (5%) envelope line and a downward deflection occurred; this also was a natural area for this to happen given the overhanging 'supply' of stock for sale per my chart notes.

Yesterday's (9/27) low seemed to find support at the 21-day moving average. Today's break below the 21-day average is especially significant if COMP also closes again below this key average again tomorrow (9/29) as it will suggest a possible decline to either retest the prior recent low or slip to at least the lower 5% envelope line in the 2380 area. The prior double bottom low in the 2330 area is also an important support.

Use of the 21-day moving average and percent envelopes of 5% in the case of Nasdaq, 4% currently in the S&P, helps give a general picture of current prices relative to how far the index could extend on the upside or the downside. Can it go less than or further than these levels? Of course, but 'overshooting' the upper or lower envelopes is more likely on the UPside when the market tone is bullish (up until July mostly) or more likely on the DOWNside when the tone gets bearish; i.e., Aug-Sept.

(From my 9/24/11 Index Wrap):

2.) "Market sentiment is showing extreme bearishness in some ways of measuring it particularly among investors, but trader sentiment as I look it from a ratio of daily call to put volumes, wasn't bearish enough on Friday to suggest any sustained rebound anytime soon."

MARKET SENTIMENT TOO 'HIGH' TO SUGGEST A BIG ADVANCE

We need to go to the bottom of the daily COMP chart above to look at my 'sentiment' indicator. This indicator and how it can be used as a trading input, is explained in a prior Trader's Corner column (6/17/10) also and can be viewed online HERE.

Firstly, market 'sentiment' figures apply to BOTH the S&P and Dow types stocks as well as tech stocks in general. There is not one 'sentiment' number for Nasdaq and another for the NYSE stocks. While bullish or bearish sentiment or an overall bullish or bearish view on where stock prices are headed, may be somewhat more bullish for one market or the other at different times, generally I use the one calculation; i.e., CBOE total daily equities call volume divided by total daily put volume, also for equities only.

I'll reproduce the chart above without the RSI indicator and more space given to COMP price action versus the lower sentiment indicator.

Back on the 22nd (of Sept) COMP broke sharply as noted by the red down arrow and my daily sentiment figure did fall to a bullish 1.2 as highlighted by the blue up arrow on the CPRATIO indicator lower portion of the chart.

Call volume then jumped on the following day, this past Friday, even though the rebound was a mild one; so, last week ended with sentiment higher than I thought was warranted. Sentiment numbers then stayed bullish in the first 2 days of this week, even though on the 3rd day of the rally (yesterday, 9/27) COMP closed near its daily low, barely holding the 21-day moving average. It appeared to me that traders were too quick to jump to a bullish outlook. Hence my statement that trader sentiment got 'too' bullish too quickly to suggest that the correction had run its course.

Generally in this current market, as can be seen by prior examples on the chart above, sustained rallies have occurred only after bullish sentiment got quite low both in terms of a cluster of daily CPRATIO numbers and in terms of the 5-day moving average.

(From my 9/24/11 Index Wrap):

3.) "Bullish potential is for a move back up to 58 (in QQQ), but another downswing just 'looks' like it is next in this pattern."

I made this comment just with my QQQ commentary only but it was not a well considered remark if taken as true for all the indexes. It's just that a lower second down leg is common in corrections.

This view comes from Wave analysis that suggests that most substantial corrections in stocks or stock indexes take the form of a 3 part down-up-down structure; also called an "a-b-c" correction. I have written prior articles on wave analysis as originally formulated by RN Elliott. I find his theory to be quite on the mark in its most BASIS manifestations.

What I tend to 'foresee' when I look at the current chart of a major index like the S&P 500 (SPX) is another substantial down leg coming after the August rebound as I'm habituated to anticipating a second deep decline.

However, this may or may not be on the mark as we've ALREADY seen a big a-b-c (down-up-down) correction completed with the 2nd decline of late-July/early-August being substantially stronger and longer than the first decline. I do see current weakness in the fact that the previously penetrated up trendline now appears to have 'become' resistance.