MAILBAG QUESTION:

"in recent writing you indicate that the intermediate trend would turn up again if the market gets back above highs made earlier this year. You also say that the short term and long term trends are up however. What makes for the difference? which trend is best to be looking at in making trading decision on the dow, s&p or nasdaq?"

MY RESPONSE:

Thanks for your e-mail. I've been traveling this month and haven't penned a new Trader's Corner column in a couple of weeks and am glad to get back to it today.

To answer your second question first, since the late-March top, assuming your charting application can plot 60-minute charts for several months at a time, a number of effective trades could have been based on a study of hourly charts, especially when EXTREME highs and lows occurred with a 21-hour Relative Strength Index (RSI) indicator; length setting for the RSI set to '21' when applied to these 60-minute charts.

Not all opportune trading opportunities were based on such extremes, but enough trades were that had you ONLY adopted bullish or bearish option strategies at such extreme highs or lows, you could have had a very profitable year. Not all trades would have worked out. Out of every 3-4 trades I normally expect to exit 1-2 that didn't work out; the reason to risk a relatively small amount on any trade.

As to your first question as to the short-term, versus intermediate and long-term trends, actually ALL are UP currently. I could have more accurately said that the intermediate uptrend would be confirmed on a move above the late-March and early-May highs.

The long-term or what Charles Dow would call the primary UP trend, would be 'confirmed' if and when the S&P 500 Index (SPX) index clears its massive 1550 double top of 2000 and 2007. SPX is the KEY index that is generally accepted as determining the primary trend.

The Dow has a different very long-term (monthly) chart picture in that the primary up trend is confirmed on a monthly close above its 2007 high in the 14000 area. The Nasdaq Composite (COMP), which had a huge bubble of course into its 2000 monthly closing high of 4696, only just cleared 3000 in March and April. COMP has a long way to go to 'confirm' ITS primary uptrend.

All such chart considerations are based on the indexes clearing prior CLOSING highs. Examples relating to the dominant trend are best seen with a close-only or line chart.

THE S&P 100 (OEX) HOURLY - DOWNTREND PERIOD

Using the big cap OEX as my first example (the stocks of which have often gotten the biggest play in 2012), my first chart highlights 'extremes' at or above 70 and at or below 30 on the 21-hour Relative Strength Index (RSI) in the downtrend of early-April to late-May/early-June.

On an hourly chart basis, length setting 21, overbought extremes in the RSI are typically seen when this indicator hits 70 or above; conversely, oversold extremes typically occur when the RSI falls to 30 or below.

In the OEX hourly chart seen first, there were 4 such 'oversold' extremes and 3 such 'overbought' extremes noted. Overbought extremes noted as '2' and '3' occurred on the upside turnaround; i.e., when OEX rallied to above the prior upswing high (example '2') and when example '3' rallied to above its mid-June high.

Just taking the above examples of RSI oversold extremes, example 1 identified a low that led to a good sized rebound of 20+ points. Oversold example 2 identified a point where a very short-term rebound occurred before the downtrend resumed (a bust!). Oversold example 3 marked a low that led to a turnaround of 14 OEX points, which was so-so as a trade. Oversold example 4 occurred at a major low that led to a substantial 40 point rally in OEX.

During the DOWNTREND period identified above, overbought example number 1 was the most profitable trade in puts, even if only staying on the short-side UNTIL the first 'oversold' extreme was seen.

In the above examples, use of upside or downside breaks below or breakouts above up or down trendlines could have been an added input on making any trading decisions in ADDITION to entry at overbought or oversold RSI hourly extremes. I think of the RSI extremes as getting poised on the starting blocks of pulling a trade trigger. The starting gun of trade entry might be the addition of a key upside or downside reversal best seen on an Open-High-Low bar or candlestick chart, perhaps along with a breakout above/below a trendline and so on.

There are other considerations in trading on a technical/chart basis but the period when RSI extremes occur tend to be what I want to see first and foremost as I like to anticipate REVERSALS when a countertrend trade is cheap in terms of call or put prices.

S&P 100 (OEX) HOURLY - UPTREND PERIOD

The uptrend apparent since the early-June hourly closing low as seen below on the extreme left (green up arrow), as its unfolded, has suggested buying dips.

However, the upside 'overbought' extreme (at down arrow #2 seen above) could have been the occasion to both exit OEX calls and as well to have gone into puts. The subsequent pullback to the lower up trendline, which was close to but not AT an 'oversold' RSI extreme, nevertheless suggested getting back into calls or simply taking put profits. Pullbacks to up trendlines or rallies to down trendlines are important chart patterns to consider.

The next 'overbought' 21-hour RSI extreme (down arrow #3 seen above) suggested exiting OEX calls and playing the downside again. However, the THIRD hourly low that formed just under the OEX up trendline was a pattern suggesting exiting puts and getting back into calls based on a key trendline.

The most recent 21-hour overbought extreme seen with the RSI above (highlighted red down arrow as '?') suggests taking profits on calls. Based on the way the trading swings have gone after high and low RSI extremes, a bearish play may have a favorable risk to reward. Stay tuned on where OEX goes next; a pullback to 620 OR only a trading pause on the way higher. The prior hourly closing highs were 642 (early-May) and 646 (early-April).


GOOD TRADING SUCCESS!