MY MAILBAG:

"I bought August index puts recently as the dow started down first and s&p followed. What chart targets might you have?"

RESPONSE:

It's really true that the Dow 30 (INDU) was the tip off index as it started breaking support first. IBM, like in prior eras was a Dow bellwether as it started making lower relative highs from the time of its late-April peak. IBM's weekly rounding top pattern was then repeated in the Dow's hourly chart pattern seen from mid-July on: the Dow chart follows the weekly IBM chart seen below first.

Next is the hourly INDU chart with a repeat of a 'rounding top', which is a potent sign for a top. Potential technical support implied by INDU's daily chart (not shown here) up trendline comes in around 15150-15100; possible support then extends to 15000 based on prior lows. The Dow is at its up/support trendline already after today's sharp sell off.

The S&P 500 (SPX) traced out a Head & Shoulder's Top (H&S) pattern, which is seen on both its daily and hourly chart but has more 'detail' on SPX's hourly chart. Coming into yesterday, the formation of a 'right shoulder' looked like it was done. The H&S pattern tends to be such an accurate harbinger of a top that many traders will short the market, buy index puts and the like, before there is a confirming break of the 'neckline'.

The H&S Top pattern is simply a series of 3 highs where the top made first, is followed a rally to higher high. The pullback that follows the 'middle' high is followed by another rally attempt that makes it to about where the first peak (on the left) formed. The so-called neckline is a line that is drawn through the various lows of this (H&S) formation. Three 'dome' like highs are the key aspect of the pattern. Using some imagination, the pattern looks like the head and shoulders outline of a person.

My next chart is a snapshot of the hourly SPX before today's break, so reflects the 8/14/13 Close. A projection of a 'minimum' downside objective from the neckline to 1660 is based on measuring the distance from the top of the 'head' to the neckline. This distance ('a') is then subtracted from where the neckline is pierced and is projected downward ('b'). By the Close yesterday, support implied by the 'neckline' had been penetrated slightly. The hourly chart that comes AFTER the 8/14 chart seen immediately below, reflects the further sizable decline of today (8/15).

The 'minimum' downside objective measured in the Head & Shoulder's top pattern has been met for the most part. This is not to say that SPX has bottomed, but does give at least an initial target.

There are a couple of other technical aspects to the Nasdaq Composite (COMP) chart highlighted next. While you can't accurately predict an 'exact' top from these aspects, as I wrote previously in my Index Trader column, COMP (and the Nas 100) looked like it had some risk of a correction based on a certain steepness of its advance. Specifically, the fact that a parabolic arc tracking prices higher ('anchored' at COMP's last reaction low) had gone nearly vertical.

When the line of such an 'arc' is pierced, momentum often stalls and very often a sharp correction follows. This pattern is highlighted on the daily COMP chart seen next. (Gold bullion had a similar vertical parabolic arc pattern going into its late-2010 top. The collapse of gold prices followed the breaking of its near-vertical 'arc'.)

Also, noteworthy as another 'warning' aspect of a technical top from this week was the steep run up in bullish sentiment (the CPRATIO line) into mid-week as seen above. The bulls finally were really believing the bullish case for stocks. (Hey, earnings were good; the economy has been picking up, etc. What could go wrong? The Fed taking away the party's punch bowl!?)

It's worth tracking the equities call to put daily volume ratios on the CBOE. This ratio is simply total daily equities call volume divided BY that day's put volume.

When equities call volume is double or more that of put volume on any given day or days (a reading of 2.0/2.0+) there is high risk of a correction to follow within 1-5 trading sessions, especially if upside momentum is faltering and even more so in the case of a bearish top pattern that's formed; e.g., in the case of COMP, penetration of a line tracking prices that formed a steep circular arc as highlighted above on the COMP daily chart.


GOOD TRADING SUCCESS!