THE BOTTOM LINE:
I wasn't surprised to see a correction set in given the short-term overbought condition we were approaching last week. Given Friday's sharp sell off it also wasn't especially surprising to also see talk re-surface of a major Head & Shoulder's Top (H&S) being in place, with a downside target in the S&P 500 to 900 or lower. I calculated 863 as a possible target IF the index had continued falling below the 'neckline' of the H&S pattern and falling substantially further, which it didn't. I'll go through the H&S chart interpretation further on.
Looking first at the odds of a correction setting in when it did this past week. It's fairly common for a downside correction when the major indexes get to an overbought extreme in terms of the 21-hour Relative Strength Index (RSI) as seen below on the hourly chart. This is especially true given increased volatility that's been with us since the current correction began in early-May. The price swings have been more extreme as uncertainties about the recovery have generated a lot of movement. 1100 appears again as a key resistance area in SPX.
I'll look next at the potential Head and Shoulder's top pattern that is being talked about among technical circles, as seen on the long-term weekly chart of the Dow Jones Industrial Average (INDU). The so-called 'neckline' has yet to be decisively penetrated, as can be seen below.
There are a couple of points to be made on whether a major top pattern like the H&S has been traced out. Usually when the trendline defining the neckline is pierced, prices keep going. The other point is that the H&S pattern is one that most of the time forms over a shorter period of time and is more seen on a daily chart basis. If INDU had kept falling and if we apply the rule of thumb target (the same as we would on a daily chart), it comes out to an 8250 downside objective.
Common thinking here is that a break of 9693, at the 'neckline' would forecast a further waterfall type decline; e.g., a 1500+ point fall. Technical analysis isn't just about applying 'mechanical' rules to a chart. If some technical considerations suggest that the market could fall 1800 points, I then also look at the current environment and see if there's a scenario that would suggest stocks dropping so much.
Earnings forecasts in general aren't falling, just some shortfalls versus expectations. Sure, if earnings are under consensus like seen Friday (7/16) with BOC and C those stocks are going to adjust, but the market in such a period as we're in overreacts. Fear has gained temporary dominance over greed; these two usually play leap-frog with each other. However, if the Dow should fall to the 8300 area, market prospects would have to be perceived radically differently than now; e.g., something unanticipated comes like a terrorist event or other big unknowns that sock us. Based on present realities though, it's a major speculation to project such lowball targets.
MAJOR STOCK INDEX TECHNICAL COMMENTARIES
S&P 500 (SPX); DAILY CHART:
The S&P 500 (SPX) rally stopped in a key area of technical resistance this past week at the upper down trendline. Technically, the rally from the lower downtrend line had better than average potential to keep going higher. However it's also true that typically there are further (and smaller) price swings that 'complete' a wedge pattern. Once the wedge pattern completes itself, 'confirmation' of a bullish breakout move comes in the form of rallies beyond prior rally highs. That can occur with velocity after the spring gets wound tight so to speak.
The rally dating from the previous week faltered over a 3-day period. Three trading periods, whether hourly, daily or weekly, churning at the same approximate highs is a clear and present danger to a trend reversal and that's what happened on earnings disappointment Friday. It's been thought that the financial sector is well positioned to recover and lead the overall market higher. NOT quite yet all around!
My longer-term outlook remains guardedly bullish, especially if the wedge pattern develops further and shows greater and greater compression; i.e., price swings (rallies and declines) continue to shorten.
The 1100 area was a show stopper and offered tough resistance as buyers stepped away. I've noted resistance at 1090, then in the 1120 area.
Nearby technical support is at 1060 and next in the 1015-1011 area.
The CPRATIO line above represents the 1-day readings for Trader sentiment, which finally fell significantly per my expectation of another period of bearish extremes before SPX would be 'ready' for another sustained advance. It's apparently going to be more than true this year to 'sell in May and go away'; at least until a fall bottom let's say.
It looks like the recent rally failure marks another disappointment period for the bulls. There's been enough sharp retreats in stocks to dampen bullish sentiment. This is often the way it is ahead of a next advance setting up. I believe a resumption of the bull market is coming still, but the time to 'event' is not easy to pinpoint. Summer tends to have more volatility historically as volume falls off.
S&P 100 (OEX) INDEX; DAILY CHART
As noted last week, "The S&P 100 (OEX) chart remains bearish until or unless there is a breakout above its (upper) down trendline, currently intersecting at 495, followed by a move above the prior 510 upswing high." OEX got slightly above 495, but couldn't surmount the psychologically important 500 level. The index fell back 'inside' a wedge formation, a pattern which I still take as longer-term bullish. Stay tuned on that!
Further price action called for revising my prior down trendline and the new (light blue) one connects more points, always the goal in drawing an internal trendline. It's also worth repeating that the wedge pattern typically unfolds over time, with the upper trendline representing resistance. Prices often bounce back and forth between the two trendlines but in a narrowing price range which represents price 'compression' ahead of a spring to the upside.
Key resistance is at 500, extending to 510.
Near support is at 480, with next lower support in the 460 area. If the index fell back to the lower trendline, fairly major technical support should be found in the 450 area.
DOW 30 (INDU) AVERAGE; DAILY CHART:
One revised trendline later, the Dow 30 Average (COMP) remains within its downward sloping 'wedge' pattern. This formation has bullish potential as long as the two opposing trendlines contain all price swings for a while longer, especially at a time closer to the apex or the point in the future where the two lines join. Usually after such 'compression', as buying and selling get more closely balanced, there is a strong breakout move to the upside.
As to the possibility that a major top has formed, I discount this forecast currently. On the bearish side however, looking at the individual charts involved (just 30 to scan) only 4 have a chart that isn't looking bearish or, at best, with a neutral interpretation. Look for lower levels ahead in the Dow. Most of the component stocks are showing at least minor downside reversals.
Near support is in the low-10000 area, then back at the prior 9614 low; beyond that, at the low end of the pie-shaped wedge, intersecting at 9537 currently.
Near resistance is at the down trendline is 10365, with next resistance at 10450, an important prior high close. A still bearish pattern of descending rally highs is what we're seeing.
NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:
The Nasdaq Composite (COMP) Index chart is bearish as the index remains within a downtrend pattern and as no prior rally high has been exceeded since the correction began 10 weeks back.
There's some bullish potential suggested by the pattern of back and forth price swings that get narrower and narrower; the resulting trendlines narrow in over time and intersect. Such price action is usually a type of buying and selling 'compression' ahead of a sharp move. If the slope of the 'wedge' is down, a springboard move is usually higher once buying and selling get in balance; as seen graphically by shortened price swings. That said, selling pressures still eventually rule the day currently and momentum has swung from up to down.
Support levels are unchanged from what I proposed last week: initial support at 2150, then at 2080, extending to the prior 2061 low. As time goes on, the lower trendline is declining toward 2000 which should offer major support.
Key overhead resistance is at 2250, extending to 2260. The prior highs in the 2321 to 2341 area form a pivotal resistance zone that, if exceeded on a rally, would suggest a shift in intermediate term momentum from down to up.
The line above representing the 1-day 'reads' on Trader sentiment (the CPRATIO line) which finally fell significantly per an earlier expectation on my part of more bearishness ahead before COMP was 'ready' for another sustained advance. It's apparently going to be more than true this year to 'sell in May and go away'; at least until a fall bottom!
It looks like the recent rally failure marks another disappointment period for the bulls. There's been enough of a sharp retreat in stocks to dampen bullish sentiment. This is often the way it is ahead of a next sustained advance. I believe a resumption of a dominant up trend is coming, but the time to 'event' is not easy to pinpoint. Summer tends to have more volatility historically as volume falls off.
NASDAQ 100 (NDX) DAILY CHART:
The Nasdaq 100 (NDX) chart remains bearish in its pattern of declining rally peaks. Momentum is still with the sellers pushing prices lower. There is also the same emerging bullish falling wedge pattern on this chart as the others. If this bullish pattern should continue to unfold, it counters the idea of a major top formation. If support and resistance continue to be found at the two converging trendlines, an eventual upside breakout would be an expected outcome. Assured? No, not like the sun will come up tomorrow. It's the Market after all! Bullish potential for the future aside, NDX will likely see more selling of its component stocks ahead.
Resistance was found at the top of the most recent NDX rally as the index bumped hard against its down trendline (at 1863). Near resistance is now seen in the 1850 area, extending up to the prior 1863 high. Fairly major resistance is expected on any climb back to the 1925-1939 area.
Near support is noted at 1780, then at 1750, with major support at 1700.
NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:
The Nas 100 (QQQQ) tracking stock's chart remains bearish. My revised light blue trendline is showing the point of intersection (45.7) where technical resistance came into play on the last rally attempt. Later, reasons were offered as to 'why' the rally reversed when it did. By the looks of the downside reversal and the point where that reversal came in, etc., look for the stock to continue to work lower.
Above 45.7, at current trendline resistance, a next pivotal resistance comes in around 47.
Support is anticipated at 43.7, unchanged from my prior week's commentary, with next support at 42-41.7 and major support at the lower trendline, intersecting at 41 currently.
Higher volume was seen at the recent top on the QQQQ chart above. I finally have concluded that the volume/price trend relationship in the Q's is an inverse one: higher volume on declines, lower volume on rallies. However, there wasn't the jump in volume that you might expect given how far the stock fell on Friday.
RUSSELL 2000 (RUT) DAILY CHART:
After the recent rally failure, the Russell 2000 (RUT) remains within its falling wedge pattern I've written about recently. It looked like RUT was going to not only break above the down trendline (constructed up to that point) but would keep on its upward romp. 'Looks' as they say can be deceiving. It's still relatively early for 'completion' of a bullish falling wedge pattern. Most often in a wedge pattern price swings narrow in and come closer to the projected 'apex' of the narrowing triangle before breaking out. I anticipate that this recent rally 'failure' means that an (upside) breakout is further away, not that it's not coming.
The down trendline I was working with got revised per my note below. Key resistance implied by the revised light blue downtrend line is at 640. Next key resistances are at 650, then around 670.
Prior support appeared in the 595 area, extending down to the prior low in the 587 area.
GOOD TRADING SUCCESS!
NOTES ON MY TRADING GUIDELINES AND SUGGESTIONS
1. Technical support or areas of likely buying interest and highlighted with green up arrows.
2. Resistance or areas of likely selling interest and notated by the use of red down arrows.
I WRITE ABOUT:
3. Index price areas where I have a bullish bias or interest in buying index calls, selling puts or other bullish strategies.
4. Price levels where I suggest buying index puts or adopting other bearish option strategies.
5. Bullish or Bearish trader sentiment and display the graph of a CBOE daily call to put volume ratio for equities only (CPRATIO) with the S&P 100 (OEX) chart. However, this indicator pertains to the market as a whole, not just OEX. I divide calls BY puts rather than the reverse (i.e., the put/call ratio). In my indicator a LOW reading is bullish and a HIGH reading bearish, consistent with other overbought/oversold indicators.
Trading suggestions are based on Index levels, not a specific option (month and strike price) and entry price for that option. My outlook often focuses on the intermediate-term trend (next few weeks) rather than the next several days of the short-term trend.
Having at least 3-4 weeks to expiration tends to be my guideline for trade entry choice. I attempt to pick only what I consider to be 'high-potential' trades; e.g., a defined risk point would equal in points only 1/3 or less of the index price target.
I tend to favor At The Money (ATM), In The Money (ITM) or only slightly Out of The Money (OTM) strike prices so that premium levels are not as cheap as would otherwise be the case, which helps in not overtrading an account. Exit or stop points, as well as projected profitable index price targets, are based on my technical analysis of the underlying indexes.