"I hear and read about it being hard to figure just where a bottom might be in the current downmove. how do you see this?"


I'll be writing my usual market review (my Index Wrap) tomorrow (Saturday, 2/1/14) but I'll take up a general look at the principles of charting/technical analysis that I find occur over and over at market bottoms. I would emphasize here that bottoms in a bull market trend will have a different pattern than tops in a bull market.

Major Index TOPS are PROLONGED and are often form over weeks. Trader sentiment gets, and stays, very bullish for a lengthily period also. Technical indicators of overbought/oversold like the RSI or Stochastics will usually get to a high (overbought) extremes and STAY that way or repeated or prolonged periods. Rallies to the upper trendline of an uptrend price channel will tend to just mark an area where upside momentum SLOWS and prices often thereafter continue higher 'hugging' such an upper trendline.

BOTTOMS are not always accompanied by extreme bearishness, but I anticipate generally that an intermediate-term bottom is made with SOME degree of bearishness. Bull market sell offs tend to END (and rebound from) AT or near major up trendlines. Oversold EXTREMES, such as measured by a 13-day Relative Strength Index (RSI); pertaining to a low 8-week (or 13-week) RSI oversold reading, these are often seen just ONCE or TWICE, rarely for prolonged periods.

I'll illustrate some of the technical elements that are associated with bottoms by using charts of the S&P 500 (SPX), the Dow 30 (INDU), the big cap Nasdaq 100 as seen via the QQQ tracking stock, and with the Russell 2000 (RUT), which, like the Dow, often trades very 'technically' or with a certain chart consistency.

You can see below in both the daily and weekly charts below how the last peak in SPX occurred very near (daily chart) or AT (weekly chart) resistance implied by the upper uptrend channel line.

The recent SPX daily price lows have occurred at SPX's long-standing up trendline, dating from the mid-November low of 2012. This has been accompanied by a 'fully' oversold RSI extreme. The recent cluster of lows could also be a bear flag or consolidation ahead of another drop of 50-70 points.

I lean to an interpretation of at least an interim bottom forming or having formed in the 1780 area in SPX. Since a decisive downside penetration of the up trendline would suggest the aforementioned bearish scenario, if I buy SPX calls or sell the index puts for example, I won't risk much of a penetration of the up trendline. If prices snap back, I can get back in.

What suggests to me above that this market may make a secondary bottom further on is that bullishness is stubbornly high in my view per my CPRATIO model. Bearish 'sentiment' hasn't gotten anywhere NEAR an extreme on even a 1-day basis. I figure that bearishness and the fear of the market so to speak will come back in. This as opposed to an "oh well, prices will just go back up soon (like they have for months)!" Great traders I've known have always a healthy fear of downside RISK and complacency.

On the weekly SPX chart seen next, I've highlighted the levels that would retrace a VERY minimal 25 per cent retracement of the last big upswing, a minimal Fibonacci 38% retracement and a deeper (but not expected by me currently) one-half/50% retracement. Note the up trendline, suggesting that a decisive downside penetration of this past week's low at 1770, would suggest that SPX was headed to a retracement that could carry into the 1725-1657 price zone. Moreover, it would most likely take such a retracement to get the 13-week RSI close to an oversold reading. Such a reading could also occur if the Index went more or less sideways for a few weeks, such as in the more seasonally weak Feb-March period.

There's another aspect I look for in most substantial downside corrections and I illustrate in the Dow 30 (INDU). Seen below: the first leg (noted as 'a') down was relatively short, as traders/investors remained quite bullish and selling was not pronounced. The rebound back up to 'b' fell short of the prior high; it could as well have hit the SAME high but not climbed above it or much above it. The second down leg 'c', in a typical a-b-c correction, is typically substantially longer than the first decline. As seen with the INDU daily chart, the first downleg (a) was 348 points from peak to trough and the second longer downleg (b) has carried (TO DATE) 902 points as measured to today's intraday INDU low.

There is a principle that suggests that down legs 'a' and 'c' will have a Fibonacci relationship; e.g., the first down leg is 38% of the second. The second downleg ('c') will be fibonacci 1.6 or 2.6 times the point distance carried on the first sell off. In the case of the Dow, at least to date, down leg 'a' is a fibonacci 38% of down leg 'b' and the second decline is (also, so far) a fibonacci 2.6 times down the first sell off in INDU. This study of the relative size of the first and second declines suggests that the Dow's correction may have run its course as the decline 'fulfills' a key relationship of the two down legs.

MOREOVER: the fact that the recent low has reached INDU's long-standing support/up trendline makes the foregoing comparison of the two declines, more relevant or more 'potent' we could say as pointing to a downside conclusion. Adding more credence to a possible bottom: INDU has reached an oversold RSI extreme.

Looking at the QQQ tracking stock for the big cap Nasdaq 100 Index (NDX) the recent low came down to the low end of QQQ's up trendline or the low end of QQQ's uptrend price channel. Since sharply higher daily trade volume or daily or weekly volume spikes often suggest a possible bottom as highlighted below; i.e., "Volume 'precedes' Price" or high volume often marks a volume-climax low in stocks and indices. Stay tuned on this!

The Russell 2000 (RUT) daily chart below is another example of recent lows stopping at a longstanding up trendline. This pattern is noteworthy in that RUT, like the Dow, often trades very 'technically'; meaning that the Russell Index often traces out patterns that are textbook examples of where and how upside or downside reversals form. RUT can at times be a bellwether index for the overall Market.

A rebound from the area of a long-standing up trendline, coupled with an oversold extreme in the RSI, lends weight to the idea of the formation of at least an interim if not 'final' bottom; even if such a low(s) gets re-tested later on.