Small caps at 2008 weekly highs, but daily charts show bearish reversal

Kevin Pendley | Aug 16, 2008 7:15pm EDT | Comment

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We have good news, and we have bad news. The good news is that the bulls are winning all the major skirmishes in small-cap stocks, and the market pushed up to the highest weekly close of the year last week. Mixed into a time frame that sees the Dow and S&P 500 still down some 12% on the year, small-caps at a yearly high close might surprise some stock market watchers.

Elsewhere on the good news front, the Russell 2000 (NYSE:IWM) confirmed our congestion zone breakout from the previous week and filled the upside target on that breakout, which was at 758. With the market now at the highest weekly close of the year, shorts will be on a very tight equity leash, which is another supportive element in play.

As for the “bad” news, there is a bearish reversal on daily charts from Friday’s pullback, and there is some risk of a double top on weekly studies in conjunction with the June and July peaks.

During Friday’s session, the market climbed to the highest point since Jan. 2, but closed lower on the day. Strictly speaking, when a market makes new highs and closes lower, that is considered a bearish reversal. Some of the sting from the topping pattern is soothed by the fact this pattern is visible only on daily studies and not weekly charts.

In fact, weekly charts show yet another positive candlestick, marking the sixth consecutive bullish weekly candle, something that hasn’t happened in three years. Momentum readings on daily and weekly studies are approaching levels that have corresponded with tops in the past, so that could be an issue moving into this week’s trading.

Although the bearish reversal off new highs Friday does raise a caution flag, I’m more concerned by where the failure took place. The highs Friday came in at 764.38, which is just slightly above the peak from the June highs. If the market retreats from here, it will leave a double top on weekly studies, and confirm that 764 zone as staunch resistance. The last time the market pulled back off that price area it triggered a wicked slide to the summer lows, so I have great respect for that testing area this time around as well.

If you’re looking for an extension of the uptrend in small-caps, then it would greatly help the outlook for the Russell to push right back up to 764 early this week, then chip away at seller resolve in that zone before breaking through to higher levels. If the market confirms Friday’s reversal pattern via a sharp slide Monday or Tuesday, then the topping formation will gain power, and the 764 zone will gain in stature as a resistance zone.

A convincing rally through 764 opens the door to push on to 775, which is a key long-term resistance point. That area at 775 represents a 61.8% Fibonacci retracement target of the entire bear market collapse. Decisive action above 775 would suggest that the bear market is over, and that a retest of all-time highs is the next logical long-term move.

If the market does start to wobble this week, then key support is at our old breakout point at 726, as a slide back below that point would suggest that this week’s rally to test the June highs was premature and that the 690 zone still could come under fire. Despite the impressive upside price action last week, the most dominant patterns are the reversal Friday and the potential double top near 764. If the market can quickly push above 765 early this week, then I would look for a test of 775. However, if the market slips, then a push down toward 726 and perhaps lower would fit with Friday’s sloppy price action.

The table below contains support and resistance points for the Russell 2000 to keep in mind heading into this week’s trading. For long-term traders, some of these key levels may remain in place for weeks...even months at a time. Those with a short-term horizon will lean toward levels that are more immediately in play. As time passes, we will build upon this table with levels that come into focus as important testing zones for trend analysis, and to act as road mark indicators for key reversal patterns.

From a trading perspective, I always keep a printout handy each day of my key support and resistance points for any stock or market I’m trading. It helps remind me of key areas to watch for signs of trend exhaustion, and also for potential entry/exit points for trades.

TECHNICAL ANALYSIS SUPPORT/RESISTANCE POINTS FOR RUSSELL 2000

- 890.16   upward channel resistance on monthly charts off 5-year run;
            also fits with potential upside breakout of congestion zone
- 860.00   projected “figure” resistance off 15-handle testing zones on the ’06 rally
- 856.48   record intraday high set July 13
- 855.77   July 13 close; record high daily and weekly close
- 852.06   Oct. 11 high; bearish reversal peak on daily charts
- 830.01   previous high from the February 2007 peak; key swing line of note
- 815.00   key swing line
- 801.00   congestion resistance zone from November-December 2006
- 775.03   61.8% Fibonacci retracement of the Aug. 2007 peak-Mar. 2008 collapse
- 764.38   new move high set August 15, 2008
- 762.89   previous move high set June 5, 2008
- 760.06   March correction low; key approximate double bottom formation support;
            Near 50% Fibonacci of July ’06-’07 bull run; violated in November ’07;
            Key swingline to watch
> 753.37   August 15 close
- 743.49   previous Aug. ‘07 collapse low; short-term support violated, now resistance;
            Also near chart gap left by Jan. 2008 employment report news
- 726.19   previous double top in June/July 2008; now support
- 722.84   20-day moving average
- 720.50   recent trading range swing point
- 719.48   20-week moving average; nice trend support for bull run; smashed on
            July/August 2007 collapse
- 700.00   “figure” swing line; no monthly close below here since Dec ’05 until Feb ‘08
- 685.00   20% decline off 2007 record highs; breached Jan. 2008 and July 2008
- 680.94   mild reversal low on daily charts Jan. 28; near 50% of the March ’08 bounce
- 668.58   July 2006 low; important bottom for summer correction
- 660.00   short-term downside target on wedge breakout; support zone
- 650.00   previous bear market move low set Jan. 22, 2008, critical support zone
- 647.37   July 15 2008 low; approximate triple bottom with Jan ’08; Mar ‘08
- 643.28   recent move low set Mar. 10, 2008
- 614.76   October 2005 bottom; next major chart related downside point
- 591.00   50% Fibonacci retracement of the 2002-2007 bull market run

In addition to the printout of support and resistance points to watch, I also like to keep in mind where sudden volatility can spring into the trading mix from the typical release of economic data and Federal Reserve activity.

The economic calendar is fairly tame this week, although Tuesday’s PPI, Thursday’s weekly claims and a Friday speaking appearance by Federal Reserve Chairman Ben Bernanke could stir things up a bit.

The table below highlights calendar event risk for next week, with the emphasis on various economic reports. Our table below has a special “Risk Factor” designation, which is simply my assignment of risk to that event, ranging from 0 to 5, with 5 marking the highest risk for volatile market swings.

CALENDAR EVENT RISK ASSESSMENT

RISK FACTOR REPORT/ITEM (all times Eastern)

    4                PPI (Tues., 8:30 a.m.)
    2                Housing Starts (Tues., 8:30 a.m.)
    2                Fed’s Fisher on US economy (Tues., 10:00 a.m.)
    4                Weekly Claims (Thurs., 8:30 a.m.)
    2                Leading Indicators (Thurs., 10:00 a.m.)
    2                Philly Fed Survey (Thurs., 10:00 a.m.)
    4?               Fed’s Bernanke on financial stability (Fri., 10:00 a.m.)