Russell 2000: Bullish hammer vs bearish outside formation

Kevin Pendley | Sep 05, 2008 5:31pm EDT | Comment

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A fascinating battle will play out Monday morning in small-cap stocks between the heroic comeback forged on daily charts by Friday’s valiant recovery rally versus the dominant bearish chart patterns in play on weekly studies. Kind of like a Russell 2000 (NYSE:IWM) chart version of the tortoise versus the hare.

There are very powerful and legitimate contrasting chart patterns visible on both daily charts by Friday’s price action and on weekly charts from the overall moves last week, and they are NOT complementary. On daily studies we see a bullish “hammer” pattern formed by the massive rebound off the morning lows and the close near session highs. These formations are often seen at the bottom of an important low in stocks. However, Friday’s lows weren’t exactly at the bottom of the market and these patterns require immediate confirmation via higher price action the following day. In this case, we’ll see just how the market responds on Monday morning.

In contrast to the bullish hammer on daily candlesticks, we see a bearish outside formation on weekly charts. Outside patterns on weekly reference points are relatively rare. We haven’t seen a bearish version of the outside reversal since October 2007. Guess how long the top from that reversal pattern held up? Well, we haven’t been back to that high yet...

In addition, small caps shed 11% from high to low off that pattern in the next four weeks, so it’s a little disconcerting to see a similar bearish pattern now in play at a time when the market desperately wants to break free of the range and to validate the recovery move off truly awful economic data from the jobs report Friday. However, if we don’t get a very fast, very dynamic, very convincing rally right away Monday then the daily chart bullish pattern quickly sheds power to the bearish weekly formation.

Even on daily charts we see the Russell 2000 slipping through the 20-, 50- and 100-day moving averages Friday, which hasn’t happened since the market was sinking to those July lows. While it was good to see Friday’s afternoon bounce lift the market back above the 50-day moving average on a closing basis, it should be noted that the market usually will sink when all three of these moving averages are violated from above (if you’re wondering, the 50-day M.A. is around 711.60 heading into Monday).

If the market does not see an aggressive opening rally Monday, then the most likely course of action will be to test the Friday lows. A weekly range in the 700-740 zone makes sense. If the market does open higher Monday and extends the move during the day, then a higher weekly range on the order of 715-750 comes into play.

The table below contains support and resistance points for the Russell 2000 to keep in mind heading into next 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; approximate double top with June ‘08
- 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
- 743.49   previous Aug. ‘07 collapse low; short-term support violated, now resistance;
            Also near chart gap left by Jan. 2008 employment report news
- 736.72   20-day moving average
- 726.19   previous double top in June/July 2008; now support
- 720.99   20-week moving average; nice trend support for bull run; smashed on
            July/August 2007 collapse
- 720.50   recent trading range swing point
> 718.95   September 5 close
- 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 all back-weighted this week, with the big numbers coming Thursday on weekly claims and then on Friday for the PPI/Retail Sales dynamic duo. The fact that the market will need to find its own path early next week with little interference from data is interesting and makes the trading currents quite a bit more challenging to start out the week.

The table below highlights calendar event risk for the coming 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) Consensus

1           Fed’s Fisher speech TBA (Mon., 1:30 p.m.)
0           Consumer Credit (Mon., 3:00 p.m.)                            $9.0 bln
4?          Fed’s Bernanke on “education” (Tues., 9:00 a.m.)
1           Wholesale Trade (Tues., 10:00 a.m.)                          0.6%
2           International Trde (Thurs., 8:30 a.m.)                       -$58.0 bln
1           Import Prices (Thurs., 8:30 a.m.)                                -1.5%
4           Weekly Claims (Thurs., 8:30 a.m.)                               438,000
0           Treasury Budget (Thurs., 2:00 p.m.)                         -$104.0 bln
1           Fed’s Kohn on econ panel (Thurs., 2:45 p.m.)
5           PPI (Fri., 8:30 a.m.)                                                  -0.5%
5           Retail Sales (Fri., 8:30 a.m.)                                       0.2%
1           Business Inventories (Fri., 10:00 a.m.)                           0.5%
2           Michigan Sentiment (Fri, 10:00 a.m.)                            64.0