Russell 2000: More upside needed for bottom confirmation

Kevin Pendley | Mar 21, 2008 8:38am EDT | Comment

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The Russell 2000 (NYSE:IWM) posted a couple of bullish patterns this past week, keeping alive some hope that stocks can forge a bottom for the big bear market move in this zone. Although the so-called long-legged doji formation we discussed last week had a short shelf life, we still see a decent double bottom on weekly charts and a nice rally back away from key support near 650.

If the Russell can maintain upside momentum this coming week and rally away from this price area, it would strengthen the potential for either a bottom or a solid intermediate corrective bounce. The first test from a short-term perspective comes in near 685, then at our old swing line at 700, then approaching 725.

It’s premature to declare that a potential bottom is in play for the stock market: remember, previous recessionary periods for the U.S. economy yielded stock market declines in the 40-50% range, and this move accounts for about 25% at the low. In addition, the chart patterns on long-term studies suggest a longer time frame might be needed for this downswing (the previous similar top back in 2000 required nearly four years to recover to new highs). However, even if a bottom might not be carved out at this point, a corrective bounce is often seen within bear market moves as the shorts pocket gains, and the longs probe around for value.

If the market does approach 725 soon, that would be the first longer-term benchmark of note, as 724.77 marks the 38.2% Fibonacci retracement target of the entire bear market decline. I decided not to add those points yet to our Support & Resistance Table below because I would prefer further confirmation of a potential low. However, if you’re curious, the 50% retracement line is at 749.92, while 61.8% is at 775.06. From a textbook standpoint, it would take a rally through the latter to confirm that the bear market run is over. Clearly, we would have even better signals earlier if that were to happen.

There was a mild volume spike in small cap stocks this week, and we have seen similar volume bursts at short- and intermediate-turning points in the past. All that said, we still need to see decent upside follow through in the coming week to avoid the fifth consecutive close below opening levels on monthly charts.

Looking ahead to the next trading week, the most likely course of action would be a range between 660-705, as the market gingerly tries to build a support base for a bigger push higher in the weeks to come. However, if we see a slide back below 650, then all bullish bets are off, and the risk to sink into another leg down comes back into play. This remains a critical spot for the market to find support. From a trading standpoint, longs with tight stops make sense here, just in case the aforementioned double bottom holds up and we push into a more pronounced recovery move.

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. Keep in mind that when the market is near record highs, it is much easier to find valid support than resistance points.

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
- 777.00   61.8% Fibonacci retracement of the Aug. 2007 peak-Jan. 2008 collapse
- 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
- 753.50   50% Fibonacci retracement of the Aug. 2007 record peak-Jan. 2008 collapse
- 743.49   previous Aug. ‘07 collapse low; short-term support violated, now resistance;
            Also near chart gap left by Jan. 2008 employment report news
- 734.40   previous key slide low; now resistance on a bounce
- 731.24   recent double top in Feb ‘08
- 729.00   38.2% Fibonacci retracement of the Aug. 2007 peak-Jan. 2008 collapse
- 717.91   20-week moving average; nice trend support for bull run; smashed on
            July/August 2007 collapse
- 712.17   support zone on weekly charts; reversal low in Oct. 2006; now resistance
- 700.00   “figure” swing line; no monthly close below here since Dec ‘05
- 685.00   20% decline off 2007 record highs; breached Jan. 2008
> 681.42   Mar. 20 close
- 680.94   mild reversal low on daily charts Jan. 28
- 680.45   20-day moving average
- 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
- 643.35   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 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.

Economic event risk is relatively tame this week, although various home sales data could stir the pot, as could the consumer confidence and personal income reports. After a long holiday weekend, the market could be a little more jittery about the economy, which adds a little extra volatility into the mix.

The table below highlights calendar event risk, 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

DAY REPORT/ITEM (all times Eastern) RISK FACTOR

Mon     Existing Home Sales (10:00 a.m.)                                3
Tue     Consumer Confidence (10:00 a.m.)                              4
Wed     Durable Goods (8:30 a.m.)                                        2
Wed     New Home Sales (10:00 a.m.)                                    3
Wed     Fed’s Evans speech TBA (noon)                                  0
Wed     Fed’s Fisher on regional economy (1:30 p.m.)                0
Thur     GDP (8:30 a.m.)                                                       2
Thur     Weekly Claims (8:30 a.m.)                                          1
Thur     Fed’s Pianalto “Federal Reserve Perspective” (noon)        0
Thur     Fed’s Lockhart on the economic outlook (12:20 p.m.)      1
Fri        Fed’s Plosser on policy panel in South Africa (6:20 p.m.) 0
Fri        Personal Income (8:30 a.m.)                                       3
Fri        Michigan Sentiment (10:00 a.m.)                                 1