Russell 2000: Bullish pattern on weekly charts

Kevin Pendley | Apr 19, 2008 1:09am EDT | Comment

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Small-cap stocks took flight this past week, holding support above the 681 zone early, then climbing back through the recent highs during Friday’s brisk rally. The Russell 2000 (NYSE:IWM) generated a bullish “engulfing” pattern on weekly candlestick charts, which is a positive signal heading into this week’s action.

The engulfing pattern (which is the same as an outside formation on traditional charts) is fairly rare on weekly studies. In fact, I spotted only five similar formations over the last 18 months in the Russell. The immediate effectiveness of these patterns is lukewarm, but they do tend to presage further upside action in the weeks to come.

The market continues to build a solid foundation from the January and March lows, which could be beneficial over time. As long as the Russell 2000 can hold above 681/672, the odds favor the upside (which made this past week’s action an important development). From a shorter time horizon into next week’s trading, a slide back below 700/695 would endanger the gains hammered out last week.

As I noted in previous commentary, there is a bullish cross between the 20- and 50-day moving average lines, and the last time we saw this type of action was last autumn heading into an impressive rally back toward the 2007 record highs. The market is now trying to push through the 100-day moving average, something that it has been unable to accomplish on a handful of instances in recent months. Moving averages are nice trend indicators, and they can also provide a hint when system traders might be looking to move into a market. As you’ll see on the attached chart, the market is also resting just below trendline resistance dating back to the October highs.

It should be noted that the relative strength index on daily momentum readings is fast approaching overbought levels, which could stall upside progress early in the week. A pause to work off short-term overdone conditions would not be a surprise, and wouldn’t necessarily be a bad thing for the market as long as the aforementioned 700 zone can hold up on a pullback.

It is interesting to note where the charge stalled out on Friday...just shy of critical long-term chart resistance near 724, which marks a 38.2% Fibonacci retracement of the bear market collapse. Decisive action through that point in the near future would clear the way toward 750 and 775, which denote the 50% and 61.8% lines, respectively. That said, many short-term traders in the coming week will likely focus on 731 as an important test, as there is a double top in that range from the early February peak.

The most likely course of action in the next week would be a sideways consolidation early on to test buying support around 714, 705 and perhaps even 700. A trading range between 712 on the downside and 745 on the upside seems reasonable as long as the market doesn’t slip through 700. A decisive breach of 700 would seriously dampen recent gains and could even set the stage for a retest of the 660 zone. As you’ll see in the Event Calendar below, the market is void of heavy event risk next week, and will likely focus on earnings news, fundamentals and chart developments.

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
- 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
- 749.88   50% Fibonacci retracement of the Aug. 2007 record peak-Mar. 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
- 724.72   38.2% Fibonacci retracement of the Aug. 2007 peak-Mar. 2008 collapse
> 721.07   Apr. 18 close
- 712.17   support zone on weekly charts; reversal low in Oct. 2006; now resistance
- 706.52   20-week moving average; nice trend support for bull run; smashed on
            July/August 2007 collapse
- 703.08   20-day moving average
- 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
- 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
- 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 print-out 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.

Event risk is thin this week. Federal Reserve speakers are at a minimum, and the market has only a handful of economic numbers to navigate. What’s more, the numbers on tap this week are relatively minor, with home sales data taking center stage.

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
   0   Fed’s Evans @ Chicago Smart Money Event (Mon., 9:00 a.m.)
   0   Fed’s Kroszner “…challenges to investment (Mon.,1:30 p.m.)
   2   Existing Home Sales (Wed., 10:00 a.m.)
   1   Weekly Claims (Thurs.,8:30 a.m.)
   3   Durable Goods (Thurs., 8:30 a.m.)
   3   New Home Sales (Thurs., 10:00 a.m.)
   1   Michigan Sentiment (Fri., 10:00 a.m.)