Friday collapse takes Russell below key 750 line

Kevin Pendley | Jun 07, 2008 9:34am EDT | Comment

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The Russell 2000 (NYSE:IWM) collapsed Friday, retreating back below our key line at 750 to form bearish topping patterns on daily and weekly charts. New highs followed by a lower close meets the criteria for a reversal top, and that certainly is in plain sight on weekly charts. In this case, those new highs were also a rejection of a six-month peak, plus an inability to hold above important long-term resistance, making the failure even more powerful.

There is an old saying among traders that the market “will leave no stop untouched” and that certainly seemed to be in play late this past week as the Russell 2000 soared through resistance Thursday ahead of the big employment report, stopping out the shorts that just couldn’t bleed anymore into a big event like jobs. Meanwhile, the rally Thursday sucked in new weak longs, seduced by the climb to six-month highs, just in time for them to get smacked in the face by a bearish unemployment number and record high crude oil prices the very next day.

The big price swings Thursday and Friday represented the first show of dramatic daily volatility since the lows were formed in mid-March, and heightened volatility at or near major long-term price levels often signals that a move is exhausted and that a change in price direction is at hand. This past week saw one of the largest one-day rallies of the year to six-month closing highs on Thursday, followed by one of the largest one-day collapses of the year on Friday – that certainly spells volatility in impressive fashion.

In last week’s column I said that we were at the doorstep of the first critical juncture of the recovery rally. Well, the market failed that test. However, the action was not simple or easy to trade; in fact, it was probably a nightmare for short-term day traders who saw the decisive breach of 750 Thursday as a signal that the market was setting sail for even higher price targets.

I’ll be watching the 750 line closely this week to make sure that there are no more rallies through that area. If 750 does not fall early in the week, then it sets up a retest of 720 support. If you have been holding long positions since the bottom in mid-March, this marks the most dramatic show of a top for the move. It’s worth noting that the Russell has not seen back-to-back weekly closes below the opening level since the recovery rally bottomed in mid-March. As we move through next week’s action, I’ll be closely watching how the market trades vs. the opening level Monday.

If the market struggles early this week, then the most likely course of action would be a decline toward the 720 support zone. A breach of 720 opens the door for a target run down to 690, which would truly unravel any recent equity-challenged longs. Persistent action this week below 750 (and particularly below the 740 Friday close) would strengthen the argument that a major correction is at hand.

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
- 763.30   recent 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
- 749.88   50% Fibonacci retracement of the Aug. 2007 record peak-Mar. 2008 collapse;
            Violated in early June, but not on a weekly closing basis
- 747.99   recent recovery peak set May 19; reversal pattern on daily and weekly charts
- 743.49   previous Aug. ‘07 collapse low; short-term support violated, now resistance;
            Also near chart gap left by Jan. 2008 employment report news
> 740.37   June 6 close
- 738.16   20-day moving average
- 720.50   recent trading range; chart support lows
- 712.50   chart-related support zone; short-term area to watch
- 710.40   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
- 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 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 this week is relatively busy, though not as drastic as last week’s slate. The highlights are Thursday’s retail sales data and Friday’s CPI report. Fed Chairman Bernanke is making an appearance Monday evening to give a dinner speech for the Boston Federal Reserve conference. The conference is titled “Understanding Inflation and the Implications for Monetary Policy: A Phillips Curve Retrospective” and Bernanke’s speech will be on “Outstanding Issues in the Analysis of Inflation,” which prompted me to put a question mark by his appearance on the risk event calendar. Although the conference and speech topic might seem tame, anytime Bernanke talks about inflation right now it has the ability to spark a move in the markets.

The table below highlights calendar event risk for this 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)

0                Fed’s Geithner at NY econ luncheon, speech TBA (Mon., 12:15)
0                Fed’s Rosengren welcome remarks for Boston conf. (Mon., 5:00)
3?              Fed’s Bernanke dinner speech for Boston conf. (Mon., 6:00 p.m.)
0                Fed’s Rosengren open remarks for Boston conf. (Tues., 8:00)
1                International Trade (Tues., 8:30 a.m.)
0                Fed’s Kohn “lessons for central bankers” Boston (Wed., 11:30)
0                Fed’s Bullard at macroecon event (Wed., 1:00 p.m.)
2                Beige Book (Wed., 2:00 p.m.)
0                Treasury Budget (Wed., 2:00 p.m.)
4                Retail Sales (Thurs., 8:30 a.m.)
0                Import Prices (Thurs., 8:30 a.m.)
2                Weekly Claims (Thurs., 8:30 a.m.)
2                 Business Invenstories (Thurs., 10:00 a.m.)
4                 CPI (Fri., 8:30 a.m.)
2                 Michigan Sentiment (Fri., 10:00 a.m.)