Bearish patterns still dominate chart structure

Kevin Pendley | Jun 14, 2008 12:27pm EDT | Comment

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Small-cap stocks retain a top-heavy structure on weekly chart studies despite a nice recovery rally off a double bottom low on daily charts Friday. The Russell 2000 generated back-to-back red candles on weekly charts for the first time since the recovery rally began back in March, which is a troubling signal.

When looking at rally moves over the last 2½ years, it is surprisingly rare for the Russell 2000 to notch back-to-back red candles on weekly charts, and when it does happen, it typically coincides with an approaching top. For now, the pullback off the June highs is strictly a correction, but we’ll want to monitor price action carefully the next couple of weeks to make sure it doesn’t deteriorate into a full-blown top.

Small caps did find support at the perfect spot last week, almost exactly on the 38.2% Fibonacci retracement line of the March to June rally, which was just below our key chart support point at 720.50. I remain fixated on the range between 750 and 720 as the consolidation zone of immediate importance. If we see a decisive breach of last week’s lows near 717.50, then it confirms the topping structure built off last week’s failure of 750 and opens the door to a slide down to 690, which is the target of a corrective pullback from the June highs.

If you’re curious about those aforementioned Fibonaccis off the March to June rally, here they are: (38.2%=717.20; 50.0%=703.09; 61.8%=688.98). In essence, the Russell found support late last week exactly where it was anticipated at 38.2%. For a longer-term trader, it would take a breach of 61.8% to suggest that any pullback off the June highs was more than just corrective in nature.

Looking at daily charts, you can see that last week’s slump marked the first significant breakdown through the 20-day moving average and that the market had a successful test of the 50-day moving average late in the week. For now, all is safe on that trend proxy test, but the charts are vulnerable here and the last three times we had a decisive slide below those two key moving average lines we saw powerful and swift market declines that lasted three to six weeks and were directly tied to the November 2007, January 2008 and March 2008 lows. If we see a push through 717 this week it would likely trigger a move down toward 690, setting up the next key support test.

This has proven to be a volatile zone for the stock market and if we pop back through 750 this week it could easily spark a sudden retest of the recent highs near 763, and it would dramatically ease any of the topping issues that are in play right now. That said, the chart patterns are more dynamic on the bearish side of things, and the most likely course of action this week would be a range between 740 on the upside and 700 (or lower) on the downside.

The table below contains support and resistance points for the Russell 2000 to keep in mind heading into next week’s trading activity. 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 and 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 five-year run; also fits with potential upside breakout of congestion zone.
- 860.00   Projected “figure” resistance off 15-handle testing zones on the 2006 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 to December 2006.
- 775.03   61.8% Fibonacci retracement of the August 2007 peak to March 2008 collapse.
- 762.89   Recent move high set June 5, 2008.
- 760.06   March correction low; key approximate double bottom formation support;
near 50% Fibonacci of July 2006 to 2007 bull run; violated in November 2007; key swingline to watch.
- 749.88   50% Fibonacci retracement of the August 2007 record peak-March 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 August 2007 collapse low; short-term support violated, now    resistance; also near chart gap left by January 2008 employment report news.
- 736.64   20-day moving average.
- 733.61   June 13 close.
- 720.50   Recent trading range; chart support lows.
- 717.20   38.2% retracement of the March to June rally.
- 712.50   Chart-related support zone; short-term area to watch.
- 709.07   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 December 2005 until February 2008.
- 685.00   20% decline off 2007 record highs; breached January 2008.
- 680.94   Mild reversal low on daily charts Jan. 28; near 50% of the March 2008 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 March 10, 2008.
- 614.76   October 2005 bottom; next major chart related downside point.
- 591.00   50% Fibonacci retracement of the 2002 to 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 light this week, highlighted by Tuesday’s PPI data. Everyone has shifted into inflation-watch mode right now, which makes these numbers (along with employment) the new key monthly data series. It’s possible that the biggest splash of volatility will stem from Fed Chair Bernanke’s appearance Monday. His speech topic is “Challenges for Health-Care Reform” but he is taking questions from the audience and could always use the public forum to jawbone on inflation.

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 FOR THIS WEEK

RISK FACTOR REPORT/ITEM (all times Eastern)

2               NY Manufacturing Survey (Mon., 8:30 a.m.)
3?              Fed’s Bernanke “Challenges for Healthcare Reform” (Mon., 10 a.m.)
2               Fed’s Lacker economic outlook (Mon.,1 p.m.)
4               PPI (Tues., 8:30 a.m.)
2               Housing Starts (Tues., 8:30 a.m.)
1               Current Account (Tues., 8:30 a.m.)
2               Industrial Production (Tues., 9:15 a.m.)
0               Fed’s Yellen remarks at Asia finance role event (Wed., 11:45 a.m.)
2               Weekly Claims (Thurs., 8:30 a.m.)
2               Leading Indicators (Thurs., 10:00 a.m.)
2               Philly Fed Survey (Thurs., 10:00 a.m.)
2               Fed’s Kohn “Risk Management…Systemic Risk” (Thurs., 2:30 p.m.)