Russell 2000: Bullish reversal after 2.6% gain

Kevin Pendley | Jul 19, 2008 4:03pm EDT | Comment

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On Tuesday morning, July 15, 2008, life as we knew it was about to change. Panic selling swept through the stock market as words like “systemic risk” and “bank failure” trembled off the lips of market pundits. The mighty government-sponsored firms that tower over mortgage lending in the United States were seen as suddenly insolvent, and they were just going to be one of the early dominoes to fall. The Dow was at 2-year lows. The S&P 500 was at the lowest point since October 2005. Then something truly dramatic happened... the market rallied back from the depths of desperation.

It might be hard to believe, but the Russell 2000 (NYSE:IWM) was actually HIGHER last week, gaining 18 handles, or more than 2.6%. What’s more, the recovery rally was stamped out from the shadow of 4-month lows in the Russell 2000. When it was all said and done, small caps forged an impressive “outside” bullish reversal on weekly charts. The outside terminology refers to a price range that extends beyond the boundaries of the previous time period under study. These patterns are extremely rare – especially at the bottom of a bear market move - and they are considered reliable and powerful reversal indicators. This is the most convincing bottoming pattern seen on weekly Russell charts since the double bottom back in March.

When looking at the CME’s small-cap 600 Index chart, there is an even more rare “key” reversal pattern, which is formed only when the market makes new lows, then closes above the previous week’s highs. What these formations suggest is that the market violently rejected new lows, which hints that a bottom is in play.

In the Russell 2000 chart, the recovery this past week also coincided with a price zone that sparked bottoms back in January and again in March. Clearly, investors have been successful in the past buying small caps in the price range down below 650. I’m a little concerned that the market now has a triple bottom at that level. Remember, double top/bottom formations command utmost respect, but triple formations don’t hold up nearly as well.

For now, the powerful bullish reversal pattern must be respected. It would take a slide back below 660 to truly suggest this was just a “head-fake” reversal that trapped longs at a previous value zone. Action this coming week through 707.50 and into 717.50 would also help validate the bullish reversal pattern.

On daily charts, the Russell 2000 closed above the 20-day moving average Friday for the second consecutive session, something that has not happened since the bear market slide began in earnest in early June. There is a little double top on daily charts on the highs from Thursday and Friday, and that needs to be tackled quickly in the next few trading days or it will gain more attention as a sudden stopping point for the recovery move.

The most likely course of action this week would be an extension of last week’s rally, but probably with a test at some point of buyer resolve down around 684 (and perhaps even down to 675). On the upside, there is noteworthy resistance at 707.50, and then at 717.50. The latter is a logical stalling point for the coming week, even on an extension of last week’s reversal move. If we see a commanding push through 717.50, then it would help validate the bullish outside reversal that was formed last week.

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
- 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 ’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
- 720.50   recent trading range; chart support lows
- 712.50   chart-related support zone; short-term area to watch
- 708.00   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
> 693.08   July 18 close
- 686.96   20-day moving average
- 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
- 643.35   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 is very tame this week, likely the calm before next week’s employment storm. What’s more, there is only one Federal Reserve speaker on the docket right now, which means that the market should be free to focus attention on earnings results, crude oil prices and the chart picture without worrying about volatility from the data.

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)

1              Leading Indicators (Mon., 10:00 a.m.)
2              Fed’s Plosser on econ outlook (Tues., 8:30 a.m.)
2              Beige Book (Wed., 2:00 p.m.)
3              Weekly Claims (Thurs., 8:30 a.m.)
3              Existing Home Sales (Thurs., 10:00 a.m.)
2              Durable Goods (Fri., 8:30 a.m.)
2              Michigan Sentiment (9:55 a.m.)
2              New Home Sales (10:00 a.m.)