Bullish pattern, upside breakout on daily charts

Kevin Pendley | Aug 09, 2008 5:11pm EDT | Comment

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This was a big week for small-cap stocks as the market finally broke free of an extended consolidation range. Friday’s action was critical as the Russell 2000 (NYSE:IWM) not only burst out of the congestion zone, but also formed a bullish “outside” reversal pattern on daily charts.

An outside pattern simply reflects ranges that were beyond the previous study period. They carry added significance because they show a scary slide below the previous day’s lows was rejected and then built upon by pushing above the previous highs. These patterns are especially powerful on weekly charts at key long-term lows, but this formation was in the middle of the long-term range on daily studies, so it has a little less dynamic power.

One thing that can’t be denied is that move through 726 was powerful and important. That area around 726 was starting to look like a troubling resistance line and a potential double top with the previous July highs. When that resistance was smashed during Friday’s rally, it validated an upside breakout from the recent range. The nice thing about that range is that the breakout move carries an upside target of 32 handles, which would correspond to 758 in the Russell. That’s a nice fit for an objective on this move as the 762 area stands as the recent move high in June. In order for Friday’s upside breakout to remain valid, it would help for the Russell to hold above 726 early this week.

Weekly chart studies show that small caps have now closed above opening levels for five consecutive weeks, which is a very rare occurrence, even in strong bull market moves. We haven’t seen six consecutive green candles on weekly charts since 2005 and momentum readings on daily charts are at levels that halted the rally back in July. Still, those readings are not yet at an extreme, and certainly not as high as they were when the market made that impressive double top on daily studies back in early June.

Looking ahead to this week’s action, there is mild short-term resistance at 742 and 748 ahead of logical “figure” resistance at 750. If the market can hold above 726 early on, then I think a push toward at least a test of 750 is the most likely course of action. If the market abruptly fails early this week and slips back below 720, then it will make Friday’s rally look like a head-fake move that trapped over-anxious bulls. If the market can push through 750 this week—which represents the 50% Fibonacci retracement zone of the entire bear market collapse—then it will be time to think about 775, which marks the 61.8% retracement target. For now, this remains a nice bounce within the larger bear market trend, and it will take a breach of 775 to eventually suggest that a bottom is in place and that the highs should be put back on the radar screen.

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
> 734.30   August 8 close
- 726.19   previous double top in June/July 2008; now support
- 720.50   recent trading range swing point
- 716.55   20-week moving average; nice trend support for bull run; smashed on
            July/August 2007 collapse
- 705.43   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 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
- 643.28   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 could easily serve up some surprises and stir added volatility into the mix this week. Important reports on retail sales, inflation and manufacturing will be released, and for the first time in a couple of weeks we’ll see speaking engagements from Federal Reserve officials. Although the weekly claims report didn’t used to be that big of a deal, that report Thursday morning could easily be the most anticipated of the week as last week’s report reflected the largest unemployment filing in six years.

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 FOR THIS WEEK

RISK FACTOR REPORT/ITEM (all times Eastern)

3                International Trade (Tues., 8:30 a.m.)
0                Treasury Budget (Tues., 2:00 p.m.)
4                Retail Sales (Wed., 8:30 a.m.)
1                Import Prices (Wed., 8:30 a.m.)
2                Business Inventories (10:00 a.m.)
4                CPI (Thurs., 8:30 a.m.)
4                Weekly Claims (Thurs., 8:30 a.m.)
1                Fed’s Stern “the financial shock” (Thurs., 2:30 p.m.)
2                NY Manufacturing Survey (Fri., 8:30 a.m.)
2                Industrial Production (Fri., 9:15 a.m.)
3                Michigan Sentiment (Fri., 10:00 a.m.)
2                Fed’s Evans on the econ outlook (Fri., 1:30 p.m.)