Market Exhaustion Leads to Partial Recovery

Market Exhaustion Leads to Partial Recovery

(Note: Unless otherwise stated, the index action described below relates to the EMini futures contracts for the respective indices. Actual index action may differ slightly in terms of pattern formation, although the market bias will remain the same.)




Good day! The market experienced a rather large partial recovery on Tuesday following record-making downside on Monday when the government's attempted economic rescue package failed to pass. Although many are reporting that the cause of Tuesday's rally is based upon renewed hopes that at some point this week a rescue package will indeed pass, a quick look at the charts reveals the technical reasons behind the move. Over the weekend I had shown you how the indices were forming a setup for a breakdown into the beginning of this week from a technical point of view. The news on Monday accelerated the breakdown, but the indices had already triggered it in both the Nasdaq and S&Ps before the votes had even been cast. Perhaps a passage of the bill would have turned things around, perhaps not. We shall never know. Regardless, the market followed through on the breakdown in a nearly textbook technical fashion.

A quick glance at the daily charts of the indices reveal that the breakdown on Monday brought the indices into support in the form of an equal move. This is a concept that I have been teaching for many years, but still is one that a lot of newcomers have yet to grasp. When any security forms a continuation pattern, that pattern has a target based upon a move equal to the trend move leading into the base or more gradual counter-trend that forms the setup. By taking that prior move and applying it to the continuation move, you can project a reasonable target.

Targets based upon "equal moves", however, are subject to another concept that you will not find spoken of very often, yet is absolutely indispensable: pace. Although quite an obvious concept in hindsight, just as the equal move concept is, it is also not one that has garnered much wordplay. Since the breakdown on Monday was stronger than the move lower in the previous week, it opened the door for a somewhat larger than equal move in the indices for this week. As a result, heading into Tuesday morning I mentioned that we had some wiggle room even though we were at this support zone. Notice in the chart below of the QQQQ that this index indeed pushed past an exact equal move. It was assisted by news of downgrades in Apple (APPL) that shook up the rest of the tech sector.

Nasdaq Composite ($COMPX)


Although the markets continued lower immediately following the close on Monday, things began to turn around afterhours. The index futures climbed steadily into the 4:00 am ET correction period as markets overseas turned higher. This rally took the S&P 500 and Dow Jones Ind. Ave. futures smack into their 38% Fibonacci retracement levels based upon the move lower off Sunday's highs into Monday's lows. They held this Fibonacci level perfectly at the same time as the correction period hit, pushing the indices into a correction off that level and that time zone. This correction continued throughout the remainder of premarket trade and into the opening bell on Tuesday. To learn more about utilizing fibonacci levels in your trading, check out my articles on Trading Markets:

(http://www.tradingmarkets.com/.site/stocks/how_to/articles/-75282.cfm)

Both the S&Ps and Dow slid lower on their premarket correction into the opening bell. The Nasdaq futures, however, began to stabilize around 7:00 am ET with this premarket correction period. While the S&Ps and Dow reacted to it briefly, they resumed their selloff into 8:00 am. The Nasdaq, on the other hand, had bounced out of the correction period and then formed a base. This created a nice Phoenix-style buy setup with the base forming from approximately 7:40 am ET into 9:15 am ET. It triggered a buy ahead of the open, but confirmed the setup with increased momentum right out of the opening bell. The S&Ps and Dow continued to lag, coming around finally at about 9:55 ET.

Dow Jones Industrial Average ($DJI)


The markets formed a solid trend day on Tuesday, but action was tricky. The price development from the open into 12:00 ET would typically have triggered a break lower into the afternoon if that same price pattern formed on an extended uptrend of two-four previous waves of buying, or had taken place on the first or second correction of a new downtrend. Given the downside exhaustion, however, it never had a chance. It would have had to have held highs into 13:00 ET, but instead the market congested and the 5 minute 20 period simple moving average zone held. The uptrend confirmed shortly thereafter. The failure to trigger in the classic short setup meant that the market was now positioned for an uptrend the remainder of the session.

Now, as those of you who have known me for a long time can attest to, I really dislike trend days such as the one which took place on Tuesday. When the markets hold the 5 minute 20 sma zone throughout the entire session, it means that moves on the smaller time frames are very scalpish and will often have a great deal of overlap. This creates a lot of false triggers, brief flushes, and fewer strong moves of follow-through. Although it's wonderful if you are trading setups on a 15 minute time frame that you may have caught early on in the session, if you like to trade setups on 5-15 minute charts intraday you will find it much more difficult. Notice how, even though the market did trend higher into the close, it stepped higher with a lot of back and forth. The last "clean" setup was the one I posted intraday as a bull flag triggering just after 14:00 ET. I greatly prefer action such as Monday's. Although quite rapid, the moves were cleaner.

Price action going into Wednesday remains bullish, but expect the 5 minute 20 sma to finally break early on in the session. Interestingly, the door is still wide open from a technical standpoint for yet another move lower on a 60 minute time frame within about a week from now. I am sure this is not what many investors would like to hear! In terms of recovery potential, however, it would actually be nice to see a move to a slightly lower low again on a 60 minute S&P and Dow chart. This would allow the pace to shift better on this time frame to allow a more rapid recovery off the lows. Without that additional flush lower, the markets can more easily creep higher and then continue lower on a weekly time frame. This would be even worse news for investors!

S&P 500 ($SPX)


Now, for the stats: The Dow Jones Industrial Average ($DJI) closed higher on Tuesday by 485.21 points, or 4.7%, at 10,850.66. Of the Dow's 30 components, 29 closed higher. This was the largest single-day gain for the index in 6 years. Bank of America (BAC) rallied 15.7%, while Citibank (C) came in at a close second with a gain of 15.6%. J.P. Morgan Chase (JPM) climbed 13.9%. The S&P 500 ($SPX) gained 58.32 points, or 5.3%, and closed at 1,164.74. Financials led the gainers, but all 10 of the index's industry groups closed in positive territory. The Nasdaq Composite ($COMPX) closed higher by 98.6 points, or 5.0%, at 2,082.33.




On the economic front, outside of the hype for the proposed rescue package, a number of reports came out on Tuesday. The Case-Shiller home price index, released by Standard & Poor's, paced the decline in home prices greater than seen the previous month. Overall values are shown to be 16.3% lower over the course of this past year. They even sent me a nice notice about my property taxes. Due to the latest assessed value, they MIGHT consider lowering my taxes for next year! (Of course, they also said that they MIGHT raise them again, but hey, they had never even hinted at lowering them before!) In other news, the Chicago PMI suggested that business activity in the Chicago region expanded "nicely" in September, while the Conference Board reported that U.S. consumer confidence rose in September for the third consecutive month. The overall level of confidence, however, remains relatively low.