Tech Stocks Pull Market Lower Following RIMM Earnings, but Market Recovers Throughout Remainder of the Day

Tech Stocks Pull Market Lower Following RIMM Earnings, but Market Recovers Throughout Remainder of the Day

(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.)

The market opened sharply lower on Friday morning following in line earnings from Research in Motion (RIMM), but a lower profit outlook. About a week ago I described how to approach such extreme gaps in the indices themselves. We have seen quite a few examples of this activity in recent weeks and Friday's open was very similar.

The Strategy: The first thing to do with any larger-than-average gap in the indices is to have patience. Sit on the sidelines for the first 15 minutes of the day. Then mark the highs and lows of those first 15 minutes. The direction in which those prices break has an incredibly high probability of serving as the primary trend bias throughout the remainder of the morning. More often than not this trend also will continue into the afternoon. There is a higher tendency for extreme gaps in the indices to favor closure in at least one of the three main indices than there is for the move to continue in the direction of the gap. That tends to occur more often if there is a larger setup in place that also favors a move in the same direction, such as the breakdown setup on September 15th.

On Friday morning the indices were already set to open into the support zone I talked about in yesterday's column, which was the trading range from Wednesday. In other words, the larger price pattern favored a gap closure as opposed to a continuation. Still, it is typically best to wait the 15 minutes in order to increase your odds of making a successful decision. Once the initial 15 minutes had passed on Friday morning, it was not long before the highs were taken out.

Nasdaq Composite ($COMPX)


The Dow Jones Industrial Average ($DJI) experienced the greatest strength on the break higher. It had the least distance to travel before its own gap would close, while the Nasdaq was weighed down by technology thanks to RIMM. The Dow was perhaps also boosted by assurance early in the day by President Bush that the bailout plan will go through, with a deal most likely in place before Monday's opening bell.

On the one hand, one might wonder why the impact of overnight news regarding Washington Mutual (WM) was not more widely felt. Regulators seized the bank and $1.9 billion in assets are being sold to J.P. Morgan Chase (JPM). On the other, the news of the failure of WM was not exactly unexpected and had been speculated upon for weeks. Even though JPM also gapped lower into the open, It closed its gap very quickly and proceeded to trend higher throughout the session, posting gains of 11% by the closing bell. In order to boost its capital position, JPM is selling at least $8 billion in stock.

The Dow followed in the footsteps of JPM and closed its own gap zone by the time the 11:00 ET correction period hit. The index had experienced two waves of upside out of the open and the second one that completed the gap closure was more gradual than the first. This allowed the market to pull back and correct for awhile into the early afternoon. Although the immediate drop off highs was rapid for a few minutes, the pace did not sustain itself and instead the market rolled higher off mid-day lows going into the afternoon.

Dow Jones Industrial Average ($DJI)


The early afternoon continuation on the upside was stronger in the S&Ps and Nasdaq than earlier in the session. They tried to play "catch-up" with the Dow and did a rather decent job at it. The rally continued for approximately the same amount of time as the earlier upside in the S&Ps and Dow, hitting resistance shortly before 14:00 ET at previous highs in the Dow on a 15 minute time frame and the prior afternoon lows in the S&P 500. The gap from Thursday morning in the Nasdaq also closed at this time and the Nasdaq hit moving average resistance in the form of a 5 minute 200 sma. All of these factors came together to pull the market lower again into the second half of the afternoon.

The afternoon correction lower off mid-day highs lasted for about as long as the late-morning correction. This is no coincidence. The symmetry of these corrections can be used to help time reversals and continuation patterns. Once a comparable amount of time had passed, the market was also hitting nice support from the breakdown level of 12:30 ET from where the early afternoon move higher triggered. This came after three waves of downside on a 5 minute time frame in the S&Ps and Dow and equal move support on a 5 minute chart of the Nasdaq, which had broken lower into 15:00 ET on a 2-wave continuation short pattern.

Following this second pullback off highs on a 15 minute time frame, the indices were again able to continue the rally. The momentum increased further into the final 45 minutes of trade and the indices easily established another equal move on the 15 minute time frame, but in a shorter period of time than it took for the early afternoon rally to form in the S&Ps and Dow. The S&Ps broke the previous day's highs, but the weaker Nasdaq could not quite close the morning's gap and held resistance into the close at the equal move level and 15 minute 200 simple moving average resistance. These levels corresponded to Wednesday's highs as well.

S&P 500 ($SPX)


The session ended on Friday with the three major indices all closing within the zone of the day's highs. The Dow Jones Industrial Average ($DJI) closed higher on the day by 121.07 points, or 1.1%, at 11,143.13. Of the Dow's 30 component, 19 closed higher. Following JPM's lead, Bank of America (BAC) gained 6.8%, while American Express Co. (AXP) came out ahead by 4.4%. The S&P 500 ($SPX) rose a mere 4.09 points, or 0.3%, and closed at 1,213.27 on Friday. Consumer staples and health care were top performing sectors, while energy, materials, and utilities moved to the downside. The Nasdaq Composite ($COMPX) closed virtually unchanged, down 3.23 points, or 0.1%, and ended the session at 2,183.34. On the week as a whole, the Dow fell 2%, while the S&P 500 dropped 3.2%, and the Nasdaq Composite lost 4%.

My outlook heading into the new week of trade is essentially the same as for Friday on the 60 minute time frame. Going into Friday morning I was looking at a move on the upside to serve as a second wave of buying on that time frame. This opens the door for a two-wave continuation short setup on this level. We do still have to see how it handles the second wave higher from Friday, however, before anything is more certain. The momentum is strong on the upside on a 15 minute time frame, but this is not necessarily enough to allow us to dismiss the pattern. It would need to pull back sharply, however, to give us confirmation. A slower correction up off the lower end of the channel made from the 24th to 26th would then be ideal to allow for a break to new daily lows or at least a retest of the prior low. This market is going to remain more tricky, because larger weekly and monthly time frames are at a strong support zone. Since these are such large time frames, there is quite a bit of wiggle room for the market to move and still be considered as holding the support. The ongoing credit and banking crisis is also going to keep things stirred up for the time being.