The Technical Pattern Traders Should Be Watching

What history tells us about Dow millennium levels

Todd Salamone
Dec 27, 2014 at 10:30 AM
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December seasonality kicked into high gear this past week, with the Dow Jones Industrial Average (DJI), S&P 500 Index (SPX), and Russell 2000 Index (RUT) each notching impressive week-over-week gains, and finishing at their highest-ever levels. What's more, despite the holiday-shortened week, the Dow closed above the previously untouched 18,000 level three times. But this isn't the only key area traders should be watching, as Schaeffer's Senior VP of Research Todd Salamone explains below.

  • The significant pattern we're noticing on the S&P MidCap 400 Index (MID).
  • Why bulls should be encouraged by the rollover on the buy-to-open equity put/call volume ratio.
  • Rocky White breaks down the historical implications of millennium levels for the Dow.

Finally, we close with a preview of the major economic and earnings events for the week ahead, plus our featured sector.

Notes from the Trading Desk: Inverse "Head and Shoulders" for MID?
By Todd Salamone, Senior VP of Research

"... the second half of December has historically been bullish, so while the market may not benefit from expiration-related short covering like last week, momentum players or those short individual equities may be supportive, as they throw in the white towel to get a fresh start next year ... [W]e are -- in the blink of an eye -- back in a situation like that of early December from a technical perspective, when round-number resistance areas were in play ...

"The MID is just below the 1,450 half-century area, which has acted as resistance three separate times since it was first touched in early July. That said, the neckline of an inverse "head-and-shoulder" formation is at 1,450-1,460, and a breakout would be bullish, targeting a 12% move to 1,640 in the five months after such a breakout.

"A few weeks ago, we observed the turn in the 10-day, buy (to open) put/call volume ratio as a risk to the bullish case. In hindsight, this was a risk well worth acknowledging. While this ratio is not near the July or September extremes, it is near extremes in 2013 and early this year that marked key turning points ... Our gut is a roll-over is in the cards with the 'V-bottom' the market just experienced, and with seasonality now bullish for the next few weeks, a breakout above resistance could be imminent."


- Monday Morning Outlook, Dec. 20, 2014

"Blue-chip & small-cap indices take out round number resistance in early going $RUT 1,205.38 and $DJIA 18,014- $SPX just 16 pts below 2,100"

-@ToddSalamone on Twitter, Dec. 23, 2014

We move into the last three full trading days of 2014 with stocks following the typical bullish pattern that has been persistent in the second half of December, as small-caps lead the advance off the December expiration-week bottom.

In fact, the Russell 2000 Index (RUT - 1,215.21) moved into new all-time-high territory on Friday, following a move above the 1,200 mark early in the week, and above the March and July highs in the 1,215 area.

While the Nasdaq Composite (COMP - 4,806.86) hit a new multi-year high and is now less than 200 points away from the big 5,000 millennium level that marked the beginning of the technology bust in 2000, the Dow Jones Industrial Average (DJIA - 18,053.71), S&P 500 Index (SPX - 2,088.77), and S&P MidCap 400 Index (MID - 1,467.90) broke out to new all-time highs, also. The SPX now sits just below another century mark at 2,100, but the DJI took out the 18,000 mark. For more on the implications of the new millennium level on the DJI, be sure to see Rocky White's research in the next section.

Plus, the MID finally broke out above the 1,450-1,460 area -- which has marked resistance on several occasions this year -- to new all-time highs. As we discussed briefly last week, the MID's move above the 1,450-1,460 area is important, as this is the neckline of a bullish inverse "head and shoulders" formation that now targets a move to 1,640 in the next five months, which is roughly 12% above current levels. However, in the immediate days ahead, the 1,475-1,480 area could be a speed bump, as this represents a 10% year-to-date gain for this index, and round-number percentage gains have been pivotal areas on multiple equity benchmarks this year. A stall in this area would likely coincide with other major benchmarks stalling, with the SPX staring at 2,100 just overhead and the jury being out as to whether or not DJI 18,000 and RUT 1,200 are behind us for good.

MID -- bullish inverse "head and shoulders" pattern

Daily Chart of MID Since July 2014

Nonetheless, bulls should be encouraged by the behavior in the 10-day, equity-only, customer-only, buy-to-open put/call volume ratio, which is now rolling over from a relatively high level, as we anticipated last week. As you can see on the chart immediately below, rollovers from a high level have typically coincided with bullish price action in equities, as pessimism gives way to optimism. This ratio is far from what might be considered a short-term optimistic extreme, which typically leaves the market vulnerable. As we mentioned last week, a risk to the bullish case is the lack of portfolio protection outstanding, with CBOE Market Volatility Index (VIX - 14.50) call open interest extremely low and SPDR S&P 500 ETF Trust (SPY - 208.44) put open interest at moderate levels. This would suggest that stocks may be more vulnerable than normal to negative headlines, if unhedged players react to negative headlines by selling long positions or suddenly demand portfolio insurance, which can have a coincidental negative impact on the market.

Portfolio insurance is a little cheaper now versus last week, which makes it a little more attractive relative to a week ago. So, if you are unhedged, and are concerned that so few have hedges in place, now is a more attractive time than a week ago to purchase portfolio insurance.

Buy (to open) equity put/call volume ratio since June 2013 -- rollover from recent peak is encouraging for bulls

Buy (to open) equity put/call volume ratio since June 2013 with SPX

Finally, the last trading day of the month and year also marks quarterly expiration for those underlying vehicles that have options with quarterly expirations, and this is not likely on the radar screen of many traders.

The SPY is one such instrument with quarterly expirations, and the open interest configuration as of Thursday's close is pasted below. The SPY closed at 208.44 on Friday, and if volume is low next week, there might be a "push" for the SPY to close between 207 and 208, which is where the maximum number of puts and calls with a 12/31 expiration date will expire worthless -- creating another solid payday for option sellers, which likewise occurred on standard December expiration.

It was a pleasure keeping you informed and up to date throughout 2014. We wish you the best in 2015, and look forward to providing you with insight you are not likely to find anywhere else.

SPY Open Interest Configuration for 12/31 Series of Options

Indicator of the Week: Dow 18,000 & Even Levels
By Rocky White, Senior Quantitative Analyst

Foreword: A milestone was hit last Tuesday, with the Dow Jones Industrial Average (DJI) reaching 18,000 for the first time ever. It's always good to reach new highs, but does it really mean anything going forward that the fresh peak reached last week was a round 1,000-point level? A lot of people theorize that the even levels are consequential. These even levels can be popular points for investors to evaluate the index and determine whether it is expensive or cheap. In the case of today's rising market, it might be a popular point at which to take profits. Looking at the bright side, the even levels can be attention-getters for investors standing on the sidelines, who now might buy in so they don't miss 19,000 and 20,000. If that's the case, we could see a pretty quick move up to those levels.

The chart below shows the Dow over the past 10 years. The even 1,000-point intervals do look to be significant at times. This week, I'm taking a quantitative look at how the Dow has behaved after running into one of these even levels. We'll see if there's any evidence that these even levels mean anything for stocks going forward.

Dow Jones Industrial Average Since 2005

First Time Crossing Above Even Levels : Starting with the 10,000 level in 1999, the table below shows how the Dow performed after the first time reaching each of the 1,000-point intervals. I summarize those returns, and then the last table shows the typical Dow returns since 1999 for comparison.

Interestingly, the index has struggled over the next couple of weeks -- supporting the premise that even levels can act as short-term speed bumps. When you get to three months out, the underperformance disappears. The data suggests short-term traders might want to take note of these even levels on the major indexes.

Also notable is the number of days between each of the 1,000 point intervals. It's interesting that the two times it took less than 100 days (1999 and 2007) to get to the next level, it led almost immediately to huge declines, and then multiple years before the next level. Perhaps the ultra-fast run up from level to level is a sign of climactic buying. The 173 days between 17,000 and 18,000 is the third fewest days in the table, but comparable to some of the other lengths of time between intervals. Hopefully, it's a sign that no major decline is imminent.

Subsequent Dow Performance After First Time Crossing an Even Level Since 1999
Dow Anytime Returns Since 1999

This Week's Key Events: Manufacturing Data Headlines a Short Week
Schaeffer's Editorial Staff

Here is a brief list of some key market events scheduled for the upcoming week. All earnings dates listed below are tentative and subject to change. Please check with each company's respective website for official reporting dates.

Monday

  • New Year's week kicks off with the Dallas Fed manufacturing survey. There are no notable earnings on tap.

Tuesday

  • On Tuesday, the S&P/Case-Shiller home price index and the consumer confidence report are slated for release. The earnings calendar is bare.

Wednesday

  • With markets shuttered tomorrow, weekly jobless claims will come out on Wednesday, alongside the Chicago purchasing managers index (PMI), pending home sales, and the weekly crude inventories report. There are no noteworthy earnings scheduled.

Thursday

  • Markets will be closed on Thursday for New Year's Day.

Friday

  • On Friday, Markit's purchasing managers manufacturing index (PMI), the Institute for Supply Management's (ISM) manufacturing index, and construction spending data are all scheduled for release. There are no notable earnings on deck.

And now a sector of note...

Retail
Bullish

The retail sector has been in the headlines recently, as holiday shopping season wraps up. While signs suggest retail sales figures will most likely meet forecasts, expectations are not exactly at euphoric levels, even as the SPDR S&P Retail ETF (XRT) carves out new all-time highs. In fact, the exchange-traded fund (ETF) notched its loftiest mark on record -- $96.12 -- last Tuesday. What's more, the shares are currently sitting atop several layers of previous resistance, including their year-to-date breakeven mark of $88.10, and $90.12 -- a 10% premium to XRT's mid-October closing low of $81.93. Plus, the round-number $90 level is roughly double the ETF's 2007 and 2010 resistance level at $45, and could now reverse roles to act as support. It should be noted, the $97 area could serve as a short-term speed bump, as it is 20% above multiple lows near $81 the ETF has panned since April.

On the sentiment front, two-thirds of the 69 retail stocks we follow are trading above their 80-day moving average. Nevertheless, the typical short interest-to-float ratio among these equities is nearly 13%, which would take more than five sessions to cover, given average daily trading volumes. Also, fewer than half of the brokerage firms covering these names have handed out "buy" ratings. All things considered, retail stocks could be poised to run higher on potential short-covering activity and/or a round of analyst upgrades.

Daily Chart of XRT since January 2014

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