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REVERSAL


The S&P's Intraday 2B

01/31/06 10:42:23 AM
by David Penn

A 2B bottom and a positive divergence show how the SPOO got its groove back in time for the New Year -- the Chinese New Year, that is.

Security:   $SPX
Position:   N/A

In a recent article for Traders.com Advantage, I took an intraday look at the break higher in the markets in late January. More specifically, I used a five-minute March emini Dow futures chart to show how a diamond consolidation led to a sharp breakout on January 26. That session -- on impressively increasing volume -- appeared on the daily charts to be the first offensive by bulls looking to get long ahead of the final Federal Reserve Board meeting of the Greenspan-era Fed.

FIGURE 1: S&P 500, HOURLY. A lower low in price is matched with a higher low in the stochastic, creating a positive divergence that suggested the downside momentum was waning. Failure to follow through on the downside as the lower low was made also caused a bullish 2B bottom to develop.
Graphic provided by: Prophet Financial, Inc.
 
This look at the Standard & Poor's 500 on an hourly basis (Figure 1) provides another look at how the bulls got their groove back after the rally that began the month began to fizzle out. From a somewhat longer-term perspective compared to what was shown in the Dow futures piece, we can get a good look at the bottoming process that took place over the days between January 20 and January 27, from bottom to breakout.

There are two technical features that stand out in that January 20-27th period. The first is a 2B bottom, as the low from late in the session on January 20 is exceeded on an hourly basis by the low from late in the session on January 25, yet there was no further progress to the downside after that late-day January 25th low. That is the simple definition of a 2B bottom -- when there is a lack of downside follow-through following a lower low -- as Victor Sperandeo introduced the concept to us in his book Trader Vic: Methods Of A Wall Street Master. Note how quickly and sharply the market moves higher following that lower low. Some have called the advance — or at least its earliest stages — a short squeeze, and that may have been the case. In fact, an hourly chart of the Dow Jones industrials shows a bearish rising wedge (or oversized bearish flag, depending on your perspective), the breakdown from which is immediately followed by an upthrust and an out-of-nowhere rally higher.

The second technical feature worth pointing out is the positive stochastic divergence that links the two lows in price. As shown in Figure 1, the lower low on January 25 is accompanied by a higher low in the stochastic. This positive divergence, which underscored the bullish implications of the 2B bottom, was another signal that the decline that began back in early January quite possibly had run its course.

Another small point on the January 20-27th consolidation that became a bottom should be made. Consolidations often act a lot like chart patterns insofar as a breakout from a consolidation (or a breakdown, for that matter) often travels at least the same distance post-breakout, as the consolidation is wide at its widest point. Looking at the consolidation here, we have a range of about 12 points (1272 to 1260). Adding that amount to the value at the top of the consolidation (1272 + 12) gives us a minimum upside of 1284. As the chart shows, this is precisely the area in which the breakout begins to run into resistance and begin to move somewhat sideways.



David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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Date: 01/31/06Rank: 3Comment: 
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