A 2B Test Of Bottom In The S&P 500

07/06/07 08:22:35 AM

by David Penn

The same formula that noted a bottom in March hints at another one in June.

Security: $SPX
Position: N/A

We won't know for some time whether the 2B test of bottom that appeared in the Standard & Poor's 500 over the course of June will be as meaningful as the 2B test of bottom that occurred earlier in the year back in March (Figure 1).

But we can already see similarities in the pattern that (a) signal that any bearishness at this moment is likely wrongheaded and (b) provide us with renewed confidence in the effectiveness of the 2B test.

FIGURE 1: STANDARD & POOR�S 500, DAILY. The lack of follow-through to the downside after the lower low is made in the second half of June paves the way for a bottom in the market�s month-long correction.

Graphic provided by: Prophet Financial, Inc.

The 2B test is one of the simplest and most straightforward ways a trader can spot and exploit a reversal opportunity in the markets. At its most basic, the 2B test of top or bottom says that when a market makes an extreme point — a new high or a new low — and then returns to test that point, failure to follow through on that test with another new high or another new low often doesn't just mean an end to the trend; it often means that the trend is vulnerable to reverse.

This was exactly what happened to the S&P 500 back in March. As I wrote at the time (see my Traders.com Advantage article "Short-Term 2B Bottom In The S&P 500" from March 16, 2007), the inability of the market to move lower as it made a lower low in the second half of March was a major signal that the correction had run its course.

As is often the case in these instances, bearishness and pessimism were running amok. While sentiment indicators like the volatility index and the put/call ratio are certainly helpful tools, even a half-engaged eavesdropping on CNBC often provides all you need to know to figure out when traders are in panic mode — and ripe for the picking.

David Penn

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

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A 2B Test Of Bottom In The S&P 500

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