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Support Tests Looming For Russell 2000

11/18/10 08:50:04 AM
by Donald W. Pendergast, Jr.

All trends reverse direction, eventually. The big question for Russell 2000 index traders: Is this only a pullback in a continuing bull run, or is it the beginning of a major trend reversal?

Security:   TF, RUT, IWM
Position:   N/A

The Russell 2000 index rose by more than 26% between August 24 2010, and November 5, 2010, helping to restore the 401K balances of many long-only investors before buying pressure began to peter out. Traders in this market need to rely on more precise timing tools than long-term investors, however, so what kinds of technical clues will we be looking for to help time various long and short trade entries in the days and weeks to come? Here are a few things to watch for that may help keep you on the right side of this volatile market.

FIGURE 1: MINI RUSSELL 2000 FUTURES, DAILY. For skilled chartists, the variety of Fibonacci and key chart support points on this daily chart should prove to be invaluable as they plan their next interactions with this highly volatile market. 738.90 and 687.90 are the two most potentially explosive S/R points to be aware of in this key small-cap index.
Graphic provided by: TradeStation.
Graphic provided by: Trading Alchemy's TrendCatcher.
Only two indicators are plotted on Figure 1, the daily continuous chart for the emini Russell 2000 futures contract (@TF) -- the Trading Alchemy TrendCatcher set for 2.382 average true ranges (ATRs) with an eight-period lookback and one pair of Keltner channels set at four standard deviations away from a 45-period exponential moving average (EMA). These are not magic numbers, but they do tend to produce meaningful trend and trend reversal imagery on this particular market. Right now, the TrendCatcher has just gone into bear mode (depicted by the lower aqua TrendCatcher trailing stop being taken out, thus turning the price bars purple) as of Tuesday, November 16, 2010. This is the first price-bar color change in nine weeks, making it of special interest, especially occurring after such a strong bullish run.

Occurring along with the color change was the first test of Fibonacci support -- the 23.4% level -- which was able to hold the first stage of this selloff, as prices managed a daily close above 701.63. If you've been reading my articles here in Advantage for any length of time, you already are familiar with a few of the basic mechanics of trend reversals; after a very strong run higher (lower), the Fibonacci 23.4% retracement will normally act as a temporary stopping point for a given market before giving way for a full test of the Fib 38.2% retracement. In extremely strong bull(bear) markets, this won't necessarily be the case, however, and you'll need to also be monitoring the trend strength of higher time frames using the average directional index (ADX) indicator as well.

In many cases, though, the Fib 23.4% level breaks and prices will usually make a fairly quick trip to the 38.2% level. That's the first thing we need to watch for here on this daily chart of the R2K for a daily close below 701.63 (preferably on heavy volume), and then we need to see if 687.90 (the October 19, 2010 consolidation low) also gives way. If that also happens, a rundown to 679.14, the Fib 38.2% support, is very likely. Based on the chart dynamics, 687.90 is actually more important than the Fib 38.2% number is, because significant chart support/resistance (S/R) should always be given higher weighting than a Fib number, given a choice.

If you've studied charts for a while now, you're also familiar with the tendency of markets to make powerful moves in the area of significant prior S/R. The market rejects the area of previous S/R and reverses or goes sideways or it plows right though it, forging ahead to make new highs or lows. That's what you want to be monitoring here in the R2K, to see how this market reacts if 687.90 is seen again within the next week or so. If the market respects that support area, perhaps we will see some sideways chop before the typically bullish year-end seasonal cycle for this market reasserts itself. If the support area fails, however, that means that a major trend reversal is the more likely outcome, with prices falling farther and harder than might be expected at this time of the year.

As far as the Keltner bands go, well, consider this: the Russell 2000 index rarely stays above that upper channel line for very long, and even if it does manage to hug the band as it climbs higher, it never strays too far from it. In this case, the index tagged the line once in October, pulled back, made another attempt at it, and failed before starting this current selloff. The Keltner midline is coming up fast (currently at 694.69), and that is another key S/R barrier to be aware of. If that gives way on big volume, expect continued downside for this key small-cap market. Again, look for 687.90 and then 669.20 (the July 2010 swing high) to step in as powerful support on a further round of selling. The support at 669.20 is critical and must hold if the August-November bull run is destined to morph into something even more impressive.

These are just a few of the chart dynamics that you need to be aware of if you trade this market from a discretionary basis instead of using a mechanical system. The concept of support and resistance is perhaps the single most important charting dynamic that you need to be aware of as you learn to interpret what the price bars, patterns, and trends are actually saying in a given market. Master the art of identifying key S/R levels and you'll be light years ahead of the typical uninformed trader and investor.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title: Writer, market consultant
Company: Linear Trading Systems LLC
Jacksonville, FL 32217
Phone # for sales: 904-239-9564
E-mail address:

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Date: 11/23/10Rank: 5Comment: 

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