Stocks, Oil Near Critical Points

09/09/2011 10:23 am EST


Thomas Aspray

, Professional Trader & Analyst

Stocks and crude oil have rebounded nicely from the early Tuesday lows, but the daily charts suggest that Friday’s action may be critical. Here are key levels to watch.

Many of the major averages show similar formations, as the rebounds from the August lows have just reached strong areas of retracement resistance.

Though the stock-market averages and the ETFs that track them have not moved above last week’s high, crude oil did make new rally highs on Wednesday. As I discussed last week, crude oil and the Spyder Trust (SPY) often trace out similar chart formations.

Therefore, watching the key support and resistance levels on both, as well as some of the other key market averages, can often give you advance warning of a breakout in the other markets. If any of the key support levels are violated today it is likely to set the tone for next week’s action.

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Chart Analysis: The Spyder Trust (SPY) came very close to the 50% retracement resistance at $123.72 last week, as the high on August 31 was $123.51. The more important 61.8% retracement resistance is at $126.90.

  • Tuesday's drop tested the lower boundary of the flag formation, line b. A break below $114.38 should signal a drop at least to the $112.41 to $110.27 area

  • The 127.2% downside target from the flag formation is $106.65

  • The NYSE McClellan oscillator hit overbought levels at +264 last week, but has now broken its uptrend, line c. It often leads prices, and may be signaling a break of key price support levels

  • The McClellan oscillator closed just above thezero line and it will take strong A/D numbers Friday to turn it higher

  • There is initial resistance for SPY at $121, with the upper boundary of the flag formation (lines a and b) following in the $124.80 area

The Nasdaq Composite retested the early August lows on August 19, which is in contrast to the action in the S&P 500. This suggests better relative performance...and the Composite did show better relative strength last week.

  • The Nasdaq did slightly exceed the 50% retracement resistance at 2,609 last week, and came very close to the declining 40-day MA

  • The more important 61.8% resistance stands at 2,675 and this level needs to be overcome on a closing basis to turn the outlook more positive

  • The McClellan oscillator on the Nasdaq shows a similar but slightly more negative formation than that on the NYSE. The former uptrend, line e, was just tested Wednesday, but it is now back below zero

  • If prices break below the August lows, the McClellan oscillator could form a positive divergence

  • There is short-term support now at 2,480 with more important levels in the 2,400 area

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The Dow Jones Transportation average has led prices on the downside since the weekly on-balance-volume (OBV) formed a negative divergence in May.

  • The current chart shows a short-term flag formation, lines b and c. The rebound from the August lows has been weaker, as it just retraced 38.2% of the prior decline

  • The longer-term downtrend, line a, is in the 4,900 to 5,000 area

  • Volume on the rebound has not been impressive, as the daily OBV is still below short-term resistance, line d. The weekly OBV (not shown) is still negative

  • There is short-term support now at 4,380, and a drop below 4,270 (line c) would complete the flag formation

  • This would give downside targets in the 3,950 area

The chart of the November crude oil contract shows that prices are reaching the apex of its flag formation, lines f and g. Wednesday’s high at $90.67 was below the 38.2% retracement resistance at $91.35 and the downtrend, line e, is in the $93.80 area.

  • The OBV showed good strength last week, but has once again turned lower. It is still above its support (line h) and its rising WMA

  • The weekly OBV (not shown) is slightly positive, but needs a positive close for the week (above $86.70) to keep it positive

  • The support from the flag formation (line g) was broken early Tuesday, and therefore Tuesday’s low at $83.47 and the chart support at $83.30 are the key levels to watch

  • A completion of the flag formation has downside targets in the $72 to $73 area

What it Means: As I discussed in detail in this week’s trading lesson, flag formations are generally continuation patterns or pauses in a major trend. This does not bode well for the market over the near term.

Here are some key support levels to watch.

  • Spyder Trust (SPY): $114.38
  • SPDR Diamond Trust (DIA): $109.18
  • PowerShares QQQ Trust (QQQ): $51.91
  • iShares Russell 2000 (IWM): $65.93
  • iShares Dow Jones Transports (IYT): $77.24
  • November Crude Oil: $83.30

A break of these levels will signal a drop back toward the August lows, but it is possible that these lows will hold. The formations do not require that the markets drop significantly below the August lows, but it cannot be ruled out.

How to Profit: Over the past several weeks, I have suggested that investors use a market rally to retracement resistance to lighten up on those stocks that are acting weaker than the market, as well as to hedge their other holdings.

Though I think the Spyder Trust could test the $110 to $112 area, the high option premiums make specific put recommendations more difficult.

Bull call spreads on one of the inverse ETFs would allow one to participate in a decline, but with limited risk and reward.

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