Use The Nasdaq 100 ETF To Make Your Next Market Move
Monday, July 20, 2009
by Jim Stanton, Technical & Quantitative Analyst and Editor of The 1-2-3 Trader
Last week, the market did what it often does best: Confounded the experts and did the opposite of what most people expected.
This time, the market teased technical traders, luring them into thinking that the Dow and S&P 500 were mapping out a bearish “head-and-shoulders” pattern in the wake of the indexes topping out in mid June.
As the news gathered momentum on blogs and in newsletters, mainstream media outlets like CNBC and Bloomberg began running with the story. And that was part of the problem!
It soon became clear that this particular pattern might not follow the conventional path - a theory that gained credibility when both the Nasdaq 100 and Nasdaq Composite traded at new recovery highs when the closing bell sounded last Friday.
So what is going on here?
This Pattern Signaled A Reversal… Or Did It?
Below is a daily chart of the Dow Industrials, which I published in the weekly “Inside Mt. Vernon Research” e-mail last Friday. (This publication is only available to subscribers of Mt. Vernon’s Research paid products).
As you can see, there is a clearly defined “head-and-shoulders” pattern spanning the last two months. However, what many people forgot is that while this pattern usually signals a reversal, it also has a failure rate of around 30% - something I also I warned my 1-2-3 Trader subscribers about.
The Breakdown Of A “Head-And-Shoulders” Pattern
When a “head-and-shoulders” pattern closes below the “neckline,” which the Dow did on July 7, sellers usually take control and send the market lower.
However, although the Dow did close below the neckline for four straight days, crucially, the bears couldn’t gain any traction. The low for the move was on July 8, which raised a caution flag.
When the media got hold of the story, highlighting the potential bearish pattern and the prospect for a reversal, the masses began shorting the market. From July 7 through July 10, the equity put/call ratio closed between 77% and 85% (bullish) - the first occasion in a long while that a four-day reading had been that high.
And as the market often does, when most people are sitting on the same side, it usually goes the other way. True to form, the market began rallying.
Let’s figure out the next move by looking at the PowerShares QQQ Trust (NASDAQ: QQQQ) - the ETF that tracks the performance of stocks on the Nasdaq 100.
How To Use The Nasdaq 100 Trust To Make Your Next Move
As I noted, the Nasdaq Composite and Nasdaq 100 both made new recovery highs last week, which should take them up to their next minimum targets. Take a look at a daily chart of the QQQQ.
Utilizing the proprietary software that I use in my the 1-2-3 Trader service, by making new recovery highs, QQQQ now has a minimum upside target around $38.34. Depending on how things unfold from here, it could set up various trading opportunities.
With most traders now realizing that the “head-and-shoulders” didn’t work out like it was supposed to, they’re getting bullish again. This was evidenced with last Friday’s put/call ratio dropping down to 58% - the lowest reading since the June highs. This means one of two things will likely happen this week.
Scenario #1: Since options traders and the market have turned bullish, the QQQQ could reach its target early this week. If it does, and the new highs aren’t confirmed by the other indexes, it sets them up for sell signals. If the Dow and S&P 500 do make new highs, all of the indexes will probably continue higher over the near term. This is the more likely scenario.
Scenario #2: The indexes pull back or go into a consolidation pattern after last week’s rally - either because options traders turned bullish so quickly and/or the markets are now divergent, with some of the indexes above the June highs and some not.
What To Do: If the QQQQ pulls back this week, I’d do some scaled-down buying. If the Nasdaq 100 goes into a consolidation pattern, it could test the $34.40 area - and while the odds of that happening at this point are low, it would represent a great buying opportunity.
If the QQQQ trades at $38.30 or higher, and the other indexes don’t trade above their June highs, it could signal a reversal.
Jim Stanton
Editor, The 1-2-3 Trader
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