Bottoming Process Begins
by Carl Swenlin

On Tuesday the market began a rally off the lows for the current correction. On the chart below we can see that the rally has continued and prices have broken out through the top of a descending wedge formation. (Bullish resolution of that formation is what we normally expect.) Volume for the rally has been respectable, and conditions were sufficiently oversold, that we could have reasonably expected a rally.

The question remains as to whether or not the rally was just a short-covering rally that will soon fail as sellers move back into the market. My opinion is that the market has begun a bottoming process that will probably take a few weeks to complete.

The next chart of the CVI (Climactic Volume Indicator), which measures extreme OBV (On-Balance Volume) movement within the context of a short-term OBV envelope for each stock in the index, reflects one of the highest ever CVI readings. Because it was accompanied by a price reversal and breakout, the high CVI reading represents an initiation climax, meaning that a new short-term trend (up) has been initiated. Next we need to determine if the new trend might extend into a longer-term time frame.

The next chart gives us a view of three medium-term indicators representing the condition of price, breadth, and volume. As you can see, all three indicators are very oversold, and they have begun rising. In general, this is a very positive situation; however, you can also see that these indicators usually zigzag into a series of bottoms before a price bottom is completed. In other words, while it is possible that the recent price low may prove to be the low for the correction, there is still a high likelihood that low will be retested within a couple of weeks; therefore, we cannot be absolutely certain that a new correction price low will not be made.

Finally, the weekly-based chart below shows that the S&P 500 has bounced off a long-term rising trend line, which is a very bullish sign. Certainly there is no guarantee that the expected retest will not break through that support, but for the present there is plenty of technical evidence that supports a bullish outcome in the medium-term.

Bottom Line: The market is very oversold and is bouncing off long-term support. We can expect a retest of the lows, but there is a very good chance that a medium-term bottom is in the making. Nevertheless, if the retest fails and the long-term support is violated, it would be strong evidence that the bull market is over.

Regardless of my personal opinion, we rely on the mechanical trend models to determine our market posture. Below is a recent snapshot of our primary trend-following timing model status for the major indexes and sectors we track. Note that we have added the nine Rydex Equal Weight ETF versions of the S&P Spider Sectors. This may seem redundant, but the equal weighted indexes most often do not perform the same as their cap-weighted counterparts, and they provide a way to diversify exposure.

Technical analysis is a windsock, not a crystal ball. Be prepared to adjust your tactics and strategy if conditions change.

BIO: Carl Swenlin is a self-taught technical analyst, who has been involved in market analysis since 1981. A pioneer in the creation of online technical resources, he is president and founder of DecisionPoint.com, a premier technical analysis website specializing in stock market indicators, charting, and focused research reports. Mr. Swenlin is a Member of the Market Technicians Association.