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More Problems for the Market

By Paul Cherney Problems unfolded in during the session on Wednesday, Mar. 10. The CBOE volatility index, or VXO, which measures implied volatility in OEX options contracts, continued to rise, and the put-call ratios fell. That's not good.

More jagged trading is possible; an opening capitulation of selling and a surge in volume would go a long way to boost my confidence that some sort of a bounce is taking place.

The swing low in Wednesday's S&P 500 session was 1,122.53, right at the bottom edge of the range (1,122.38). The S&P 500's recent trading range had been defined here as: top of the range, 1,163.23 (Friday's intraday high); bottom of the range, 1,122.38. But the index might have other problems (see below).

The Nasdaq's recently established trading range -- top, 2,094.92, bottom, 1,991.05 -- has been broken.

I am expecting some sort of price stability to emerge but I need to see some tangible technical proof that buyers are moving in, even if those buyers are just bears covering shorts.

I have reviewed the Nasdaq chart and am re-defining the immediate Nasdaq band of

support from 1,994-1,959 to 1,994-1,939.56, with a focus of support 1,982-1,965.

There simply has not been any real panicked selling. When you start declining on larger volume, it only makes sense to expect that a finale to the price decline should be marked by a spike in volume and high put-call ratios as sellers capitulate and demand for put protection is evidenced in a high put-call ratio. On Tuesday, Mar. 9, the CBOE P/C ratio actually moved lower; as of 3:30 p.m. ET, the total P/C ratio was down to 0.80, while the equity only was down to 0.63. There is no fear yet.

The broad picture of Nasdaq support is a band at 2,001-1,783, established over the months of October, November, and December, 2003. The index has well-defined support at 1,994-1,939.56, with a focus of support at 1,982-1,965.

Immediate support for the S&P 500 runs from 1,129-1,120.90.

Immediate intraday

resistance levels for the indexes are thin lines, but if prices exceed them, then become temporary supports: S&P 500, 1,129.93-1,134.40, Nasdaq, 1,974-1,985.71.

I was wrong in the previous column when I expected a rebound in prices because the VXO had spiked and then retreated in Tuesday's session. In Wednesday's session, the VXO did not continue lower, it reversed and moved higher.

Other Potential Problems: I have to bring this observation to your attention. While the Nasdaq topped out at the end of January, the S&P 500 moved sideways. It was the shift into cyclicals (out of techs) which helped lessen the impact of the declining techs and created a sideways pattern for the S&P 500. The result for the S&P 500 was a sideways band of consolidation. This has created what I refer to as a line of death (definition below). The line of death for the S&P 500 is 1,120.90. Usually, the first test or undercut of a line of death produces a rebound. If that rebound runs out of upside momentum and then undercuts again, then the downside risk opens for a test of the next layer of support, which for the S&P 500 is 1,077-1,031.20.

Line of Death: A "line of death" is the lowest price point in a sideways consolidation. A pre-requisite for a "line of death" is a sharp (asymptotic) rise in prices and then just a sideways consolidation pattern. The truly important "lines of death" occur after a multiple week (or month) uninterrupted trend higher which finally reacahes price levels where buyers and sellers meet in equilibrium (that's why prices just move sideways in consolidation).

The line of death is the lowest price point established during that sideways consolidation. It represents a "towel toss" level for the people who went long during the consolidation and it also represents a "take profits" point for the people who shorted near the top of the sideways consolidation. The first test of a line of death often produces a hard, fast rebound.

Why? My theory is that the first test of the line of death usually produces a rebound in prices because it represents the bears who were playing the trading range and when prices reach the bottom of the range, they are happy to take all or some of their short-side profits by buying to cover. Oftentimes, (in a generally bullish market), their buying turns the market up for another trip to the upper edge of the band of consolidation, but, if the lift generated by the short-covering at the bottom the consolidation (at the line of death) fails to generate followthrough buying and prices rollover and pierce the line of death again, then bulls who had gotten long during the consolidation give-up on the long-side and sell, adding to the downward pressure. Cherney is chief market analyst for Standard & Poor's

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