Watch the Russell 2000

 | Jan 17, 2012 | 4:00 PM EST
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Yes, there is always something. Some index giving us some reason to be on the lookout for a top. Today, it's the Russell 2000 (RUT), which is signaling the completion of another retracement pattern. This is the retracement of the decline from the Aug. 3 close. Recall, the next session, Aug. 4, the market collapsed with the Dow off more than 500 points at the bell. The sharpest drop in the Dow in more than two years. In any case, that drop left a bunch of gaps to be filled. And it is the gap in the Russell 2000 that is of particular interest today, as it's only the RUT, which hadn't filled its gap from Aug. 4 until today.

In the Russell 2000, as shown in the chart below, that gap was originally 765.00-772.78. Though the gap was probed in late October and narrowed considerably as the RUT popped up to 769.46 on October 27, it wasn't filled in its entirety till this morning when the RUT traded up to 773.26. So this morning, the RUT filled the gap from August 4, exceeding it by less than ½ point and from there has begun to back off. Though the opening gap is still intact from 764.20 to 768.15. That's now a likely short-term downside target. For the near term, a pop above the morning highs at 773.26 should point still higher, but until then, this area marks a possible near-term top and is significant resistance.



Russell 2000 -- Finally filling its Aug. 4 gap
Source: OptionsXpress



Speaking of gaps and all that, did you happen to notice how the market sold off on Friday to neatly fill the gaps from last Tuesday? In the S&P Futures, you get to see more clearly what really happened last week, so here it is.


Note in the chart below that the island at 1279.75 finally got aborted on Friday after the E-Mini came within a point of getting it done on both Wednesday and Thursday. Friday's selloff did better than that as the futures collapsed to 1272.75, which completely took care of Tuesday's gap at 1275.50 as well as the island. That was obviously the spot to buy and, accordingly, I was adding to positions in the SPX for client accounts at Rydex, at the morning pricing of 1280.86 in the cash. As we all too often find, the filling of these downside gaps are buying opportunities and little more.


Was there a reason for the selloff? Probably. Now, ask me if I care what the reason was. I don't in the least. Now that last Tuesday's gap has been filled and the island has been aborted, that's all there was to that. But now, just the next session, another gap and island has been formed and it now provides another downside target for a pullback. If you weren't selling into this morning's gap up opening, you might want to ask yourself, "Why not?"


This time around, the gap at 1289.00 is so close to the island at 1289.75-1291.75, that odds are good that both the gap gets filled and the island aborted before the week is out. Maybe today. Short term, it may be a spot to buy for a bounce, but I will probably be looking for more of a pullback before I do anything much more aggressive on the long side.



E-Mini S&P -- Forming another bullish island reversal
Source: R.J. O'Brien




The story told by the chart of the SPX is a bit less compelling as there is no bullish island reversal here. But there is still an opening gap at the 1289 level. That's a gap that should be filled in the days ahead.



SPX -- Also with a gap at 1289
Source: OptionsXpress



Finally, on the indicator front, the jury is out till we see how the market closes today. A strong close will push the McClellan Oscillator back into overbought territory, as it settled Friday on the overbought side of neutral at +81.


The sentiment outlook is still quite worrisome as the Market Volatility Index (VIX) hovers near its multi-month lows at the 20 level. New lows in the teens in the VIX will be another sell signal just as the usual crowd embraces the collapse in the VIX and rushes out to buy new highs in stocks, like they always do, just before the next sharp decline.



VIX -- Nothing bullish about all this complacency
Source: OptionsXpress


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