Technical Analysis
Russell 2000 Warns of a Top Again
 By Harry Schiller
RealMoney.com Contributor
3/26/2008 4:15 PM EDT
URL: http://www.thestreet.com/p/rmoney/technicalanalysis/10409398.html

Every time the market rallies sharply off of a short-term low, it's the same thing: the bulls getting excited about the upside after the Dow rallies 600-800 points in a matter of a few days. These same guys are never interested in buying as the market is revisiting multi-month or multi-year lows. They only get interested after the sharp rally, wanting to make the bet that the big bull market is once again alive and well.

I will never understand that line of reasoning. It's like betting on a crash after the Dow is already down 2500 points off the highs. It's just not a good bet. It happens once every few decades, and yet there are traders who make that bet every few weeks. Not me. I am not interested in hitting home runs. I hit singles, sometimes a couple a day, and that is just fine for me. Once again, the market generated signals of a short-term top at Tuesday's highs. This isn't necessarily the end of the recovery, but at least signaled a needed pullback. It has already been tradable; for me, just another base hit.

The Russell 2000 (RUT) called this short-term top. Not the durable-goods numbers or renewed worries about the financials. And this isn't the first time it marked a top by filling or almost filling one of its overhead gaps. You may recall it doing so just days ago as it clawed its way back up to its March 6 gap at 681, stalling within a point of that level for three consecutive sessions (March 12-14), and then collapsing 5% into last Monday's lows.

Well, it did it again.

Once again calling the turn this week was the much-maligned and generally ignored Russell 2000 which apparently had its Feb. 29 gap at 705.72 in its sights early this week. On Monday, nobody seemed to notice that the Russell 2000 was surging to that gap, topping out at 705.12, just .60 shy of its target, then pulling back about 1% from there late in the day.

On Tuesday, it popped up to a marginally lower high and sold off again before climbing to a higher high of 705.99 and that was it, topping just .27 above its gap. Now this morning, it gapped down from that same level and has pulled back 10 points from Tuesday's highs. So that's another gap for us to keep an eye on, that will get filled, that could mark another top.

This ain't rocket science, folks. It's just a matter of paying attention to these numbers on the daily charts. The Russell 2000 warned for two days of a top at the 705-706 level. And now that index and the entire market have sold off following the filling of that gap.

Russell 2000
Calling another top as another gap is filled
Click here for larger image.

Of course it's never just one index or chart. And usually, the S&P finds its way into the mix.

This move up from last week's double-bottom low (on the continuation charts) was no exception. Here, as well, there was a very visible gap from 1354.70 to 1365.80 in the now-expired March contract beckoning. Monday's 1361 high was near the gap's midpoint, and that's as close as it would get.

Tuesday's lower high produced a bearish non-confirmation with the Nasdaq, which also signaled that some kind of pullback was near, which was another reason to sell into Tuesday's muted advance and look for the pullback, which I did, especially in the S&P.

The bigger picture is that there is much to like about the pattern in the S&P, not the least of which is last week's bullish island reversal pattern. Note that the selloff into last Thursday's lows held narrowly above that reversal. That was another sign that the rally might carry, which it has done.

S&P Futures
A double bottom and Island Reversal marking the low
Click here for larger image.

Not much different from the pattern seen above in the futures is the SPX (cash) index. But here, you can see something else that played into the recent rally off of last Thursday's lows. Note that last Wednesday's sharp selloff bottomed right at the 50% retracement, 1299, of the preceding rally.

Wednesday's low was just a fraction of a point lower at 1298.42, though the SPX pulled back another 3 points Thursday morning before surging to the upside. The selloff should have come as no surprise, as the market demanded a retracement of its massive rally, and 50% is a pretty standard number.

S&P Cash
Bottoming last Thursday at the 50% retracement of last week's rally
Click here for larger image.

In the Dow, where the 50% retracement weighed in at 12,109, the idea was the same. Wednesday's low (which was a couple of points below Thursday's low) was just 12 points below that level, and from there, it was off to the races again.

Also calling for a solid recovery was last week's bottom in the Nasdaq 100 (NDX) and the island reversal that continued to hold throughout the week.

And not by much as the NDX held just above the island gap last Thursday -- by just 12 pennies. These are the kinds of things I look for at a bottom. For the moment, it looks like a potentially important low is in place.

But short term, it is no coincidence that this week has seen the NDX stall after filling its Feb. 5 gap. The gap got filled at 1828.80, and Tuesday's rally carried only 3 points higher. Now we have another gap down from that same area, which is another gap that gets filled and perhaps marks another top.

NDX
Stalling after filling the February 5 gap
Click here for larger image.

Finally, the indicators that called a low last week have now just as loudly warned of a short-term top (Tuesday). For one, the McClellan Oscillator closed at a fully overbought +134.5, which is not the kind of thing I want to see if I am holding long.

Then there was the VIX, which so neatly called the bottom last Monday, topping out less than 2 points shy of its Jan. 22 multi-year high. Now that was a time to buy the market.

Since then, it has generally trended lower, while reflecting the market's gyrations. On Monday, the VIX traded down to 24.75, representing a 30% drop from last Monday's highs. That's certainly not very bullish for the near-term, as recent history has repeatedly shown us that buying stocks after a 30%-35% drop in the VIX has generally not been a profitable strategy.

VIX
No longer so bullish
Click here for larger image.

Early last week with the market at its lows, I was holding positions up to a maximum of 70% invested. Tuesday at the close, I cut back to just 25% long. If they hit it, I will buy it. Otherwise I can wait.

At the time of publication, Schiller was long SPX, Russell 2000, NDX, Dow and Financial Services mutual funds up to 35% levels, with lots of cash on the sidelines, although holdings can change at any time.

Dr. Harry Schiller is a Registered Investment Advisor with the California Dept. of Corporations. He holds a Series 7 General Securities license as well as a Series 4 Options Principal license. He has been owner and editor of the Short Term Consensus Hotline since 1988. For more information, see www.harryschiller.com. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.