Over the past month we have been following reversal strategies and the price development on the daily time frame. The support levels have been strong enough with momentum slowing on the downside into July that it suggested we would see some form of larger weekly reaction off lows in the second half of the summer. This process began with a momentum shift in late June and into the first half of July in which the pace of the selling dropped off substantially. This played a large role in the bullish bias I had formed heading into this past week. The indices had bounced off daily lows in mid-July. After that point the Dow Jones Industrial Average ($DJI) and S&P 500 ($SPX) both began a two-wave sideways correction on the daily time frame. This was where they stood heading into last Monday. This can be seen more clearly on the 60-minute charts on which I've shown the two waves of correction in red.

Dow Jones Industrial Average ($DJI)


The indices were congesting at lows on Friday, August 1, but the larger bias meant that the indices would be unlikely to follow through strongly on any break lower from this range. In fact, the breakdown came early on Monday morning. When compared to earlier corrections on a 60-minute time frame, the congestion from Friday was relatively brief and the break lower was too early to be easily sustained. This created a very slightly lower low in the Dow and S&Ps to form a 2B reversal pattern. This is a type of double bottom (2 Bottoms) where the second low is slightly under the first, creating a type of bear trap.

A third push lower into Monday afternoon completed a larger momentum shift on a 30-minute time frame where the action from Friday afternoon into Monday afternoon was substantially slower when the trend channel was transected than compared to the initial decline the previous Thursday into Friday morning. This type of reversal typically leads to a strong move higher once the upper end of the slower channel breaks. I have drawn this channel on the 60-minute chart of the NQ in green.

The momentum reversal pattern triggered right away at the open Tuesday morning when the market gapped sharply higher. This type of breakaway gap is a powerful one. When the market breaks the 15-minute high on a stronger-than-average gap such as the one on Tuesday morning, then the odds are very high for at least an uptrend throughout the morning. When combined with a larger setup like the one on the 30-60 minute, however, the odds are highly favorable for a trend day. The indices did slow down into the early afternoon following the strong morning rally, but they surprised me with an even stronger surge into the close that ended at highs. The Dow Jones Industrial Average racked up a 332 point, or 2.9%, gain, while the S&P 500 rose 36 points, or 2.9%. The Nasdaq Composite ($COMPX) gained 64 points, or 2.8%. These were the largest one-day gains for the Dow and S&P 500 since April 1 and the largest in the Nasdaq since July 16.

S&P 500 ($SPX)


The financials really led the way higher for the market on Tuesday, but took more of a back seat on Wednesday even though the overall market continued to push higher. Freddie Mac (FRE) reported a loss for the quarter that was three times greater-than-expected, resulting in an 80% dividend cut to a mere 5 cents a share. The larger market move was aided by the fact that oil remained under pressure and the U.S. dollar gained strength against the euro. On Wednesday crude ended at $118.58 a barrel with the average price of retail gasoline finally showing marked improvement, down to $3.862 a gallon after highs of $4.114 on July 17. Energy stocks went against oil's performance and was one of the strongest sectors on Wednesday, followed by materials, metal stocks and technology stocks. The Dow closed higher by 40 points, with the S&P 500 up 4 points and the Nasdaq Composite up another 29 points.

After 2.5-3 days of upside in the market, whereby the indices hold a 15-minute 20-period simple moving average, the market has a high probability for forming a larger correction and breaking that support. 2.5 is more common than 3 days and with the lows hitting on the 4th, it meant that by the 6th we had seen that time limit zone hit into Wednesday's close. The market gapped sharply down on Thursday and this pullback continued with a second wave lower on a 15-minute time frame in the afternoon. Two-wave corrections are very common and since the daily time frame triggered a buy on Tuesday it was easier for the market to pick up the buying once again on Friday.

Nasdaq Composite ($COMPX)


The Dow Jones Industrial Average ($DJI) gained another 303 points on Friday, or 2.7%, to close at 11,734. For the week as a whole it added 3.6%. The S&P 500 ($SPX) rose 30 points on Friday, or 2.5%, which amounted to a 3% gain on the week with a close at 1,296. The Nasdaq Composite ($COMPX) had the strongest weekly gain after lagging the Dow and S&Ps in mid-July. It rose 4.5% last week. On Friday it added 58 points, or 2.5%, and closed at 1,296. These were the largest weekly gains in the three indices since mid-April.

Crude-oil ended the day on Friday at $115.20 a barrel, down nearly 8% on the week, although still up 20% on the year. This was the lowest close since May 2 and is about a 22% decline off July 11 highs. The retail price of gasoline was reported at $3.836 a gallon on Friday, while wholesale gasoline futures were down 2.8% to $2.8874 a gallon. This gives hope to motorists that prices at the pump will continue to drop. It should be noted that we are currently experiencing the second-largest monthly decline in commodities ever.

The U.S. dollar really stood out on Friday. It rose nearly 2% against the euro for the largest one-day advance since July 2002. The advancing dollar affects a number of commodities tied to the currency, such as oil, which make them more expensive for holders of other currencies. The pace of the dollar's advance has fueled speculation that the dollar will hold lows and continue to firm up for at least the remainder of the year. I agree than there is definitely a strong argument to be made along those lines. The dollar's rally off July lows has gained substantial momentum and corrections from such a move are generally much more gradual. In order to confirm the reversal, however, it still needs to prove that the larger correction is more through time than price, particularly over the next couple of weeks. There is strong support coming up this week in the euro, hence resistance in the dollar, from the congestion of late last year/early this year. The mid-way zone of that congestion will often hold and lead to a correction off that level. For prices to continue in the direction we are seeing so far this month we need the reaction off that zone to be more gradual than the move into it.

The larger daily bias in the market this week remains bullish. I have drawn in some of the major resistance levels to watch out for longer term on the daily charts. The more quickly prices rise off these levels, the easier it will be for them to test the upper resistance levels by fall. The market is likely to stall for several weeks, however, at the closest levels from mid-June. These will be equal move zones in the Dow and S&Ps, as well as price resistance from prior congestion and moving average levels.

Earnings season will be winding down this week. 449 of the S&P 500 companies have already reported. Most notable this week will be the retailers. Among them, Wal-Mart (WMT) reports on Thursday, as does Nordstrom Inc. (JWN). Abercrombie & Fitch (ANF) and Penney JC Inc. (JCP) both report on Friday. During this earnings season as a whole for the second quarter, earnings are expected to have fallen just over 22% since Q2 2007. Since many companies had lowered expectations, 66% of companies so far have beat forecasts, while 10% matched them. Third-quarter forecasts have also been lowered. Given the current weekly time frames in the indices, however, there is a strong probability that the market will be able to hold the lows for the remainder of the year, at least in the Dow and S&Ps.

Toni Hansen is President and Co-founder of the Bastiat Group, Inc., and runs the popular Trading From Main Street. She can be reached at Toni@tradingfrommainstreet.com.