This past played out very well with our expectations. As stated in last Monday's column, while the indices were looking higher into the open on Monday (which they accomplished with a gap to the upside), "the larger intraday time frames (were) favoring a reversal off highs once again rather early on in the week". Several of the factors contributing to this bias included the completion of three waves of upside on the 60 minute charts for the Dow Jones Industrial Average and S&P 500 EMini futures contracts and major price resistance on a daily time frame in the Nasdaq 100 EMini futures contract at early summer congestion levels.

The kicker for the reversal in the indices came from the formation of a 60-minute 2T reversal pattern on the Nasdaq Composite. An initial high was formed on 8/11 with a slightly higher high, relatively speaking, on 8/15. A smaller 2T was also formed within the second push into the highs from the 11th on a 15 minute time frame. The first high on the smaller 2T was on the 14th, while the second high on the 15th. The 2T on the smaller time frame assisted the change of pace necessary to procure a strong price correction. Initially the push into the second high on a 60 minute time frame was as rapid as the move into a second high on the 14th. The slightly higher high on the 15th rounded off the highs, leading to what is most commonly known as a head-and-shoulders pattern from the three-day period the 14th through the 15th on a 15 minute time frame. It then triggered a short when the afternoon congestion from the 15th broke lower on Monday morning.

Nasdaq Composite ($COMPX)


Once the selloff was under way, the indices continued lower until both the S&P 500 and Dow Jones Ind. Average found support on Tuesday in the form of an equal move on the 60 minute time frame. Last week I showed how well this concept works in terms of determining resistance, accurately predicting the highs on the 11th. It works equally as well for determining support.

To predict when a flag or breakout will mostly likely stall or reverse, take a look at the previous trend move in the same direction. In the above case, measure the move from the highs on the 11th to the lows of the 13th. Then take the high of the next move lower and project that forward. The highs from the 18th, when taken and extended lower to the same degree as the drop early the previous week show price support right in the zone of the lows which took place on Tuesday. This support was also the same as the 200 period simple moving average on the 60 minute ES (S&P 500 EMini) and the middle of the two-wave formation on the daily time frame in both the Dow and S&P futures.

The Nasdaq experienced a more mellow selloff than seen in the S&Ps and Dow. Without the extension, it was not as exhausted heading into the second half of the week. The three indices each fell into congestion throughout the day on Wednesday, but while this congestion held in the S&Ps and Dow into Thursday morning, the Nasdaq broke to a slightly lower low on the 60 minute time frame and the 20 day simple moving average on Thursday.

Dow Jones Industrial Average ($DJI)


After rounding off at lows, the market turned higher Thursday afternoon and into Friday. The pace increased on the upside Friday morning following a decent gap higher into the open. Contributing to the move was news that Lehman Brothers (LEH) may be a possible takeover candidate. This caused the stock to gap up into Monday's opening price zone on Friday morning.

The action in LEH over the past week was quite comparable to action displayed on both the Dow and S&P's 60 minute charts. The difference is that both of the indices ran Friday morning, while LEH achieved the same pattern objectives with the gap. In other words, all three had two waves of selloff from the highs of the 11th, followed by rounded lows between the 19th and 21st and the sharp move higher Thursday afternoon into Friday morning. The pattern alone was already a highly bullish one, but the news certainly didn't hurt its prospects!

The morning rally on Friday in the indices had a difficult time pushing through resistance and held upper levels early on. Since the pace of the buying was so strong, however, it made it difficult for the indices to roll over. Instead it created congestion once again, leading to light volume into the weekend. In addition to the price resistance from the previous week, the Nasdaq hit resistance at its 60 minute 50 sma and its mid-week highs. Although the larger time frames are pointing higher this week, the resistance from Friday stands a good chance of holding into Monday morning. The 20 sma on a 60 minute time frame will be support. A pullback into this level can then lead to a second wave higher on a 60 minute time frame mid-week.

Based on current pace action, there is not a strong bias on a 120 minute time frame for a larger move on the daily charts at this time. The Nasdaq is forming a cup-with-handle, however, the handle is likely only be about halfway complete, which would cause a lot of chop over the next two weeks. The "cup" of this pattern would be the move from June with lows rounded into July and a break higher into August, followed by the "handle" creation since August 11th. The Dow and S&Ps will likely continue to congest along the 50 day sma while the Nasdaq's handle develops.

As long as prices hold up at these zones, then the indices can easily break rapidly higher in September to take them to the next daily and weekly resistance levels from May (shown on the charts in dark red). The lighter volume throughout August is a bonus. While part of this can be attributed to the fact that August is a typical holiday season, particularly in Europe, it is also indicative of a lack of strong bearish sentiment throughout the correction (congestion).

S&P 500 ($SPX)


The Dow Jones Industrial Average ($DJI) ended lower last week by 0.3% at 11,628.06. This was after the 197 point recovery on Friday (+1.7% on the day). The financials led the gainers with Citigroup (C) up 3.8%, J.P. Morgan Chase (JPM) up 3.9%, Bank of America (BAC) up 4%, American Express (AXP) up 4.7%, and Lehman (LEH) up 5%.

The financials also drove the S&P 500 ($SPX) on Friday for a 1.1% gain on Friday to close the week down by 0.5% at 1,292. Financials climbed 2.9% Friday, while consumer discretionary rose 2.4% on the day. The energy sector ended in the red, down 2.4% after chopping around throughout the week.

The Nasdaq Composite ($COMPX) rose 34 points on Friday, or 1.4%. Due to the heavy losses experienced earlier in the week, however, the index closed at 2,414 on Friday, down 1.5% on the week.

Federal Reserve Chairman Ben Bernanke provided a boost on Friday to assist the technical bias in the market by making comments that indicate the Fed is expecting U.S. inflation to remain in check this year. This has fueled speculation that the Fed will not raise interest rates in the near future.

Over the past week or two the dollar, the euro, and crude oil have all held the levels I pointed out in last week's market action video. Both the euro and crude oil held support, while the dollar held resistance. Warren Buffet told CNBC on Friday that he felt U.S. stocks are now more attractive and is no longer betting against the dollar.

Closely tied to action in the dollar, support hit in oil at last March's highs and May's lows at about $110 a barrel, while the dollar to the euro rallied into the congestion level from November of last year to February of this at about $0.68. Oil was particularly interesting this past week due to the extreme rally on Thursday for a $5.62/barrel gain to $121.18 followed by a $5.69/barrel, or 4.4% loss to $114.59/barrel on Friday. This was the largest dollar decline since January, 2001. In related news, the retail price of gasoline now stands at an average of $3.692 a gallon, although I saw it as low as $3.56 this weekend (Sarasota, FL). I am expecting both oil and the euro to slide further over the next week to two weeks, but that they will show a greater reaction off support into the fall.

Mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) were again grabbing headlines last week. Both broke to new lows after stabilizing momentarily in late July and early August. They had created two-wave triangle patterns on a daily time frame during that period and triggered a selloff setup on August 8th. Then they stalled and congested into Monday, but broke sharply lower again into Monday's open and continued to selloff into Thursday. FNM closed on Friday at $5.00 a share, while FRE closed at $2.81 a share. Consider for a moment that FNM closed on Aug. 22, 2007 at $69.38 a share, while FRE closed at $64.89 just one year earlier.

Last week was a light one for economic data. On Tuesday the Labor Department reported a 1.2% increase in the Producer Price Index. This index measures wholesale prices and was higher than anticipated. Over the past year producer prices are up 9.8%. The core PPI, rose 0.7% in July, which was also higher than expected. Over the past year core prices are up 3.5%.

On Thursday the Conference Board's report on leading U.S. economic indicators showed a 0.7% decline in July. A decline of 0.2% had been anticipated. The data for the week suggests the remainder of the year will continue at a slow pace economically.

Meanwhile, initial jobless claims fell by 13,000 last week to 432,000. The 4-week average for claims rose to 3.3 million. Last year they measured 2.55 million.

This next week will be much more active. Data to keep an eye on in this coming week includes the Case-Shiller home prices index on Monday, home sales data on Monday and Tuesday, the monthly consumer confidence index and the FOMC minutes on Tuesday, durable-goods orders on Wednesday, the revised estimates for second-quarter GDP on Thursday, and personal income growth and spending on Friday. The Chicago PMI and Michigan Sentiment data also comes out on Friday.

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.