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Stock futures show gains

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Stock futures are trading fractionally higher this morning. Fractionally compared to the past couple of trading sessions anyway. This morning we're seeing S&P futures (SP01M) edge higher by 2 points, NASDAQ futures (ND01M) are up 32 and Dow futures (DJ01M) are stepping up 25 points. Fair value for the S&P 500 is $6.96. That price will not change during the day. Computers are set for buying at $9.06 and selling at $5.36. For more information on fair value and buy/sell programs you can visit www.programtrading.com.

From oversold to overbought

If there's two charts or indicators that are keeping me calm, but licking my chops for a pullback it would be the Market Volatility Index (VIX.X) and some bullish percent charts that give hint that the current market environment has gotten very bullish. In fact, some might say it is just too darned bullish and represents great risk for any new bullish positions that are far from support. Of course, this is easier said when you're not short the market. For an old bear, he/she has to be thinking that things are getting away from them and this could still see the markets add to recent gains. However, from the risk management side of things, the risk of loss is now greater for new bullish positions than for new bearish positions. Those attendees of the OptionInvestor Expo will know what I'm talking about. If we understand the VIX and bullish percent, we can surely see that we've gone from "oversold" to "overbought" in a very short amount of time.

Market Volatility Index (VIX.X) Chart - last eleven months

If you believe like I do that the VIX can be used as a contrairian indicator then you can see how we've gone from a high level of bearishness (near 40) to a relatively low level of bearishness in a matter of about 10 trading sessions. We've had the above retracement bracket on the VIX for months. Notice how the VIX almost pegged our 38.2% retracement level during yesterday's session at 26 before rebounding to close at 28.45. Also notice how the session high was very close to our 50% retracement level at 29. I think the MARKET is watching this indicator closely and making some buy/sell decisions off of these moves. Those that are just learning about the VIX can think of the 29 level as somewhat of a waterline. When we're above that waterline, the market is usually somewhat bearish. When the VIX gets above 32, then things are getting overly bearish short-term. The opposite would be true. Below 29 would be considered bullish and when the level dips below 26, then things are getting overly bullish. Take note of September 2000 when the VIX was down below 20. Now take a look at this and see if you believe you should be raising some stops on long positions.

NASDAQ-100 Bullish Percent Chart - 2% box scale

If I think that the VIX might be indicating that there are just too many call buyers in the markets, then I might want to take a look at the bullish percent charts to give me further insight into an "overbought" or "oversold" condition. The above chart is simply a measure of the 100 stocks that make up the NASDAQ-100 Composite. What it is measuring is the percentage of stocks in the NASDAQ-100 that have given a buy signal on its point and figure chart. Levels above 70% are considered QUANTITATIVLEY overbought. Just remember... a stock on a point and figure chart is either on a "buy signal" or "sell signal." Right now we can see that 82% (82 of the 100 stocks) have recently given a buy signal. Note than in September of 2000 this was also the high reading for this indicator. Again... the bullish percent is used to assess RISK and not necessarily used to predict index price movement. What the above chart of the NDX bullish percent tells us is that current risk (risk of losing money) is high for new bullish positions.

Microsoft Chart - $1 box

At the OptionInvestor Expo, I used Microsoft's (NASDAQ:MSFT) chart to teach attendees how to calculate bullish and bearish price objective. MSFT had an uncanny ability to peg both bullish and bearish price objectives. What I want traders to understand from the above chart is this. MSFT is a large component of the NASDAQ-100 Index (NDX). MSFT first contributed to the bullish percent for the NDX when it gave a "buy signal" at $57. Even though the stock has given several buy signals since then, it only gets "one vote" toward the bullish percent. Probably the most important thing I can write about now is that it would take a pullback and a trade at $51 to have this stock give a sell signal. From an institutional perspective, this stock is overextended on its point/figure chart and a pullback to $57 would likely be viewed as an excellent buying opportunity. Is there something on the bar chart that also coincides with the $57 level? I think the 50-day MA is pretty close.

Am I looking to short MSFT?

No Way! Why would I even think about shorting a stock with a bullish price of $71. Especially a stock that has an uncanny habit of meeting bullish and bearish price objectives like this stock does. What I would do however is keep an eye on this stock. Earlier in the week, I alerted traders that 1/2 position long at $62 wouldn't be a bad idea on the spread quadruple top buy signal. That buy signal was given yesterday. I thought 1/2 position would be a good idea just in case this stock ran to $75 without stopping. However, if we did get a pullback in the stock, then the position could be rounded out to a full position if the stock pulled back into its base and then reversed back into a column of O's.

Bar Chart Enthusiasts

I cut my teeth on bar charts and one thing I noticed over the years was that I wanted to see a stock break above its 200-day MA on BIG VOLUME to signal a true change in posture toward the stock. Yesterday, MSFT traded 78,373,000 shares. The 30-day average volume for MSFT has been running about 46,600,000 shares per day. With "Mr. Softie" breaking above the 200-day MA on above average volume, I'd say the next pullback on this stock is a buying opportunity. Keep it on your list! If you can go back to January 1996, you'll see a similar setup in the MSFT bar chart. The stock broke above the 200-day MA on BIG VOLUME, and then pulled in nicely to its converging 50-day and 200-day MA's near $11.13. By June of 1996, MSFT had bounced off its 50-day MA twice on its way to $15.67, representing a 28.9% gain. Let's see.... Bullish price objective is $75; 50-day MA is at $57. Hmmmm... $57 to $75 would be a 31.5% gain. Makes you think doesn't it? Will history repeat itself? Until the charts say different, I'm bullish on MSFT and licking my chops for a pullback or a test of the 50-day MA.

Try it, you'll like it!

Try using some of the above ideas on other stocks you're eyeballing. Do they have some of the same characteristics? Can you find some past history of trading to identify good long candidates on a pullback?

Bullish Percent Symbols for Stockcharts.com

Every charting service has different symbols for different indexes and indicators. Here is a quick list of bullish percent symbols at www.stockcharts.com for broader market indices. $BPNYA: NYSE COMPOSITE; $BPOEX: S&P100; $BPSPX: S&P500; $BPCOMPQ: NASDAQ COMP; $BPNDX: NASDAQ100; Please remember that these are updated daily at the end of the trading session. Some services just update these types of indicators on a weekly basis as they feel it removes much of the noise from everyday fluctuations. I personally am torn between daily and weekly updates. For shorter-term traders, I feel that the daily updates give better indication of "overbought" levels as the market is 80-90% buy side and is quicker to pull the trigger on the sell side when the risk of losing money becomes known. I think when you look at some of the bullish percent charts, you too will realize this and will see how the bullish percent charts have a habit of basing near "oversold" levels more so than they do at "overbought" levels.

Jeff Bailey
Senior Market Technician

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