Option Investor
Market Updates

Potential trade for FOMC

HAVING TROUBLE PRINTING?
Printer friendly version

Last week we put together a "hypothetical" portfolio that had us imagining that we had invested roughly $1,000 into each Dow stock on September 10th (day before terrorist attacks). We did this to help us understand potential relative strength winners/losers and make some sector associations.

Today I just noticed that there are several stocks that have or had recently rallied right up to their September 10th closing level, but found selling near those levels. This observation might be useful to both bullish and bearish traders in the coming sessions. If market participants are laying in wait to perhaps sell near levels found on September 10th, then we should make this observation and be aware of it in stocks we may be trading.

We're going to use the same portfolio of Dow stocks with approximately $1,000 invested at the close of trading on September 10th. I've added a horizontal green line at a level, which helps us visualize what stocks are trading above their September 10th close and below that close. Those just under this green line are therefore trading right up to their Sept. 10th close and might be candidates where some sellers are nearby. Before we go shorting every one, it would be helpful to find those with the least amount of relative strength. Those are the "weak sisters" and those that a bearish trader might have the most success with.

Dow Components - Sorted by % gain/loss since Sept. 10th

What I'm doing here is sorting down from Citigroup (NYSE:C) and looking for a stock that perhaps represents a good bearish trade candidate. I went over to the point and figure charts and started typing in the symbols of the stock and measuring their relative strength. Shares of International Business machines (NYSE:IBM) is perhaps a stock for bearish traders to be keeping an eye on. Here's what I'm looking at.

Relative strength of IBM vs. Dow Industrials

The relative strength chart of IBM is describes as..."relative strength is on a sell signal, but in a column of X's.) What the relative strength chart of IBM may be saying is that the stock began severely underperforming the Dow Industrials back in November of last year (relative strength sell signal just before the red B at 9). Then, this spring or early April, shares of IBM began outperforming the Dow Industrials (red 4 and 3-box reversal higher in relative strength). Today we can calculate a value of 10.4 for IBM as it relates to relative strength. This is enough for a drop of 1-box, but we actually need a drop of 3-boxes to have the chart falling to 9.5.

Perhaps a trader looking to try and trade our observation of a Dow Component that has rallied back near September 10th close of $96.47 is keeping a close eye on IBM at current levels and ready to jump on the stock on signs of weakness. There are some hints that relative strength is starting to fall off.

IBM Chart with retracement - last nine months

We can use our retracement bracket on IBM to help set up a bearish trade. A short/put position established by traders based on the forthcoming FOMC announce and a potential negative reaction, might be worth taking a look at. Shares of IBM have rallied nicely off our 80.9% retracement at $87.51 and are trading in positive territory. Should we have a negative market reaction to today's FOMC interest rate announcement, a trader might play the IBM Oct $95 put (IBMVS) and follow any trade with a stop just above the 61.8% retracement at $95.50. A bearish trader might then be looking for a re-test of the $87.51 level or the breaking of that level and potential $80.06 level for a more negative reaction.

A trader that is bullish shares of IBM wants to see a move above the $95 level and at that point they must assess risk down to $87.51. If we look at IBM from both sides like we are doing here, it looks like risk/reward is in favor of the bears at this point, thus my current bearish bias on IBM.

Jeff Bailey
Senior Market Technician
Premier Investor

Intraday Update Archives