Option Investor
Market Updates

Hear comes Santa Claus\?

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Stocks have shown some renewed bullishness after what has been a 3-day respite on the heels of this morning's retail sales data. A bullish response for equities, offset by a bearish response toward Treasuries may have equity bulls looking for the proverbial "Santa Claus" rally into the end of the year.

But there's some work to be done and one thing I'm noting on a "cleaned up" bar chart that I tend to mark up with retracement brackets, Bollinger Bands, trend lines and moving averages is a potential head and shoulders top in the Dow Industrials (INDU) 8,514 +1.38% that finds the Dow right at the potential "right shoulder" of the pattern. However, a break much above the 8,550 (8,558 was the 10/24/02 relative high for left shoulder) would have bears second guessing the potential head and shoulders top and could se some short-covering come in and have not only the relative high of 8,800 in play, but also the psychological 9,000 and 200-day SMA as upside targets into the holiday shopping season.

Dow Industrials Chart - Daily Interval

One thing I haven't noticed in the Dow Industrials (INDU) 8,516 +1.4% is the POTENTIAL for a head and shoulders top to be forming. However, today's retail sales numbers are getting what I observe as a bullish response, not only from the equity side of things, but selling in Treasuries, which will free up cash that could well find its way into equities.

As such, I feel a good trader ALWAYS looks for potential trouble as this keeps him/her honest. While some bears may be playing a rather low risk, potentially higher reward bearish trade in the Dow on a head/shoulder top pattern, a break above 8,560 would be a stopping point. A Dow bull may realize that and look to inflict some pain to a bear on such a break higher as upside potential to the relative high then becomes a bear's immediate risk and if that's broken, well, Santa Clause may exist after all and have the Dow looking to test 9,000.

This type of upside action, should it unfold, could then impact market psychology. Not only here in the U.S., but around the globe. The Dow Industrials is perhaps the most widely quoted and followed major market average in the world.

Bulls playing a break higher in the Dow Diamonds (AMEX:DIA) $85.62 +1.2%, would look for a break above the 10/24/02 "left shoulder" high at $85.90.

Options traders in the DJX, would look for a similar break above 84.95 and I'd favor a January 84 call (DJXAF) currently $4.80 on the break and look for a potential double in the option with a target of $90. Don't over-leverage in the options and January gives the trader an extra month for Santa Claus to make a call, see if retailers don't come in with some strong numbers after the holiday shopping season has been completed.

Dow retailing components have Home Depot (NYSE:HD) $27.85 +3.33% and Wal-Mart (NSYE:WMT) $55.05 +0.07% currently showing gains on the session.

Jeff Bailey

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