Option Investor
Index Wrap

We Sit, We Wait

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       11-6-2001            High     Low    Volume Advance/Decline
DJIA     9591.12 +150.09  9600.60  9386.51  1.3 bln   2053/1054
NASDAQ   1835.08 + 41.43  1835.49  1777.91  1.9 bln   2079/1513
S&P 100   576.30 +  9.62   576.86   563.14   Totals   4132/2567
S&P 500  1118.86 + 16.02  1119.73  1095.36
RUS 2000  442.78 +  5.24   442.79   435.70
DJ TRANS 2291.15 +  6.43  2292.36  2257.71
VIX        29.85 -  2.09    32.66    29.22
VXN        57.34 -  1.62    60.13    57.26
TRIN        0.91
Put/Call Ratio       .58

Contact Support

They cut, we deliberate. Shorts cover while pundits bull the market up for breakouts across the board during the final half hour of trading following the 50 basis point (bp) rate cut. Some days I shake my head in amazement at the lunacy of what passes for analytical information and legitimate investing. Today was such a day. Yet I could write volumes on the fundamental reasons why this market should be dropping. But I will spare us all of agony of my thinking that is currently out of step with a market that wants to be bullish. We are traders after all and it should not matter which way the market moves, just so long as it moves and we can see it in a chart.

As Jeff Bailey often notes on sister site, OIN, "Trade what you see, not what you believe." The market is not good or bad, it just is. We trade in the direction of the trend. You know it already. "The trend is your friend." The trend is currently up.

So now that we have another 50 bp rate cut under our belts that had markets breaking out over previous resistance in the final half hour, what's next? Glad you asked. It is beginning to look a lot like last April just before the big downleg started.

Candle patterns beginning in early April that lasted until late May for a saw the SPX gain 124 points in about 34 trading days. The SPX rose from a low of 1191 to a high of 1315 over that period. The market's current run began in late September, and to date has lasted roughly 32 trading days with an SPX ranging from a low of 965 to a high of 1118 for a total of 153 points gained. Might I suggest that his market is running out of steam? I might but I won't just yet.

There are two possibly important differences between now and then - the first of which is seasonal. There is a well established history of markets giving up ground from April to November in a majority of years since the records were kept. The declines through late September (excluding events of 9/11) are consistent with market history. Contrarily, November through April has traditionally provided the greatest gains of the year. Seasonally speaking, we are entering the sweetspot for market gains.

The second difference is that stochastics were rising along with the candles then. Currently we are seeing some divergence between the two with daily chart candles moving sideways to up and the stochastic moves sideways to down. While this suggests that the strength of the move might be suspect (as in bearish divergence) as prices move up, it also suggests that when "strength" bottoms presaging the next cycle up, candles will have likely held at support. Even without stochastic enthusiasm, prices continue to edge up.

Put another way, if the current trend continues and the stochastics reach oversold while price action remains sideways to up, a stochastic reversal could have corresponding candles launching bullishly into orbit. While there may be some validity to these observations in favor of the bulls, I am not prepared to make that leap yet, which probably has bulls now shouting at me that I must be crazy. Of course, the obligatory question follows of how much more proof do I need to come out of my cave?

My answer is "lots" more proof. It is precisely at these times when folks are most bullish in thinking that upward movement is a sure thing that can't be stopped. The "nothing can stop us now" mentality is the kiss of death. And it is precisely at this time that the bears come out of their caves to eat their sirloin lunch - steak tartar, anyone?

All that said, candles are looking toppy, but the oscillators suggest there is more fuel in the rocket that needs to burn itself out. Shall we take a look?

Dow Industrials chart (INDU):

NASDAQ-100 chart (NDX):

S&P 500 chart (SPX):

Once again, notice the similarities among the charts? Let us start with the candles. In all cases except the weekly chart, all have cleared their 50-dma's (magenta line on the daily chart), which shows good bullish strength. If prices were going to fall, the 50-dma should have provided the excuse to do so. That did not happen. However, the Bollinger bands of all time frames (except the weekly) across all indexes are now being stretched to the upside. Just as prices tend to bounce up from the lower extreme, so too are they prone to bounce down from the upper extreme - bearish! Meanwhile the support levels that held over the past two days provided support again today as prices tested the pre-Fed levels. More bullishness!

As for stochastics, Note that all have entered overbought across all time frames with the fast blue line. There is still ample opportunity for the slow red lines to catch up. I do not put much credence for direction on the small hook reversal in overbought as seen in the 30-min time charts of all indexes. But of particular interest to me is the strength shown in the daily stochastic that finally broke back above the declining resistance line - also bullish.

Now about those weekly charts. The logical question becomes, "Hey Buzz - those things are so stochastically overbought. Aren't they about to reverse? Isn't this MOPO (MOAPO - Mother of all put opportunities - shortened to MOPO)? Two weeks ago, it sure looked like it. However, those following the stochastic fiddlings of Fundamentals Guy will remember one discovery that with the 5(3),3 settings, stochastics reach extremes very quickly and stay there. Reaching stochastic extreme does not necessarily mean the move is over. So for those wanting to load up on puts based on the weekly chart hitting oversold - DON'T! The bulls could have plenty of play left in them. Remember as Austin often notes and Molly Evans use to point out, "The market can stay irrational much longer than I can stay solvent".

That said, what of tomorrow? If I had the answer and was always right, we could charge $10,000 per month for the newsletter and our readers would gladly pay it because it would be a no-brainer to make that kind of money every day. Wish I had the answer. Alas, such is not the case.

The VIX has fallen under 30 for the first time in two months - the same frequency with which The Great Northwest sees the sunshine. While a reading of 30 or above use to be considered so bearish as to be a contrarian indicator for pent up bulls to charge, following the last 60 days of 30 or above, today's reading of 29.85 seems downright bullish and may prove to be enough so as to bring the contrarians out of their bear caves. Similarly, markets have had a habit of selling off once Fed rate-cut euphoria wears off. Honestly, with Fed Funds rate of 2% and a discount rate of 1.5%, what does it say about our economy that it needs that kind of stimulation? Not good in my book.

But clearly based on the charts across all time frames, bulls have the upper hand and shorting or buying puts against the prevailing trend for all but the skilled daytraders is to risk big with little reward potential. Bulls will be bulls and we can't fight that. Until the daily oscillator trend reverses from its yet to be overbought state, calls will be the higher odds play. Personally, I will take the call plays but will keep the positions REALLY small using 75% loss capital. I figure if it goes past 50% loss, it's going for a reason and better save something for another day. It will also have me getting on the opposite side if it proves to be a bigger trend.

See you at the bell.

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