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Index Wrap

Hit me with your best shot....

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Pat Benatar scored her first Top 10 hit with the song "Hit Me With Your Best Shot" from the Crimes of Passion album, and while the album itself was certified platinum, the song was certified GOLD!

Other hits from Ms. Benatar's Crimes of Passion album were "You Better Run" and "Hell is for Children."

You know where I'm going with this. Don't you?

Bulls look to have survived a one-two punch from this morning's economic data, which had weekly jobless claims coming in weaker than economists forecast (421k) at 442,000, while April factor orders were also weaker than forecast (-1.8%) with a 2.9% decline.

"Well you're a real tough cookie with a long history
Of breaking little hearts, like the one in me...."

Overnight European Central Bank interest rate cuts sparked buying in gold stocks as the equal weighted AMEX Gold Bugs Index ($HUI) $147.14 +4.05% surged. Meanwhile the stock weighted Gold/Silver Index (XAU.X) 77.70 +3.46% may have "broken the hearts" if not the potential head and shoulders top formation with today's move above the 76.69 level.

Is the move higher in gold stocks a "bad sign?" I'm not sure, but I don't think so. Some economists as well as the Fed are on the alert for "deflation," but when one considers what the stock market is doing, I tend to lean more toward the "inflation" camp at this point. I would certainly think that if "deflation" were in play, then stocks wouldn't be hitting multi-month highs. Now, this isn't to say that at some point the market won't have change in thought (gets more information), but for those torn between thoughts of "deflation" or "inflation," it may be gold stocks that benefit most.

"That's O.K., lets see how you do it
Put up your dukes, lets get down to it...."

What's "in play" is trader/investors seeing a falling Producer Price Index and Consumer Price Index, that's sign of "deflation." But what about the aggressive Fed and now ECB policy of lowering key interest rates? Now... the Fed hasn't made an interest rate move since cutting the fed funds rate by 50-basis points on November 6, 2002, but as noted in yesterday's 01:00 PM EST Update, the MARKET is looking for at least a 25 basis point cut by its August meeting, as depicted by the August Fed Funds Futures contract (ff03q) 99.04. In fact... as of today's close, the MARKET is looking at a 15% chance of a 50 basis point cut by the Fed between now and the August meeting.

August Fed Funds Futures - Daily Interval

Something's "out of whack" isn't it? The August fed funds futures are climbing and getting close to their March 10 contract high. Where was the S&P 500 Index (SPX.X) 990.14 +0.39% on March 10? How about 807.48.

Deflation? Mmmmmm.... no. I don't think so. Inflation? Mmmmmm... perhaps.

Why does the Fed or ECB lower interest rates? To pump liquidity into the system to stimulate growth. If growth comes, what does one expect? Inflation or deflation? Some inflation right? If the growth is to robust? I'll say it now... "hyperinflation."

Ahhhh! But what if growth doesn't come and product prices continue to fall in order to still try and spur some demand for those goods? "Deflation," Right?

What's a commodity that tends to perform well/bullish under "inflation" or "deflationary" environments?

The WORST-case scenario for gold is ECONOMIC GROWTH, with NO inflation.

Gold/Silver Index (XAU.X) - Daily chart

I now look for or am further alert to "short-squeeze" trade to develop in many gold stocks based on today's break of the "left shoulder."

As a trader, I think it is good to try and build scenarios for "why" an index may be trading the way it is, as it relates to some type of "economic meaning."

Now... lets put the "short-squeeze" trade aside for a moment and look at periods where the XAU.X and major equity indexes that some of us may be trading showed some DIVERGENCE (what we're really interest in) and times where the XAU.X and major indexes moved in unison. Like they have been in recent months.

From the far left of the chart shown above, the XAU.X made a very big move higher, while during the same time frame (January 2002 - May 2002) the SPX fell from 1,160 to 1,050) and from May, BOTH the SPX and XAU.X got back in unison.

Some economists interpreted the price action in the XAU.X simply as a massive short squeeze in gold. "Gold bugs" confirmed that notion, but also said that gold prices were going back to $700 an ounce as the economy was headed into a recession.

Hmmm.... were both wrong?

What I've "liked" and still "like" about a trade in gold, is that there's enough UNCERTAINTY between the various scenarios of "deflation" and potential "inflation" brought on my easy money and lower interest rates, that the "kicker" is the potential for another short-squeeze to take place.

Now... I point to the downward trend. I RESPECT trend and like to monitor and try and understand its implications.

I still say that at the EARLY part of a potential economic recover, INFLATION IS GOOD! Its after a prolonged period of economic growth that INFLATION IS BAD! Remember a couple of years ago when the markets would rally on any type of "weak" jobs data? Wage inflation was the big concern.

As I see it, I've basically got three different economic scenarios in play.

One is deflation (the rate at which the general level of prices for goods and services is falling).

The second is inflation (the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling).

The third is economic growth with no inflation.

Gold has the opportunity to benefit from the first two (is your U.S. dollar buying you more today than it was a year ago?) The US Dollar Index (dx00y) 92.52 -1.29% closed at a new low today. Forget my previous question about "a year." The US Dollar Index (dx00y) has fallen 7.5% from the 100.00 level since April 13. Now... the decline in the dollar impacts you and I more significantly if we like to buy foreign goods or services.

Right now, I don't see the "inflation" from the CPI or PPI and if the MARKET is playing inflation, its because of the thought of "easy money" now coming back to haunt us in some way.

Where our downward trend may come into some importance from a technical and ECONOMIC scenario standpoint is this. And that's the DEFLATION standpoint.

I'm going to suggest that if the XAU.X breaks above that trend and we were to see the major equity indexes break back lower, then the MARKET may then be putting greater emphasis on DEFLATION.

"Hit me with your best shot! Why don't you hit me with your best
shot! Hit me with your best shot! Fire away!"

Now... if I start hearing.... "oh, its just a short squeeze in gold," then a bull with a partial position could care less what's in play. And that's the "kicker."

"Knock me down, it's all in vain, I'll get right back on my feet again!"

S&P 500 Index (SPX.X) - Daily Interval

The SPX got "knocked down" early, but not enough to even come close to yesterday's low. I received some questions from traders that were trying to better understand the "inside day" technique of finding a an action point, but also simply using this technique that really instills discipline into a trader of once you've initiated a trade, then following it systematically with a stop.

I've tried to show some of the "inside days" that the SPX has had in recent sessions. The "inside day" in itself is a "neutral" day as the day's range was "inside" the previous day's trade. This has the shorter-term and even swing trader entering the next day with a NEUTRAL bias as it relates to that day's trade. All he/she does is say, "if the SPX breaks below the inside day, then short/put and follow with a stop just above the "inside day's" high. (#2 was an inside day the broke lower the next day, then stopped out for small loss the day after that as SPX moved above the previous bar's high).

Right now, a trader that traded bullish on Wednesday (#4) now moves his/her stop up just under today's low.

For "inside day" (#3) I marked with a red arrow the bar that would have exceeded the prior bar's low and had a trader stopping out.

Now... with the major indexes, you may want to give a little "fudge room" to a stop of this sort. Back test the "inside day" technique with the index or stock that you look to trade and see if it works consistently (say 70% of the time).

Even if you don't use the inside day, it may be helpful to "pretend" you are trading it. Then, count the duration and perhaps the price move that you would have been in the trade.

What you find right now, is that the BEARISH breaks of "inside days" tend to be short-lived, and stopped out rather quickly, while the BULLISH breaks either result in small losses or last a little longer than would the BEARISH breaks. As time passes, an "inside day" trader can begin to sense changes.

I've also incorporated the use of LEVELS from the DAILY/WEEKLY/MONTHLY pivot analysis data.

Today's not a real good example, but imagine (for the future) that you traded an "inside day" to the upside 5 days ago, and now sitting on a 40-point move, with 10 of those points coming in today's trade. Do YOU really want to give back 10 of those points to today's low? If not, then you might simply look to the pivot analysis matrix, look for a level that fits your downside RISK comfort level for the gain you've got, and then it is OK to "hope" that there are some "buy side" computers at that level that keep the SPX from hitting your stop.

I've said before that I don't use "hope" as a way to trade. I do use "hope" in this instance when I'm trying to protect a PROFIT!

Today's trade saw a net gain of 11 stocks to new point and figure buy signals as the S&P 500 Bullish % ($BPSPX) rose 2.2% to 80.4%.

A subscriber posed a very good question today as it relates to "bellwether" leadership. His point was... "where is it?" Microsoft (NASDAQ:MSFT) $24.09 -3.13% and International Business Machines (NYSE:IBM) $24.09 -3.13%. He also asked about Intel (NASDAQ:INTC) $21.85 +2.19%, which jumps to $22.34 after mid- quarter update, and Oracle (NASDAQ:ORCL) $13.36 -1.62%.

His observation I think is very meaningful toward technology at this point, but not a bank, a homebuilder, healthcare stock or even a resurgent airline stock mentioned.

With the SPX bullish % at 80.4% this rally has been building broad (it has to be to get the bullish % this high). When the "leaders" lag thought, its a very good observation to be alert!

S&P 100 Index (OEX) Chart - Daily Interval

I have a pretty good sense of humor about things, and I think a subscriber was "jabbing" me a little regarding a potential head/shoulder top after my long oration about intra-day head/shoulder tops that had been failing at the right shoulder. However, I've shown the POTENTIAL (heavens sake, the head hasn't even formed yet) but when I've looked back at head and shoulder patterns that HAVE developed and unfolded, the HEAD often came a a high level of bullish % (especially in sectors) and the BEST place to have SHORTED/PUT was when the right shoulder developed, when the BULLISH % was in a COLUMN OF "O" and internals didn't confirm the rebound that formed the RIGHT SHOULDER.

Today's trade saw a net gain of 1 stock to a new point and figure buy signal in the S&P 100 Bullish % ($BPOEX) and has this bullish % indicator growing to 76%.

"You come on with a come on, you don't fight fair..."

I had a friend back during the Pat Benatar era, and he was a pretty tough guy and liked to go around picking fights. He thought there was no such thing as fighting "fair." With what looks to be a positive response from Intel's mid-quarter update in after-hours trade, bulls aren't going to pull any punches in the NASDAQ-100 Index (NDX.X) 1,231.72 +0.56% and Tracking Stock (AMEX:QQQ) $30.64 +0.72% with after-hours trade at $30.83.

NASDAQ-100 Index Tracking Stock (QQQ) - Daily Interval

The Q's look to have a shot at $31.16 early tomorrow morning and that's not a "stretch" with after-hours trade at $30.83. This morning's "first hour" of trade turned 25.8 million shares, with support coming just above DAILY S1 of $29.90, but most likely the extension of the upper end of our "bullish wedge." It was laaate Tuesday that we thought a trade at $29.85 was the "trigger" for a bull to try and inflict some "pain" on bears that may have been shorting that trend, which broken, did look to be resistance intra-day on Tuesday. This morning's "gap lower" good spot for short-covering and as the session grew long, so did a bear's FEAR. Tomorrow's GREED point for bulls is the MONTHLY R2 of $31.63. I wouldn't be GREEDY and $31.48, just below $31.50 would be an early exit. Day traders that don't like to chase gaps, but willing to take a shot at $31.48, WATCH the 5-minute bar chart and try and MAKE SURE you get a 5-minute close ABOVE $31.16.

Today's trade saw a net gain of 3 stocks to point and figure buy signals in the NASDAQ-100. This has the NASDAQ-100 Bullish % ($BPNDX) rising to 87%.

Dow Diamonds (AMEX:DIA) - Daily Intervals

When the bullish % are as high as they are, I become more like "Sherlock Homes" than anything and I think a bull wants to see a break and close above that "tweezer top" dating back to August of last year. The Dow Industrials (INDU) 9,041.30 +0.02% is perhaps the most-often quoted index in the world and looks determined to close the 9,000 level. Bulls don't want to keep market psychology positive and a close above 9,100 then brings thought of 9,250 and 9,500.

Bulls do NOT like the way IBM and MSFT are trading and if tonight's "good news" out if INTC finds selling, then a tight stop under today's lows provides the protection I think bullish traders need at these higher levels of risk.

Today's trade saw no net change in the very narrow Dow Industrials Bullish % ($BPINDU). Still 76.67%.

Pivot Analysis Matrix

Treasuries found selling as the session progressed and with the U.S. Dollar weakness noted above, its my thought that some money was repatriated by foreign investors after the ECB cut rates 50 basis points.

The gloves have come off in this battle between bulls and bears and its has gotten UGLY for the bears. But, as I agree with the floor trader's comments discussed in last nights Index Trader Wrap, when the reversal comes, it isn't going to be pretty for the bulls, so like a wise street fighter, bullish traders should be ready to cut and run if things aren't going as planned.

One observation I'll repeat from a subscriber today is that he was looking at a list of stocks from a stock screen of BULLISH technicals, oscillators, etc. The comment was that EVERYTHING looks bullish.

Jeff Bailey

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