Option Investor
Index Wrap

Dow under 10,000 grabs attention!

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MY OUTLOOK -
Does it mean anything to have the Dow back under 10,000? - maybe not. The prior daily closing low at 9911 is a number to watch. This past week did bring a new weekly closing low at 9962 relative to late-May at 9966. This upcoming week is key now as to whether buy money flows in again in this area. Or, are fund managers too spooked by the upcoming elections and espcially now to lowered earnings expectations. The oversold condition would suggest some rally potential ahead - that and my up volume indicator - more on this in a minute.

Tech, particularly the semiconductors (SOX), a driving "engine" there, is still acting as a drag on the overall market as stocks continued lower this past week. Oil is not backing off from a price above the 40 dollar mark, which is scary to market mavens.

I tend to try to anticipate bottoms and tops for optimal index option prices, but when the momentum shifts and sentiment is still a wee bit too bullish, best to go with the flow and check an impulse to start buying calls.

My options sentiment indicator indicates more of a rising bullish bias as prices fell this past week. Maybe traders and investors are becoming more smart and buying areas of perceived value. Perhaps. The market has been in a broad trading range from S&P 500 (SPX) 1140/1150 on the upside to around 1080 on the downside since January. The question is whether the range gets blown.

The Nasdaq Composite (COMP) had been trading 2050/2075 on the upside, 1870/1880 on the downside since earlier in the year - however, COMP has fallen under the low end of this prior range with a weekly close at 1849 - looks maybe headed to the 1800 area as the SOX seems likely to get down to around 400/390 (wkly close: 405.6).

FRIDAY'S TRADING ACTIVITY -

Stocks ended lower on Friday and sharply lower for the week, with the Nasdaq Composite falling to its worst closing level in many months and blue-chip stocks hitting a 2-month low again on concern over slowing corporate earnings growth.

As Larry Wachtel put it (forever the chief market strategist at Prudential, now at Wachovia Securities and someone the Street listens to): "We continue to get an inflow of negative guidance from tech companies as it becomes evident that corporations pulled in their new spending as the second quarter ended".

THE NUMBERS -
In the past week, the Dow and the Nasdaq both fell 1.8% - don't annualize this figure if you own stocks. The S&P 500 Index (SPX) closed 11 points lower, -1%, at 1,086.20. for the week, SPX was off 1.4%. The Dow (INDU) was off 88 points, -0.9%, to 9,962.2, the first time INDU has finished below 10,000 since late-May.

The Nasdaq Composite Index (COMP) was off over 2%, to close at 1849, a loss of 39.9 points. COMP last closed below this level last October.

The Russell 2000 (RUT) as has been typical of the more favored small cap sector, did not fall quite as much as the Composite, as it closed the week at 539, off 1.3%.

THE REPORTS & EARNINGS NEWS -
Microsoft (MSFT) fell over 3% to $28 after the company reported better-than-expected quarterly sales, but fell short of earnings estimates, as investment income declined before a monster dividend payout that is coming up. MSFT also forecast higher- than-expected revenue for 2005 but lower earnings than analysts were expectations. Technically, Microsoft is left with a so- called "island top".

After disappointing news from eBay (EBAY) on Thursday, Internet stocks were hit again when online mega-monster Amazon.com (AMZN) posted Q2 earnings and revenue that missed consensus estimates - - the stock fell nearly 13% to 39.98. The company indicated that its slowdown in sales was due to an unfavorable comparison with the same quarter in 2003, which was then buoyed by exceptional sales of Harry Potter books and some associated products. Blame it on Harry Potter and he is supposed to be a wizard!

On the big board, Coke (KO) was the hardest hit of the Dow 30 components, dropping $3.80, almost 8%, to $45.17- this after its earnings were reported. Analysts noted a volume shortfall in Coca-Cola's German discount channel as a "dangerous long-term challenge," and said a weak start for the company's lower-sugar C2 soft drink was disappointing. Well, I liked it!

Telecom bucked the down trend - Verizon (VZ) was up 2% BellSouth (BLS) was up 1.7% and SBC Communications (SBC) was up 2.7% - this sector benefited after my old company, now UBS brokerage, upgraded the telecom operators on their potential for market share gains in residential local and long distance business after AT&T (T) saying on Thursday it was mostly abandoning those markets.

OTHER MARKETS -
Crude oil ended about one percent higher on the week, so is holding comfortably above $40 a barrel - not a situation to make stock market mavens happy.

Treasury bonds and notes were slightly higher on Friday, but were down on the week, for the first time in several weeks. Expectations remain for a series of Fed rate hikes over the balance of this year

In the Forex market, the euro was down to a 3-week low of $1.2119. Versus the Japanese yen, the dollar moved slightly up to 109.97, after Japanese industry output came out at the lower end of forecasts.

MY INDEX OUTLOOKS -

S&P 500 Index (SPX) & my Up Volume indicator - Daily chart:

Major lows are often made only after a 10-day moving average of daily up volume contracts to a "baseline" area. In the past few months, this has been around 530 million shares - see the level green line in the lower portion of the chart below -

I've highlighted with green up arrows when the NYSE up volume has dipped under this line, and liked it with a price low at or soon after these points - see the "volume average" chart above. By this measure, the market should not be far from a low.

Rather than say more here about the whys and wherefores of this up volume indicator, I wrote more extensively it in my past week's trader's corner article.

Another wrinkle with my up volume indicator is that timely "signals" with this indicator have tended to occur along with bullish sentiment readings, usually within 1-5 days prior to a bottom. This was not the case in the past week as can be seen from the lower Indicator potion of the chart below -

On a price basis, the S&P 500 is approaching the low end of its trading range - a price range that has been fairly consistent this year. However, there are a lot of things out there that can spook investors - among them the fact that in relationship to possible terrorism, everyone is kind of holding their breath ahead of the political conventions and the election.

S&P 100 Index (OEX) - Daily chart:

A key test of prior lows in the 526-530 area looks to be in the offing this week. The last low in the 530 region took a few days to set up - if another low is setting up, this time may be similar. I don't assess there being a lot of selling interest below 525 in the S&P 100 - stay tuned on that.

545 is key overhead resistance, call it 525-526 on the downside. There was a new closing low in OEX. However, I will want to do some index call buying in this area if reached on the basis of my assessment of further downside risk relative to the reward potential of even a moderate rebound. This market is nearing an oversold extreme based on what can be seen with the 14-day Relative Strength Index or RSI level below.

The mid week rally back to touch the 200-day moving average, followed by a quick and steep drop to new lows, was bearish. The buyers are still spooked easily.

Dow 30 Average (INDU) - Daily chart:

The Dow 30 Average (INDU) could fall to the 9800/9775 area if it were to follow its hypothetical trend channel lower per the way I have it highlighted on the chart below. Ability to stay above the prior closing low at 9911 would offer a bullish note based on the possibility of a double bottom.

Even more apparent with the Dow than with the OEX above, we can see how clearly that the last cluster of lows occurred right around the 200-day moving average - with it later defining the opposite condition of selling interest/resistance. Wednesday's rally failed right at the 200-day average, followed by a sharp downside move. Buying interest just collapsed.

10,200 is key overhead resistance, 9900 is key near support. INDU is oversold, almost at the lower line that tends to mark a real extreme. Not to say that the Dow won't sink still lower. A move to under 9900 would likely jump the level of bearish sentiment and this is what we are not yet seeing. Most significant lows see traders more bearish than what I'm seeing with the tools I use.

Nasdaq 100 (NDX) Index - Daily:

1450 continues to look like key resistance, 1367-1370 now looks to be an area of potential support IF the Nas 100 Index (NDX) will continue to trade in the broad range its been in since January. Based on the trading range concept, still the most likely in my mind - I want to be ready to exit NDX puts and do some call buying if further lows are made above 1360 and a bottom appears to be forming.

A couple of closes at new lows would suggest that something different was going on then a broad sideways trend such as the way the charts look now - index options traders have excellent opportunities when a market goes into a broad trading range, as put and call purchase opportunities become well defined.

A broad trading range market is ideal for Index options trading as I've said before - and will say again no doubt! Since its ideal, my focus is to see if another bottom is going to be established shortly and "confirm" this trading range.

Since we all get in and out too soon sometimes, this situation gets more problematic with trade reentry during times of a strong up or down trend as time premiums get rich on the side of the dominant trend. Not so - if we get in too soon at the low/high end of what turns out to be a broad trading range market, trade reentry is still favorable as the chances are we got in near a multiweek extreme.

Nasdaq 100 tracking Stock (QQQ) Daily:

If prices stabilize in the 34 area, or even a bit below, like 33.5/33.75, I want to be in the Q's by owning the stock or the calls. You can look at the QQQ daily chart below and figure that a triple bottom might be setting up. I am still a bit cautious on this score.

Unlike double bottoms, or tops, instances of triple lows or highs are not as reliable a pattern - there is often one more spike down, or up, before there is a meaningful trend change.

One more new low, such as to the 33 area followed by a rebound would suggest covering short positions in the stock and exiting puts - and, suggest a solid buying opportunity for buying the stock or its calls.

If a new closing low set up without a similar lower low in the RSI, a bullish price/oscillator divergence would be established that might also signal a bottom. On balance, I'm prepared to move and take trading action, but also ready to watch how things unfold a while longer.

Good Trading Success!

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