THE BOTTOM LINE:

I spend quite a lot of time looking at my point of view for the market each week as to looking bullish, bearish or mixed. There's no doubt from a technical standpoint that we remain in a bullish pattern but tech looks to be struggling and could be on the verge of a pullback. Technically, you could make a case for shorting it, or remaining long. Take your pick!

What I wonder about is what happens to the market if leadership shifts from tech to some of the more mainstream economy stocks; e.g., consumer, consumer cyclical, etc. I've been looking for a correction given how bullish traders have been. My sentiment indicator on a 5-day basis recently got as high (extreme bullishness) as it's registered since late-2006 after a multiyear run up going back to the 2003 lows. Maybe a little overdone here folks!

I've had the most fun as a technician in years recently when I got back in looking at and tweaking some trading systems I used to play with. If you apply certain 'objective' trading rules mechanically (always the same), we can call it a trading strategy that you take into account. If you use that strategy to generate buy, sell (and maybe) stop-loss orders, that's what I would call a trading system .

Although the terms are used somewhat interchangeably, a system is strictly mechanical so to speak. When you want to 'overlay' a trading 'signal' with a judgment call, then it's no longer a 'system', at least until you do further back testing and development of the trading rules. The idea is that a system takes the emotional component out of the equation. You know, like when the Fed pulls the plug on the economy but you're strategy rules still has you long everything.

TAKE YOUR PICK: be long Calls or Puts.

I've been analyzing the Nasdaq 100 (NDX) intraday history I have (2 years and 9 months currently or 1000 calendar days). I started with the idea of shorting (buying puts) when the 21-period hourly Relative Strength Index (RSI) went BELOW 70 with entry assumed on the close of that hourly bar or period and staying short/long puts until the RSI dipped under 30, but only reversing into calls WHEN the RSI then rose ABOVE 30; i.e., exits puts and buy calls.

My TradeStation software, which is the ultimate in Systems Testing and Development (STAD), is better set up to show a back tested P&L for stock trading, so I was keen to use the QQQQ (NDX) tracking stock. With a stock, I can enter a starting account size, a 'slippage' factor (assumes a fill that is more than or less the point when the signal was generated), and a commission. I could enter a stop-loss trigger also, but didn’t in this run.

I then 'optimized' as to which RSI triggers (which levels) produced the best profit for the 2 year, 9 months of intraday data I had. Lo and behold, I got different trigger levels and different results, in terms of profitability, for the QQQQ NDX tracking stock versus the underlying index. My QQQQ 'RSI system' has me still long or still on a buy 'signal' and the NDX RSI trading system has me short.

Go figure. The ultimate hedge, flip a coin strategy, or use your more emotional or reasoned take on being on one side of the market or standing aside, at least as far as NDX. Some systems traders would stand aside when one system says be long and other to be short as they cancel each other out!! I find it interesting and will follow the outcome, but lean to being in puts for a trade; I have an exiting stop point however; if NDX closes above 1650, I'm out.

I'm just going to go ahead and present these results as they have back tested for the admittedly short period to test a 'system'; I'm going to start keeping up to 5 years of 1-minute data however and continue to try to develop better indicators to share with you.

CHARTS OF THE WEEK:

When I optimized the QQQQ RSI 'system' described on the chart below, I got the 'best' values to use as 72 on the high side and 39 on the low end of the 21-hour RSI. My RSI strategy has me still long the stock or long calls. In this system I'm buying a 100 shares and have seen the system call for buying several hundred shares when a 'signal' in the same direction occurred multiple times. I don't mind price averaging in a strategy, although conventional market strategy suggests not to do that in options or trading futures; i.e., speculative stuff.

I would be long QQQQ in this system described above. Next is the test results of 'applying' this system going back to the first trade on 12/11/06. I started with a theoretical $10,000 but the back testing results suggested I need at least 21,000 to trade this system for the time period given the maximum number of shares bought or shorted at any one time AND the largest loss sustained on an unrealized or realized basis. I also entered a 'slippage' factor of .01 and commission cost of $25.

Results for 12/11/06 to present period are shown below for 142 trades in QQQQ; with one current LONG position still open:

Notice that the percent profitable is 64.8% and that the average losing trade was several hundred more than the average winner. This was ok since there were nearly twice as many winning trades as losing, producing a net gain of $10,578 so far. Not bad for a 2 year 9 month period. The 'maximum intraday drawdown' says that the at one time anyone trading this system was down $21,610 and that up to 2900 shares (not 'contracts') was held at one time by taking multiple positions (pyramiding). So, if you can take the heat of having up to a maximum of 15, count em FIFTEEN, consecutive LOSING trades for the time period tested, this system is a winner.

What I further want to know however, is how the heck the same system idea produced a current SHORT (long puts) in the underlying NDX index and which one is MORE profitable for the period shown as I want to see which system has (PERHAPS) the greater probability of being right on the future direction of NDX and perhaps the market.

The answer to the first question is that I don't know why the following NDX system tested differently, except to say that we know the underlying index is more volatile. The buyers and sellers of the stock are a more 'conservative' lot of investors and hedgers who don't push the stock to the same RSI extremes.

Optimization of the RSI values to trigger a long or short position in the underlying NDX were different that the above QQQQ system; 72 and 39 for QQQQ and 69 and 31 for NDX, in terms of the same 21-hour length setting in the hourly RSI. The really other interesting thing is that the point gains were greater than in QQQQ. However, the true profitability of using the strategy to buy calls and puts can't be figured given all the possibilities of which calls and puts were bought, entry levels, commissions, etc. However, I was primarily interested in the winning percentage and the total (net) point gain in NDX.

The NDX strategy applied below from 12/22/06 to 7/24/09 (with a multiple short position still OPEN) with different RSI 'triggers', had 55 wining trades, versus 21 losers; 72.4% were profitable. The total net NDX point gain to date was 1,197 points, but the account trading this system had to sustain a 'maximum intraday drawdown' of 4,212 points in the underlying index but that was spread across multiple positions; e.g., the strategy had price averaged a number of calls or puts over time during at different periods of time.

Bottom line, the trading strategy system suggesting that we want to be short NDX, assuming you don't mind 'counter-trend' trades, has what looks to be the superior track record.

But I digress in a major way from my usual analysis. Just trying to add some value to what I usually do and keep learning myself as what might be the most predictive of the trend in the way of indicator patterns.

MAJOR STOCK INDEX TECHNICAL COMMENTARIES

S&P 500 (SPX); DAILY CHART:

The S&P has gone into another sideways trend that looks like a consolidation of the prior bullish up trend as long as dips hold above the high end of the previous price range; i.e., in the low 1000 area. So, the chart remains bullish in its pattern and I don't project any resistance before 1070.

If SPX starts retreating under the 1015-1000 area, especially on a closing basis and especially if for more than a single day, then it will look susceptible to a further pullback. It would be normal to see that but the bulls are not letting the bears have that; or those who want to buy/buy more, get 'in' so to speak. Those bulls, selfish to the end.

As far as indicators, the latest highs are not being 'confirmed' by the RSI but that is not uncommon in a strong upside move. Buying is a multiple decision event as people and institutions buy, then buy some more, then buy more still. Buying is not a 1 or 2-time decision, the way emotional scary sell offs can be. This is why 'oversold' readings in terms of the RSI type indicators are less common than 'overbought' readings.

Near support is still indicated around 1015, then down in the 980 area. Near resistance implied by the previously pierced up trendline is intersects in the 1070 area currently.

Upside momentum has slowed since SPX reached a 'minimum' upside objective that I projected back when, but this recent sideways trend is most often part of a natural consolidation process; that's what sideways moves (after an initial spurt higher) are usually about. At what point this 'natural' process of up, consolidation, up, consolidation or minor dip, ends is very hard to predict.

TRADER SENTIMENT:

Speaking of scary, I do find the EXTREME bullishness recently seen on my 'sentiment' indicator above makes me a nervous bull and a bit anxious about being on the same side of the market as the thundering herd here. As I noted in my 'bottom line' comments above, my particular sentiment model hasn't been this high on a 5-day basis since late 2006 after a multiYEAR bull run.

But, the trend is the trend and it's still strongly UP. Myself, I like getting into calls when there's not so much company. I don't like crowds. It tends to make me feel I'm overlooking something when everyone I talk to is bullish. I feel the same way about gold as so many tell me there 'has' to be inflation ahead and bad inflation at that and gold is a (somewhat) sure thing to go up a lot more.

S&P 100 (OEX) INDEX; DAILY CHART

The S&P 100 (OEX) Index chart remains bullish after the decisive upside penetration of its line of prior resistance. OEX hasn't made huge headway since its strong rally from its recent 455 low but this is such a common pattern in trends, a bearish take on the fact that the market isn't quite galloping to the upside isn't warranted. From the lows at 317 just a few months back to 480, it's been quite a run.

I continue to anticipate support on pullbacks to the line of prior highs as this area should now offer support. If there is a couple of consecutive closes below 470, that's a bearish sign for a correction that might push OEX below 455. This would be 'normal' in an advance. A second dip often ends up going under the first corrective downswing. What is 'normal' in THIS market in terms of technical patterns and projections is harder to say given that we've been in such a deep recession and have a long ways to go to get back to sustainable growth.

Recent price resistance has been seen on rallies to 480-483. Next projected resistance above this area is up in the 500 region. Near support should be found around 470, and then I'd assume next support would lie in the area of the prior 455 low.

DOW 30 (INDU) AVERAGE; DAILY CHART:

The chart of the Dow 30 (INDU) is like the S&P: A bullish sideways consolidation after the last spurt higher; pullbacks are mild and hold well above the line of prior highs.

An 'obvious' next target is to the 9800-9820 area at the red down arrow at the previously broken up trendline that has been a rising line of at least minor resistance; i.e., where upside momentum tends to slow.

I don't think that there's much question that we'll see 10,000 again in the not too distant future, probably in the next 4-6 weeks and this will have all the media talking heads in a lather. However, it is true that numbers that are multiples of 10, 100, 1000, depending on the level of the stock or index, often tend to be big deals.

Near support is in the 9400 area, then down in the 9100 area in the area of the prior recent lows. I could keep mentioning the bearish price/RSI divergence at the risk of sounding like a broken record. These kind of divergences may not lead to much in a strong advance. When they do 'forecast' an interim top, you can't predict WHEN. Hey, I want to know when and where; I want to know WHERE it's headed. Best guess for a sort of normal correction is a pullback to the 9300 area; worst case back to 9000.

NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:

The Nasdaq Composite (COMP) has been struggling in this latest rally to gain much traction above the key 2000 level. One key as to whether the bearish RSI and sentiment indicators will prove to be any kind of harbingers for a pullback is whether COMP can stay above 2000 on daily and weekly closing basis.

A 'normal' correction would see the index re-testing prior lows in the 1930 area of COMP or maybe falling under the prior 1930 low, such as to the 1850 area. An currently unexpected stock market correction should bring down the overly optimistic bullish expectations that seem currently built into the market. As is often the case in illness, things get worse before they get better and as certain stimulus money dries up (cars and housing) there may be another economic dip to worry investors.

But let me stick to what we can SEE here and the key thing is that COMP hasn't gained much further traction after the substantial snap back rally from 1930. We have to see how this plays out. A rally FROM the 2000 area, with this a floor of support keeps the bullish chart pattern intact. A break under 2000 suggests a further fall ahead.

It appears that selling could come in again at 2060-2065. Fairly major resistance is noted around 2180 on the daily COMP chart below. Key support as already discussed is in the 2000 area. Next support has to be assumed in the area of the prior 1930 low.

NASDAQ 100 (NDX) DAILY CHART:

The Nasdaq 100 (NDX) chart remains bullish but we have to see how able NDX is to mount a sustained rally above the prior 'breakout' point around 1635. Part of a bullish pattern is the ability to build on each prior rally but NDX was struggling this past week. Of course tech stocks have had the greatest advance and money seems to be naturally shifting to some underexploited stocks in areas that are more mundane than tech.

A close under the 1635 to 1616 levels (under the 21-day moving average) would be mildly bearish if this was more than a 1-day affair. If there's this kind of pullback, the next area that would be a prime re-test of continued buying interest is at the prior lows around 1563. I don't see much downside past 1550 currently however; e.g., it seems unlikely that NDX gets back to 1500.

Overhead resistance is at 1670, then up in the 1750 area.

A continued sideways trend will at least continue to mitigate the recent overbought extreme. A pullback AND a sideways move will bring the RSI down to a more 'neutral' level.

As noted extensively in my initial 'bottom line' commentary, I have one technical strategy that suggests remaining long in the NDX (QQQQ) tracking stock (from 38.7) but suggests a put position in the actual index. Go figure, but it is a mixed bag technically (and fundamentally) so it's not so surprising that there would be differences in forecasting models.

The mixed directional picture suggests risk as far as new call or put buys, while selling inflated call premiums and strategies banking on NDX staying range bound (e.g., between 165o and 1550) could pay off.

RUSSELL 2000 (RUT) DAILY CHART:

There wasn't much sustained headway made by the Russell 2000 (RUT) this past week and highs stopped short of resistance implied by the upper end of its broad uptrend channel.

578-580 is the key near support area, extending to 568. Next pivotal support is around 547, at the prior (down) swing low.

Key resistance is at 590-595. A decisive upside penetration of 595-600 would suggest that a new up leg was underway.

GOOD TRADING SUCCESS!



NOTES ON MY TRADING GUIDELINES AND SUGGESTIONS

CHART MARKINGS:

1. Technical support or areas of likely buying interest and highlighted with green up arrows.

2. Resistance or areas of likely selling interest and notated by the use of red down arrows.

I WRITE ABOUT:

3. Index price areas where I have a bullish bias or interest in buying index calls, selling puts or other bullish strategies.

4. Price levels where I suggest buying index puts or adopting other bearish option strategies.

5. Bullish or Bearish trader sentiment and display the graph of a CBOE daily call to put volume ratio for equities only (CPRATIO) with the S&P 100 (OEX) chart. However, this indicator pertains to the market as a whole, not just OEX. I divide calls BY puts rather than the reverse (i.e., the put/call ratio). In my indicator a LOW reading is bullish and a HIGH reading bearish, consistent with other overbought/oversold indicators.

Trading suggestions are based on Index levels, not a specific option (month and strike price) and entry price for that option. My outlook often focuses on the intermediate-term trend (next few weeks) rather than the next several days of the short-term trend.

Having at least 3-4 weeks to expiration tends to be my guideline for trade entry choice. I attempt to pick only what I consider to be 'high-potential' trades; e.g., a defined risk point would equal in points only 1/3 or less of the index price target.

I tend to favor At The Money (ATM), In The Money (ITM) or only slightly Out of The Money (OTM) strike prices so that premium levels are not as cheap as would otherwise be the case, which helps in not overtrading an account. Exit or stop points, as well as projected profitable index price targets, are based on my technical analysis of the underlying indexes.