Option Investor
Market Wrap

Never, ever trust a central bank in a foreign country with it's currency under attack.

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       WE 1-15           WE 1-08         WE 12-31         WE 12-25
DOW     9340.55 -302.77  9643.32 +461.89  9183.43 - 36.56  +342.17  
Nasdaq  2348.20 +  3.79  2344.41 +152.22  2192.60 + 29.52  +119.15  
S&P-100  616.46 - 19.56   636.02 + 32.08   604.03 -  3.91  + 25.30  
S&P-500 1243.26 - 31.43  1275.09 + 45.93  1229.23 +  4.15  + 46.31  
RUT      427.05 -  4.18   431.23 +  9.27   421.96 + 16.42  + 11.78  
TRAN    3148.53 -211.75  3360.28 +210.97  3149.31 +108.48  + 73.44  
VIX       29.75            23.88            25.41            22.04
Put/Call    .56              .48              .55              .52

Never, ever trust a central bank in a foreign country with it's currency under attack.

Remember the vow from the central bank in Brazil on Thursday? "We will utilize every reserve at our disposal to prevent the disastrous floating of the Real". I guess their reserves were as limited as my wife's checking account since less twelve hours later they announced they would float the Real on a temporary basis in order to protect their reserves. Sounds like a contradiction to me. So why did the markets rebound instead of crash as analysts had predicted?

Ask ten analysts and you will get ten different answers but the two most common are "it took a level of uncertainty out of the market" and "relief that the free market forces would now determine the level of the Real and not artificial stability enforced by the government". The first one makes no sense at all. On Thursday the Dow crashed -228 points on worries that Brazil MIGHT float. So on Friday they floated and because there was no uncertainty left the market exploded? Lost me there. The second reason make much more sense. Brazil has been fighting the flight of funds from the country by raising interest rates to a crushing 40% or more. How would you like to have that kind of credit card interest? How can a country survive paying 40% on it's debt? It can't, not for long. The relief shown in Brazil markets was immediate and huge. The Bovespa surged +1,690 points or +33.41%. That would be the equivalent of +3,123 point Dow day. (please, please, just let me be fully invested the night before!!) I bet they are still celebrating in Brazil today. Yes their money is worth less but now they can at least keep more of it. The remaining problem is with Chile, Argentina, and the other closely linked South American countries. They will be watching the Real and if it sinks fast then they will be forced to devalue as well. The dominos are already lining up. All eyes will be on the support given to Brazil by the U.S. and the IMF in the coming weeks to see if the Real can stand on it's own or become a blackhole, sucking everyone in South America down with it.

Now back to our reality. The market, for whatever reason, exploded Friday, the day before a long weekend, when it should have been cautious. Remember the oversold conditions we talked about on Thursday. The rubber band analogy I used last week on the +500 point gain also works on a -500 point loss. When markets get stretched so tight either way there has to be a relief day where things snap back to normal. We experienced that Friday. I have been preaching the return of the January bull market rally after the profit taking for over a week. Surprise, it is back! Those of you who bought the dip on Thursday are looking pretty smart today.

The Nasdaq actually finished up for the week! Tech stocks rebounded strong and were really not supported by the Internet stocks. Some Internets were up Friday but the majors were still taking profits. Speaking of major Internet stocks, we are starting YHOO again today for the split run. Yahoo dropped -98 points in the last four days but closed +$13 off it's Friday lows. The 2:1 split is Friday Feb 5th, only three weeks away. We know the Internets have had several downgrades in the last week but they were only downgraded on price, not performance. Those of you who have the ability to trade YHOO should look for an entry point this week. Don't blindly jump in on Tuesday. Confirm lack of downward movement first.

We had a conference at the office here last week with many of the newsletter contributors coming in from all over the U.S. We were planning the first Option Investor Seminar in February. (details below) What really came out of the planning process was the need to educate traders on "trend trading" (not trend holding) and setting profit goals. While all this will be discussed in detail at the seminar there is a real need based on the email we get to touch on some of the concepts here.

Let me try an analogy for trend trading. The market is like the waves on the ocean. If you are standing on one of the major surfing beaches you will see wave after wave come crashing through. Between each major wave is a period of calm which may have several smaller waves. If you have ever stood in the surf you are familiar with the sensation called undertow. This is when the water rushes back out to sea in preparation for the next wave. Now picture yourself with a desire to surf. You have seen people do it. You go to a surfboard shop and buy a board. You ask the salesman if surfing is hard. No problem, he says. Lay on the board, swim out in the surf, catch a wave, stand up on the board and surf back in. Easy! Now I ask you, can you surf? If you are like most beginner surfers you get out to the waves but now you feel more like a piece of driftwood bobbing in an endless sea than a human mastering the art of surfing. You are battered, soaked, tired and more likely then not pretty frustrated with being abused by every wave you tried to catch. Options trading is like surfing. Trading, the salesman says, is easy. You just open an account, (board), jump in the market (ocean), catch a wave (stock), buy some calls (surf), and end up safely on the beach (profit). NOT! Most beginning traders think it is this easy. Most end up on the rocks (broke).

What we want to teach you is to be a successful trader, not a buy and holder. When you are learning to surf you probably practice on hundreds of smaller waves. Each one moving you only a few yards before you fall and have to start over. Learning how to trade is the same way. You should try to catch many small moves and practice improving your skills before attempting the long run to the beach. I am constantly besieged by email on new people expecting to buy a $3 option and sell it for $15. That would be the equivalent of swimming half a mile off shore, catching a fifty foot wave and surfing all the way to the beach on your first try. It just does not happen. What we have tried to teach people in the past it to take a small profit many times instead of a large profit once.

For those that are mathematically challenged let me illustrate. If you start with a $10,000 account and generate a 10% profit every week for a year, WITHOUT COMPOUNDING, after twelve months you would have over $60,000. If you COMPOUND the 10% then you would have over $1,000,000. At just 10% a week! Now before you start firing off those emails I know you can't compound 10% every week. First you may hit some losers now and then but you are also going to hit some bigger winners more often. Just to illustrate. If you bought an option for $5.00 and sold it for $5.50 that is a 10% profit. Now how many times have you bought an option and watched it go up $1-$2 and then slip back down again the next day? More often than not! Now, if you had put in a sell for $6.00 that is a 20% profit and probably would fill the same day. If you did that twice a week, how much would that be a week. CLUE 40% Now if you could get only 10% or $.50 per week compounded over a year it would be over $1,000,000. Is $.50 hard to do over and over and over? Of course not. Is 40% possible? absolutely. The real number is somewhere in between.

It is only hard to do if you HOLD and not TRADE. How far are you going to get if you just hold on to your surf board with both hands for dear life? You will be pushed to and fro wherever the ocean (market) takes you. Sometimes you will be pushed to the beach (profit) or onto the rocks (broke) or drift out to sea never to be seen again. (clueless)

Now that I have completely lost my train of thought let's get to the point. Every stock ebbs and flows. Remember the 3-5-7 trend cycle from last week? Up three days, down one, up five days, down three, up seven days, down five. Every stock will normally trade in one of these cycles. The trick is to buy the stock on the down side and sell it on the up side. Again, you do not have to be in the market every day. It is better to only be in the market WHEN THERE IS PROFIT TO BE MADE. Everything else is noise. Sometimes expensive noise. Learn to play the trends. Watch a stock for several days. Study the charts. Watch the intraday charts. Learn how it moves. I traded TXN early last year for a month. It would always jump up at the open, wander during the day and drop at the close. For weeks I would sell at the open for a $.50 to $1.00 profit and then buy the same option back at the close for almost what I had paid for it the day before. Day in and day out. Cash flow. 10% a day. (don't even bother to compound that) In this current bull market there are many, many stocks that you can make 10% or more a day just trading the trends. The larger your account becomes the easier it gets. You can start taking 5% a day. For instance, look at a CSCO chart or an ASND. Can you see any way possible to not have made a $1.00 a day, two or three days a week, just trading those stocks?

The positive trend is the key. Find a stock with a trend, pick an option, WAIT for an entry point, set a limit sell. Repeat, repeat, repeat, repeat......

I want 10 volunteers. Pick a stock or two, practice the above plan and send me your results. I will publish the results and give each of you a years free subscription. Obviously I will have 15,000 emails tomorrow volunteering and I can't take you all. The first 10 with verifiable results will qualify. It does not matter whether you trade one contract or one hundred. The key is the pattern. No fair using past results. All trades must be after today. Trade confirmations must be available.

When I publish these results you will never look at a mutual fund claiming a 25% annual return again. How can they brag about beating the S&P!! I would be embarrassed.

I have not seen any earth shaking economic news so far this weekend and the Fed does not meet again till February so I would expect the rally we had Friday to continue next week. I am excited and you should be also. Earnings are starting to flow and we have many split candidates in the next 2-3 weeks. This is the perfect time to be in the market. If you don't profit from it you should be in mutual funds.

Good Luck

Jim Brown
Editor

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