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Market Wrap

Dipster to the Rescue (Again)

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The double dip over the past few days has meant a double opportunity to buy the dip. The first attempt at buying the dip on Thursday and Friday morning of last week did not work so well for the dipsters as the sell off on Friday and yesterday took the market to new lows below Thursday's. But that new low looks to have been an even better buying opportunity. The first 5-min DOW candle today was a screamer (as in it got the bears to scream and jump out the window). Just when the bears thought they had this one made, along comes a few well timed buy programs and that's all she needed.

I (Keene Little) will be filling in for Jim tonight so I thought it would be a good idea to follow up on what I presented last Wednesday. I went out on a limb and called a market top as of that day's high so we'll review that call and see if I'm still hanging out on that limb. Short answer is yes but I sure don't like the bull who has climbed the ladder and is sawing on my limb. I'll review some important levels that will tell us where the bulls vs. the bears rule the playing field.

As for today we had a very nice rally. When I saw a huge 5-min candle on the DOW as the first candle of the day I had to wonder what the great piece of news was that got everyone all excited. As usual it wasn't anything in particular but instead a big buy program that got the bears running and then just the usual relentless buying we've seen so often during this rally. Was it too much too fast again? Only tomorrow will answer that question but this has been one heck of a yo-yo market in the past week.

Helping volatility this week is of course the fact that we're in opex. The squaring of February options positions can exaggerate price movement as traders get caught on the wrong side of an expiring position or the desire to take profits before the market reverses again. That's why follow through during opex is sometimes missing.

Another possibility is Bernanke's meeting with Congress tomorrow. Did the Fed inject a little extra "happy money" into the market today to make sure there's plenty of liquidity to handle any potential disappointments tomorrow? It's always possible since they've been more than happy to make lots of money. But it would probably be more effective tomorrow during his talk. What better way to show the market's support than to have it rally. Speaking of money, another reason we could be seeing some liquidity being injected this week is because the Fed was relatively quiet the past two weeks. As the calculated M3 money supply chart shows, the total money supply actually dipped last week:

Calculated M3 Money Supply, Weekly chart, courtesy nowandfutures.com

The rate of change (light blue line) is down from the beginning of the month, as is M3. The market pulled back from last week's high and now it'll be interesting to see what this chart looks like at the end of the week (it's updated at the end of the day on Fridays). If we see a big jump in M3 for the week then today's rally will have been a likely result of all that new money coming in. Can't fight the Fed. Also, when you think about how much trouble some banks are having with bad loans, it's quite possible we'll see the Fed continue its hyperactive (not to mention hyperinflationary) money creation.

I had mentioned last week that the high counted out well from an EW (Elliott Wave) perspective for the end of the rally from July. While that's still a possibility the kind of pullback we've had since then and now today's strong rally puts that top in question. We'll simply let price show us the way but take note of the make-or-break levels on the charts that will clue us to where price could be heading next.

I had mentioned the Fed could be goosing the money system out of concern for the health of some of our banks. The Fed well knows how vulnerable the system is to a financial crisis and they will pull out the stops and do everything they can to protect it. The Fed believes it is very powerful in this regard and has a lot of tools at its disposal. Some of the rumblings we're hearing, and which could cause some stress to our financial system, is coming from the mortgage banks.

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Filling the news recently are stories about the subprime lenders and the difficulties they're having. HSBC Holdings (HSBC), the UK bank that had decided to get involved in the riskier subprime lending business in the U.S. (chasing higher yields like the rest of us) is probably not happy it decided to get into that business. HSBC shocked the financial markets with an unprecedented statement about their expectation for a major hit to their earnings. They announced they had to set aside nearly $1.8B for bad debts associated with the subprime market in the U.S. after borrowers defaulted on their loans.

New Century Financial (NEW) has been cut almost in half this year due to its warning that it will need to place more money in reserves for bad loans, primarily for its subprime mortgages. This is money that comes straight off the bottom line so investors didn't like that bit of bad news. Today ResMAE announced that it would be selling most of its assets to Swiss bank Credit Suisse (CS). This was trigged by Merrill Lynch (MER) demanding ResMAE repurchase more than $300M worth of loans that MER no longer wanted on its books. This caused ResMAE to default as it was unable to buy the loans back. This follows news that Lehman Brothers (LEH) had to bail out Mortgage Lenders Network USA. Many banks are being forced to repurchase the loan packages they sold to other investors so as to remove the risk of the subprime loans. That places the risk back on the banks' books.

What this all tells us is that even the major banks are at risk here and may be next in announcing some earnings disappointments related to all these bad loans. And as we know, the health of the banking industry is an important signal to watch. The banking index (BIX) topped in December whereas the broader market kept rallying in January and February. But the recent price pattern has me thinking a little more bullishly here and is another reason I think that bull is sawing at the limb I'm hanging out on. Since we're talking about the banks, and they're a good proxy for the broader market, here's its chart:

BIX banking index, Daily chart

The fact that the pullback from the December high found support at its uptrend line and then rallied back above its 50-dma, and found support there on Friday, this is a bullish looking chart. I've left the bearish wave count on there because it's still entirely possible that the bounce off the January low is nothing more than a 2nd wave correction. But after the pullback from last week's high and the rally off Friday's low, there are some bullish things here. The "break" level for the bearish wave count is a new high so any rally above 412 could see this index rally back up to the top of the channel near 423 and take us into March. It's also possible we'll only see a double top with lots of bearish divergences so we'll watch this one closely.

Today was quiet from an economic report perspective. The only major report was the Trade Balance which came in at -$61.2B vs. the prior -$58.1B and slightly more than expected. But there was no surprise and no reaction. Tomorrow will be a lot busier with economic reports and Bernanke's discussion in front of the Congressional Banking Committee so the market will have more to chew on and cogitate about what it's next move should be.

Interestingly, today got a big rally but it was in the face of expectations that Bernanke will only make official what we've been hearing consistently from other Fed heads, namely that interest rates stand a better chance of rising than anything else. For a market that rallied so strongly the past 7 months on expectations for a rate decrease one would think this would be damaging to the bulls' psyche. But then you'd be trying to use logic if you thought that. This truly is a market that has its cake and is eating it too. The market remains in lala land.

So let's get to some charts and see what the past few days are telling us.

DOW chart, Daily

The DOW gave us a brief head fake break again below the trend line along the lows since November. This is the bottom of its ascending wedge and a break of that line would signify that a top has been found. It takes a break below the 12431 low on January 26th to confirm it so until then the bulls rule and they showed their stuff today (either that or the bears showed their lack of conviction and screamed like little children running away from the bad bull). We've got mixed signal right here--stochastics heading down out of overbought and RSI back above the 50 line and heading up. But that long-running bearish divergence on RSI will soon catch up with this market. The question tonight is whether we'll get another price high with yet another bearishly divergent RSI. Any rally back above 12675 would put us on a bullish path.

DOW chart, 60-min

After last Wednesday's high I had shown an EW count that called the rally complete. The trouble is the ascending wedge that we've been in has several alternative ways to label it (due to its choppy 3-wave price action inside the wedge). This leaves us susceptible to continued whipsaw price action and it's why I identify price levels where a bearish vs. bullish wave count is confirmed or negated. I'll call these key levels for the market or make-or-break price levels. This 60-min chart shows this and while it's a little confusing with two different wave counts on it (bullish in green and bearish in red) it shows the important levels for the counts.

With the strong sell off to last Thursday's low, the strong rally, strong sell off on Friday and then strong rally again today, other than making us seasick, it gives us two equally potential wave counts. The bearish one says we've had a sequence I'll call the 1-2, 1-2 setup. We got a 1st wave down, 2nd wave bounce and then started the 3rd wave down on Friday. Within that 3rd wave (which will be a 5-wave move) we got the 1st wave down and today a 2nd wave bounce. That potentially sets us up for a very bearish 3rd of the 3rd wave down. I call these the screamer waves since if that's what's going to play out we will probably see DOW 12400 in a heartbeat.

But if the down-up-down sequence that played out to yesterday's low is instead just an a-b-c pullback from last week's high then that's a correction to the rally and not the start of something bigger to the downside. That's why 12675 is important--any rally back above that will leave that a-b-c move in place and strongly suggest we have not seen the highs for the market yet. In that case the green wave count says we need to look for at least another 3-wave move up to probably above 12800 (I've got some Fibs pointing to 12820-12844) and very likely take us into March. Tomorrow could be critical in letting us know which of these scenarios is playing out.

SPX chart, Weekly

As I did with the SPX charts last week, I'll start with the weekly chart to keep things in perspective and to keep the bigger picture in mind as to where we are. As a reminder, the 1455 level that's identified on the chart is where SPX would have two equal legs up from October 2002, a big A-B-C correction to the 2000-2002 decline. It missed getting tagged last week by about 2 points so perhaps there's some unfinished business there.

SPX chart, Daily

This daily chart is a little busy with all the potential wave counts and scenarios but again pay attention to the key levels--identified on the chart as 1453 and 1417. Any rally above 1455 would likely have us on a path up towards 1465-1475. It probably would not be a smooth ride up to that level but instead one that takes a couple of weeks chopping up and down and being very difficult to trade (like the past couple of months). If on the other hand SPX breaks below 1417 then that would be a confirmed break down out of its ascending wedge, which indicate the top has already been made.

Like the DOW, if we see SPX head for a new high, it will probably be met with RSI divergence again as shown on the chart. This divergence, as price has chopped higher inside its ascending wedge, is the confirmation of the bearish interpretation of this pattern. It is by no means fool proof and as we've seen since October these divergences can go on and on. That's why it takes a break below 1417 to confirm it's finished. Until that happens it remains a risk for those who are trying to find a top by nibbling on shorts (I'm guilty).

SPX chart, 60-min

Zooming in closer with the 60-min chart shows a similar setup to the DOW's 60-min chart. Once again the critical level is the last high near 1453--any rally above that puts us on the bullish wave count. Notice by the way where SPX stopped today--right at the shelf of support for last week's lows before falling off the cliff. Support turned resistance? We'll know tomorrow.

I show a key level down at 1431 which would be a break below Monday's low. While that move down could simply turn into a larger corrective pullback, and would therefore become part of a new potential bullish wave count, the preferred count would be the bearish one that would call for a bigger and faster decline. At a closing price of 1444 SPX is near the middle of these key levels and it could literally go anywhere in between and not mean a hill of beans as to what's next. We need a break of one of the key levels to tell us which direction we want to trade. In the meantime be careful of continued whipsaws, especially this being opex week.

Nasdaq-100 (NDX) chart, Daily

Due to price candles getting squashed together, because of all the tight price action over the past couple of weeks, I've expanded the chart just a little from the one I showed last week. It doesn't show the price action from the July low but we really only need to concentrate on what's happening right now. There are two trend lines that traders seem to be using at the moment--the uptrend line from July and the one from March 2003 through the April 2005 low. Currently price is threatening to break the July uptrend line but right below that one is the March 2003 trend line, which has been supporting pullbacks since NDX got back above it in October. A break of these trend lines, with confirmation by a break below 1763 would confirm that the January 16 high was the end of the rally. Until that happens a rally back above 1820 would suggest we'll see the techs continue their rally into March at least.

Nasdaq-100 (NDX) chart, 60-min

I'm showing on this 60-min chart trend line resistance and a Fib cluster around 1794-1796 to watch for resistance if this continues its bounce into Wednesday/Thursday. After the steep decline from Friday's high I'm expecting to see a corrective bounce that then leads to another stronger leg down, the one that should easily break below 1763. After a bounce, any move to a new low below 1774 should be a heads up that 1763 is next. Otherwise, a push back above 1810 would likely be a heads up that 1820 will be broken to the upside next. In between we could see a lot of chop. However, I like the setup for shorting the bounce.

Russell-2000 (RUT) chart, Daily

Sorry for the messy chart here. It's hard to squish all the trend lines, wave counts and nomenclature on there without obliterating price action. I show the key level for the bearish wave count as a break below the uptrend line from July, currently near 792 which is where the 50-dma is also located. A drop below yesterday's low would certainly be short term bearish but it wouldn't negate the bullish wave count until we get the trend line break

Russell-2000 (RUT) chart, 60-min

I show price broke down from an ascending wedge on this 60-min chart. If that's the correct pattern interpretation, with the 5th and final wave up to last week's high, then it would be typical to see a relatively fast retracement of that wedge--so a decline to 780 in a quick move. A drop below 802 could usher in a lot of selling. Then watch for support at the uptrend line since we'd only have a 3-wave pullback at that point which could lead to another run to new highs (have I mentioned the bears need that trend line to break?).

The bullish wave count depends on a break above its last high near 817. In that case the first upside target would be just under 822. We'd probably have a pullback from there and then we can look at other more bullish possibilities (such as another upside Fib target near 845 with a rally into March).

SMH semiconductor holder (ETF), Daily chart

The semis are a mess, just a choppy ugly going nowhere mess. This index needs to break out of its range (33-35.50) before I'd suggest anything here. A break of uptrend and downtrend lines has not resulted in any follow through and therefore not worth considering. Need to wait (still) on this one.

I showed the banks above and while they look like they could give us yet another high, I'm not so sure about that possibility for the brokers. I've often mentioned the importance of Mother Merrill (MER) which many traders watch. If MER is diverging with the broader market many traders will fade the broader market. In other words, follow Mother. So watch the broker index is important for potential heads up as to what's coming.

Broker/Dealer index (XBD), Daily chart

I've got an EW count that calls the double top in January as the end of the rally from July. Now the break of the uptrend line from September is another heads up that the rally has topped out. The 50-dma is currently providing support, and watch for a retest of the broken uptrend line, currently near its 10-dma at 252, to see if gives a kiss goodbye (good shorting opportunity if that happens). A bounce followed by a break below the 50-dma would likely set off sell alarms in institutions' computers.

U.S. Home Construction Index chart, DJUSHB, Daily

The home builders have pulled back sharply the past week. All of a sudden we're seeing another dashing of the hope that the builders' CEOs were wrong in their bearish assessment. I had shown a weekly chart last week to show that the rally from July in nothing more than a bear market rally, a bear flag. Analysts have been all bullish about this rally because of the recovery off the low but it has so far only retraced a little more than 38% of the drop from the July 2005 top. It also met the first Fib projection for the 2nd a-b-c move up in the a-b-c-x-a-b-c double zigzag correction for wave-(b). The significance of this wave count is that we're due a strong wave-(c) down which will take the index to much lower levels before the correction to the housing bubble is finished.

Oil Index chart, Daily

After retracing 62% of the drop from December it looks like oil stocks are ready to head lower again. Right now price is ping-ponging between the 20 and 50-dma's and then the 200-dma is just below. If price breaks below the 200-dma at 615 I suspect it will also break its uptrend line.

Oil chart, March contract, Daily

Oil looks ready to roll back over as well. The down-channel still looks intact and as long as oil holds below $60 we could see it head back down towards $45. The real test would another test of $50 if it were to get back down there.

Transportation Index chart, TRAN, Daily

The Trannies had a bullish day and ran right back up to the May 2006 high. They'll need to keep rallying this index to prevent another test with another bearish divergence. That would not be a good thing. If this can get above 5013 and then use this level for support then there's lots of blue sky above.

U.S. Dollar chart, Daily

The US dollar looks like it could be in a bullish consolidation pattern just beneath layers of resistance. Any rally above 85.50 would be considered a breakout by the dollar. But any further drop from here would be a break of its uptrend line and potentially bearish.

Gold chart, April contract, Daily

Gold has retraced 50% of the drop from May but if it can continue to push a little higher to a 62% retracement at 693, that's also the level where the rally from October would have two equal legs up. I'd look to take profits on gold there and even consider shorting the shiny metal since it's possible gold is due another leg down like the first one from May.

Results of today's economic reports and tomorrow's reports include the following:

Tomorrow will be a little busier for economic reports although there's not much there that should be market moving. If retail sales come in disappointingly low that could cause some heartburn but I think most will simply be waiting to see what Bernanke has to say.

If the Fed is a little worried about how the market may react to what he has to say they could be ready with lots of cash to shove into the market. But basically you have to wonder if today's rally was in anticipation that Bernanke is going to say something market friendly. Most of the Fed heads have been out in the last week prepping the market for what they're about to hear so there shouldn't be any surprises. In fact we've often seen the market disappointed by what he has to say.

That raises the possibility that today's rally was done so that it has some "head room" for some selling tomorrow. That's all speculation of course but we've seen this happen more often than we can count--rally into a news event and then sell the news. Watch for that possibility on Wednesday or Thursday.

This is of course opex week and that means moves could continue to be exaggerated and not necessarily mean much in the larger pattern. I provided some price levels in the major indices to keep your eye on so that we'll have some better clues as to what this market is up (or down) to. It's been a volatile past few days and many traders are getting whipped silly. Both sides are currently frustrated in not keeping money they had in their trades. Frustrated traders make for error-prone traders so keep calm, watch the important levels and then try to trade with the direction those breaks tell us to trade.

I'll be back here tomorrow night and hopefully tomorrow's price action will give us a few more clues as to which EW count is floating to the top. In the meantime, trade light and quick and don't be afraid to take profits when offered. If you're not day trading and looking for a swing entry it looks like we need some additional price action before you'll be able to more confidently put on a trade. Either that or you can pick a direction and then use the key levels I identified on the charts to help you manage the trade.

Good luck and I'll see some of you on the Market Monitor tomorrow and back here tomorrow night.
 

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