Option Investor
Market Wrap

Die Hard XX

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The bulls are putting on their best Bruce Willis impersonation here. What they don't realize is that they're key players in "Sixth Sense". For those who didn't see that movie (which was outstanding), the bulls may not be seeing that they're already dead. OK, I exaggerate a smidge. It's probably the bears who think there's no life after death.

The other title I thought about for tonight's Wrap was "Belay My Last". For those who've served in the US Navy you'll remember that phrase to mean "ignore what I just said." Last Wednesday I called a top to the market, or at least I said it was a great setup for a top, and that you should be short the market against last Wednesday's highs. The DOW climbed above that high this afternoon and thereby negated the bearish setup on that index. Such is the life of one who tries to pick tops and bottoms.

Am I discouraged in all this? Yes and no. It's certainly been an exercise in frustration trying to find a top in what is turning out to be a blow-off top. These kinds of moves happen very infrequently and it's not something you can plan on happening. Clearly the best strategy has been to hold on and let the market tell you when it's done (by breaking below uptrend lines or important moving averages. The hard part in waiting for the break down is chasing a market lower after a support level is broken. We've all seen many times a head fake break only to be followed by another jam higher which spooks the shorts.

This is why my preference remains finding a setup that looks good for a top (or bottom in a decline). It enables me to have a clearly defined, and usually tight, stop level. The environment we're in has made that particularly challenging but it's been very successful for me over the years (by staying disciplined and stopping out as soon as the setup is busted--don't fight the tape). Whether I trade intraday or looking for a position trade on the daily/weekly charts, the technique is exactly the same. The difference obviously is where stops are placed and therefore how much I'll risk per trade.

For this newsletter I'm attempting to find swing/position trades because I know many of you trade option strategies that are not intraday trading and many of you don't stay glued to your screen during the day. Therefore, considering how risky I think the market is to the upside it has been my preference to look for potential tops rather than how to set you up for a long play. Intraday it's a completely different story but that's because day traders can jump out a lot more quickly. In my Market Monitor updates I often switch sides and recommend long trades. I'm less comfortable doing that in a once-a-week update.

So, the DOW has busted the bearish setup from last week but so far is the only index to have done so. The interesting thing here is that the DOW was the only index to spike to a new high last Thursday but was not followed by any of the other indices. Will it happen again? If the market sells off right away on Thursday then it will leave the DOW with a non-confirmation from the other indices. It's something to be aware of for tomorrow.

That means the bearish setups discussed last week and in the weekend Wrap still stand for the other indices. But it also means the market must sell off immediately Thursday morning. If it even hints of heading higher by going sideways then it's very likely the others will follow the DOW to new highs.

I had a lot of work to do to get charts updated for tonight in order to show the bullish potential and therefore I'm not going to spend a lot of time on other things--I'd rather get through the charts and be sure you know how the picture has potentially changed from what I presented over the weekend. But first, today's economic reports:

Economic reports

The only economic reports today were Crude Inventories and the FOMC minutes. There was no significant change to oil inventories and prices are still too high. Any questions?

The FOMC report had nothing new or unexpected so the market rallied. Any questions?

And with that exhaustive review of today's economic reports let's get to the charts. At the end of the report I'll talk about a few interesting numbers (interesting to me anyway) about dates and levels to watch in trying to determine what this market is up to.

Starting with the DOW's daily chart, even though you can barely see the new high, the short term pattern of the move up supports the idea that we'll see a little higher before either topping sooner rather than later (in a week or so) or is just the start of a larger move up.

DOW chart, Daily

Price action has been choppy and unfortunately that opens up several possibilities for what is playing out here. It could literally go either way from here and a rally or decline of 100 points could mean very little before we see a complete reversal of the move. That tells me that you shouldn't be looking for any big moves for at least another week. Price could consolidate sideways for another week, it could chop directly higher from here or it could first pull back to near 13400 before heading higher again.

Upside Fib projections for the 5th wave up, if that's what we have ahead of us, is first to 13726 and then basically 14K. If the DOW makes it to 14K, with so many calling for it, would likely be met with a lot of selling since that would meet the objective of so many analysts. But because so many are calling for it I have to wonder what the chances are that it'll happen. From a contrarian sense I don't think we'll see it but the bulls have proven me wrong once or twice before.

The bearish thing I see, and this is consistent across the board, is the bearish divergence at new price highs, something that's been true since the early May high. But we saw the same bearish divergence run for a few months into the February high. Getting in a little closer I'm going to use two separate 60-min charts to show some bullish potential.

DOW chart, 60-min, immediately bullish

I call this one immediately bullish because it's based on expectations that we'll see a choppy move higher that forms an ascending wedge. The reason it would likely form an ascending wedge is because of the way the rally started correctively (3-wave move). That's usually a good sign that this kind of pattern will develop. It's also a very common pattern for the last leg up after a long bullish run. It gets very choppy because more distribution starts to make it more difficult for the bulls to keep the rally alive.

And then when the selling becomes too much then the break down happens quickly and the entire wedge gets retraced quickly. I show a Fib projection to 13777 which is based on the 5th wave making it up to 62% of the 1st wave in the rally off the March low. This is also very typical for a 5th wave in an ascending wedge (ending diagonal). It takes a break below 13450 to negate this pattern.

This other chart shows some kind of pullback/consolidation before it rallies higher.

DOW chart, 60-min, bullish after pullback/consolidation

There are two possibilities presented here--the first is a harder decline to a new low below last week's that finds support above 13300. That would be an A-B-C pullback for a 4th wave correction before the rally in the 5th wave kicks into gear. This would suggest we'd see a rally into the end of June.

The other possibility is more of a sideways consolidation, as depicted in a sideways triangle. It's very common to see these 4th wave triangles as it signifies we're near the end of a run. This pattern says we'll chop sideways into next week and then rally out of it. The completion of the rally in this case could coincide with another bullish opex week (Friday June 18th).

Some of the numbers I'll review at the end support the idea that we could rally into mid month to finish off this rally so stay aware of this possibility.

SPX chart, Daily

SPX came within 2 points of exceeding last week's high. That's why the market must sell off immediately on Thursday if it's to maintain the possibility for a bearish resolution here. Don't hold your breath. Of course if another nasty surprise comes out of Asia overnight then one never knows how we'll open in the morning.

If the bulls can keep this going then upside Fib projections are to 1552 (coincidently at the March 2000 intraday high?) and then 1580 above that. A break below 1500 could be trouble but really not until a break of the May 10th low near 1491.

SPX chart, 60-min, potential triangle consolidation

I show the bearish wave count on the 60-min chart but obviously it needs to hustle to the downside immediately on Thursday otherwise the bearish setup will be busted on this one along with the DOW. Otherwise I think we'll get a sideways triangle consolidation as shown. From there we'd be due another rally in the final 5th wave.

I show the retracement levels for last week's decline but what I really wanted to show here is the Fib projection from that decline (those Fib levels above last week's high). It's very common to see price move to the 162% projection of the previous move and that's at 1549, very close to the 1552 Fib projection I showed on the daily chart (which is where the 5th wave = 62% of the 1st wave in the move up from March).

One thing I like to look for are fractal patterns. This is basically what EW patterns are so it's a common "exercise" I go through. The following two charts is an attempt to show one that points us higher.

SPX chart, 60-min, first fractal pattern

This shows price action from the firs high put in on May 4th. After that high we got some choppy price action to a minor new high followed by a steep sell off. That sell off was then followed by a continuation of the rally to the high labeled wave-(3) at the top right on May 21st. Also notice the pattern of the rally off the May 10th low and how it chopped its way higher at first and then took off from May 16th. Now look at the next chart of the past week:

SPX chart, 60-min, second fractal pattern

It's a little distorted in size but has the same general shape as the pattern in the chart above--the high on May 21st was followed by some choppy price action to a minor high which was followed by a steep sell off. That sell off has now been followed by a continuation higher. After initially choppy its way higher from last Thursday low it shot higher today. This is playing out just like it did earlier this month and the last time price made it a little higher than the 162% projection shown on this chart to 1549. A little higher might mean the same 1552 projection as on the daily chart.

So based on what I see now, and until I see something that changes this picture, I'm leaning towards seeing SPX rally up to the 1552 area. It would certainly make a good swing trade to the long side and I'd normally recommend it. But in this case, since it's the final 5th wave up that I'm looking for, which are notoriously unreliable, it would be a very risky play to get 20 SPX points. The downside risk is higher I believe. But if the SPX does manage to rally up there I'll be once again looking to nab the top.

This next 60-min chart of SPX is to show the more immediately bullish possibility that ties in with the fractal pattern I just reviewed above:

SPX chart, 60-min, potential bullish ascending wedge

Similar to the ascending wedge idea that I showed for the DOW, this shows SPX rallying up underneath its broken uptrend line from March, with the uptrend line from today's low pinching it into the apex. If I could get my wish as to how this rally will end, this is it. This would be one of the best short play setups I could ask for so if you see it play out this way over the next week or so, get yourself ready to try shorting it again. But not yet.

Nasdaq-100 (NDX) chart, Daily

The techs remain confusing to me and I can't quite figure out if they're getting ready to be more bullish or if they'll continue to be a drag on the market. The techs have been underperforming the blue chips and I expect that to continue. Based on that I think price will chop a little higher but probably not much, as depicted with the green wave count. A break of its uptrend line from March would say the rally is over, confirmed with a break below 1867.

Nasdaq-100 (NDX) chart, 60-min

You can see the dark red a-b-c bounce off last week's low. This view still fully supports the idea that we've already seen the high for the techs. After the sharp drop from last week's high we now have a 3-wave correction of it and if I looked at nothing else I'd say you need to be short the market. The bounce would achieve two equal legs up in the bounce at 1918.88 so a minor new high on Thursday morning could be followed by selling. If you want to play the short side I think picking on the techs (NQ for futures, QQQQ for stock/options) would be the better choice.

To keep things in perspective on the techs, here's the weekly chart for the COMP:

Nasdaq (COMP) chart, Weekly

Price is wedging higher up against the top of its long term up-channel from 2004. Bearish divergence as it reaches the top of the channel does not inspire me to get bullish this market and certainly suggests you be very careful with long positions here.

Russell-2000 (RUT) chart, Daily

The small caps give me the same impression as the techs--it's as though they're being dragged kicking and screaming higher by the blue chips. If another down-up sequence as shown in green plays out then it will likely finish the rally. A break of the uptrend line from March, currently near 825 would say we've seen the high. In the meantime this pattern says expect lots of chop and whipsaws.

Russell-2000 (RUT) chart, 60-min

Also like the NDX this pattern looks very good for a continuation lower. After the sharp decline last week the RUT has done a 3-wave bounce for what could be a 2nd wave correction to the 1st wave down. The bearish price pattern shows a decline to the uptrend line from March, a bounce and then a strong break down from there. The bullish wave pattern suggests we'll see price pullback but then chop higher again into June.

NYSE (NYA) vs. New 52-week highs in NYSE, Daily

This is becoming an old story--new price highs not being met with more new 52-week highs. Today's new-highs number was abysmal. This is not a timing tool but it tells you not to get excited about upside potential. This is telling us very clearly that this rally is closer to an end than even the middle. This kind of negative divergence always favors a break of the trend. It's just a matter of when.

BIX banking index, Daily chart

The banks broke the uptrend line from April and at best I see the possibility that this index will make one more run higher to test its February high. But I'm leaning towards the bearish depiction here and continuation lower, even if it bounces slightly higher first.

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

With the daily oscillators rolling back over it appears the housing index is ready to resume its decline. But I show the possibility that it will rally a little higher, maybe even making it up to the top of its bear flag pattern where it intersects its downtrend line from January 2006, just above 700. But I consider that to be less of a possibility than directly lower from here (or from slightly higher in its current bounce).

Oil chart, ETF (USO), Daily

Oil (USO) hasn't confirmed its bearishness with a break back below 47 but it's close. In the meantime it's in a downtrend so stick with the trend until proven otherwise.

Oil Index chart, Daily

The oil stocks continue to diverge from the commodity with oil stocks rallying while the price of oil drops. This will not continue as they should synch up soon. Considering where this index is in its wave count and channel I'm thinking it will tip back over soon and join oil in a move lower. But first I see the possibility for the oil index to make a stop up towards 750. A break below 717 would be bearish, confirmed with a break of its uptrend line from March.

Transportation Index chart, TRAN, Daily

With the TRAN up near the trend line along the highs from May 2006, and its choppy rise since the May 1st low, I'm getting the impression that the Trannies are finishing up their own little ascending wedge pattern here. If it makes a quick move up to around 5300 followed by a drop back inside the pattern, that would be a sell signal and suggest that the top is in.

U.S. Dollar chart, Daily

The bounce pattern in the US dollar continues to look overlapping and corrective and I keep thinking it will drop out of its small up-channel and head back down. But the uptrend line held again on the last pullback so the uptrend holds. As long as that stays true then the downtrend for gold should continue to hold as well.

Gold chart, StreetTrack Gold ETF (GLD), Daily

The down-channel for gold's (GLD) decline is taking on more of a descending wedge appearance would be bullish if true. This pattern suggests we could see it drop to uptrend support (from July 2005) and its 200-dma and then rally higher, as per the dark green depiction. If at any time the dollar breaks its uptrend we'll probably see gold break its downtrend (light green) but until that happens the trend is down so stick with it.

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

Thursday starts a busy two days for economic reports. If the market sells off right away on Thursday then likely as not one of these reports will get the blame (vice versa too). For example, if GDP were to come in very weak then I suspect that would scare a few bulls who became more worried about a slowing economy. The PMI number at 9:45 also has the potential to move the market. And then Friday are the big numbers that the Fed watches carefully.

SPX chart, Weekly, More Immediately Bearish

Not much of a change to the weekly chart--after last week's small red candle we've got another white one in a long string of them. Overbought is simply becoming more overbought. Chase it if you want to the upside but not me. I'll wait for the next shorting opportunity thank you very much.

Before wrapping things up here I just wanted to make a quick comment on the Chinese stock market, which tanked last night and was the reason our equity futures were so much in the red this morning. When bad news like this is quickly defended by those who believe the market will continue to rally you have to wonder if they're trying to convince themselves or others. Many analysts were coming out this morning to debunk the idea that we're in any way linked to the Chinese. While that's true literally it's not true relationally.

By that I mean all the world markets are now attached at the hip. We're all in synch and any analyst who doesn't believe that has simply refused to compare charts of the various stock market indices around the world. So to say the Chinese market doesn't matter is ludicrous. It may be the first one to break (or not) and it would be an indication that fear is entering their market. Trust me, when that happens I can guarantee you fear will also enter our market.

But I had to laugh at Bloomberg's report this morning where the writer referred to the conclusion of a number of international economists and former government officials (like I'd believe them anyway) where they stated the Chinese stock market has little correlation with its economy because "Chinese participation is limited to less than 10% of the population--means the effects of a bursting of the bubble would remain contained."

First of all, 10% of the Chinese population still puts the number of trading accounts at over 100 million. That's a lot of trading. Second, what people don't understand is that the popping of the stock market bubble will have a very significant negative impact on the spirits of the Chinese people, especially business people. It will not be contained I can assure you.

OK, onto some fun/interesting facts to consider:

Last week's high was SPX 1532 and May 22nd was 1532 days from the March 12, 2003 start of the bull market.

Ron Griess, from TheChartStore.com, compared the current market to the bull markets in 1942-1946 and 1982-1987. The final thrust higher in 1946 lasted 77 trading days. The final thrust in 1987 lasted 67 trading days. The current thrust higher, if measured from March 6th, the first spike low from the February high, would achieve 67 trading days on June 8th and 77 days on June 22nd. Right in between is June 15th.

Opex Friday is June 15th. The next Bradley turn date, which is supposed to be the first significant turn date for 2007, is June 14th.

So it's interesting that the dates are around June opex week and I've got some Fib/price projections showing the possibility for a consolidation this week followed by more rally into mid-June. It's certainly been typical for us to see a bullish opex week and a final stop run to get SPX up to 1552 is quite possible. We've got several things now pointing to that possibility for the last fling for the bulls.

For the short term I see the possibility for a lot of choppy price action through the rest of this week and into next. I showed a more immediately bullish possibility for the DOW and SPX but a bearish set up for NDX and RUT. While everyone was in synch last week, that is no longer true. That says watch out for chop.

If we sell off immediately on Thursday morning then it would certainly add to the possibility that NDX and RUT will lead us to the downside. But even there we might only get a relatively small drop followed by another choppy move higher. Therefore my best recommendation as of today's price action is nothing, as in do nothing. There are many times in the market where flat is the best position and that's what I'm recommending here. Don't trade until you like the setup and there are enough questions for me tonight to not like the setup. Once the picture clears up then I'll look for the setup again.

I've laid out the key levels on the charts and discussed the important support and resistance levels. Use those to help make decisions about where this market may be headed next. There will be plenty of busses to come pick you up when you're ready so don't force a trade just to trade. Good luck over the next week and I'll be back next Wednesday. As always, I'll try to keep up with this changing environment on the Market Monitor. See you there.

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