Option Investor
Market Wrap

Horse Shoes and Stop Losses

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[Image 1] Market Internals

After a strong close on Friday, the markets opened with a bang after news that President Elect Obama plans to launch the largest infrastructure investment program since the 1950s. Other reasons that helped inflate today's stock prices include progress in financial relief plans for the US automakers and an economic stimulus plan that will be large enough to get the economy back on its feet. President Elect Obama also noted that he can’t be concerned with the fiscal/budget deficit in the short term and that he aims to create 2.5 million jobs by 2011. Both Ford (F) and General Motors (GM) advanced on the news that the government was making headway with their bailout package. It was reported that a $15 billion dollar bailout package was being sent to the White House for consideration. F closed up $0.45 or 28% to $3.38 while GM closed up $0.60 to $4.93.

The NYSE (New York Stock Exchange) Euronext Exchange closed up 4.41% or 238.43 points to 5,639.68 today. The exchanges’ stock (NYX) price closed up $4.89 to $26.21. There were 1.75 billion shares traded at the big board, which was slightly less than the 50 day average of 1.78 billion. About 78% or 2,474 of the issues advanced while 710 declined. Only 9 stocks posted new 52 Week highs while 22 hit new 52 Week lows. The longer the market stays down in this range the easier it will be for stocks to post new 52 Week highs. Basically, all any beaten down market needs is time to heal. The NYSE ARMS Index or TRIN closed at 0.60. This shows that a lot of the advancing stocks also had advancing volume. As for the NASDAQ Composite, the technology heavy index soared 4.14% to 1571.74 or up 62.43 points. The volume was slightly lower, at 2.33 billion shares, than the 50 day average of 2.44 billion shares. There were 2,095 advancing issues versus 820 decliners. Only 8 new 52 Week Highs were set on the Comp and 81 new 52 Week Lows.

Other Corporate News

3M (MMM) issued downside earnings guidance for fiscal year 2008 and 2009 and reported that it will cut 1,800 jobs in the fourth quarter. MMM declined 2.47 to $57.38.

McDonalds (MCD) reported that global same-store sales rose 7.7% in November. MCD's U.S. comparable sales increased 4.5% in November due to the strength of McDonald's market-leading breakfast business and the popularity of the chicken line-up. The company also commented that the sales were up because of the everyday value throughout the menu. Breakfast competitor, Starbux (SBUX), has seen slowing growth nationally as a potential result of MCD's burgeoning breakfast menu and as premium coffee alternative. About 4 months ago, I used to wait up to 15 minutes in line to get my order in and coffee delivered through the window. I prefer SBUX coffee, especially with only a couple of cars in the drive through lane. However, the strong dollar concerned investors and caused the stock to decline $2.43 to $60.92. If the dollar weakens in December, the 4th quarter EPS and December sales should help the bottom line. Make a note to watch for that as a indicator for a long or short trade. Coca-Cola could also have the same fate as MCD as both stocks are diversified globally.

Trading Idea: A Pairs trade is a strategy where one establishes a long biased trade on a strong stock in a particular sector or industry while also establishing a short biased trade on a laggard stock in the same sector or industry. One could buy 200 shares of MCD stock at $61 for a total investment of $12,200. Since we want to maintain an equal weighting, we would then sell short 1100 shares of SBUX at a target price of $10.50. If SBUX and MCD both move up an equal percentage, there should be no gain or loss except for slippage. We want SBUX to drop back to its lows near $7.00 and MCD to run back to 67, its all time high. That would be perfect. But if SBUX moves up 5% and MCD moves up 10%, we still profit.

The Indices

Even though I covered a couple of the indices in the internals section, the widely followed Dow Jones Industrial Average (DJIA) advanced nearly 300 points to 8,934.18 which is just short of its 50 day simple moving average (SMA) or 8,941. Referring to the chart below, the next barrier, should the senior index break above the 50 day SMA, is at the November 4th highs at 9600. Then the 89 day SMA comes into play as resistance. The Money Flow Index has been consolidating in the 50s while the DJIA is attempting to find support. The ADX is still declining since the DJIA established a new low at 7,449 on November 20th. This indicated that the downtrend has weakened. A new trend will be indicated, uptrend or downtrend, once the ADX moves higher. I have drawn a Fibonacci retracement from the November low to the high from 11/28/08. The 50% retracement was tested perfectly twice. This is actually a positive sign in that the market was allowed to take profits in an orderly manner and allow investors a chance to re-establish positions not once, but twice.

[Image 2]

The next view is a more microscopic view of the daily chart. A positive indication from the chart below is that the RSI is only at 66 and still has room before becoming overbought. In addition, the Slow Stochastics has re-crossed the moving average and is still out of over bought territory. Today's advance had the DJIA close above the November 28th high of 8831. I realize it may be difficult to make out, but the 8 day exponential moving average (EMA) closed at 8583 while the 21 day EMA closed at 8582. The 8 day EMA is the green line and the 21 day EMA is the magenta line. This is my Blue's Clues chart because the Bollinger Bands are colored in the same color as Blue the puppy while the moving averages are colored the same colors as Blues friends Steve for green and Magenta for Magenta. Anyway, we have a moving average crossover on the DJIA. At 9250, the upper Bollinger band is the near term target. I would like to see the DJIA run up and sell off to test the 21 day EMA before changing the trade bias to uptrend. It is difficult to think that the market could be in an uptrend soon.

[Image 3]

I can't be as positive on the S&P 500 (SPX). The 50 day SMA is 20 points higher at 929. As we found out today, there is heavy resistance from the mid November highs at 918. While the SPX closed above the November 28th high (Black Friday), there is now a gap up that needs to be filled in at Friday's close. If the markets are up tomorrow, one could short at the 50 day SMA and set a target at Friday's high of 879. Don’t get greedy or stuck on exact numbers. Trading is very much like horseshoes and hand grenades; close is good enough.

[Image 4]

The market, however, may try to make an early run to the upper Bollinger band at 955. This level coincides with another resistance point from the 11/10/08 high. Remember, when there are coincidence resistance levels, it just makes them stronger because there are more people finding a reason to sell at that level. Traders, myself included; place target sells at resistance levels. But I usually place the sell order a little lower than the actual resistance price level because the market has a way of coming up just short of a target. As with the DJIA, the SPX's RSI and Slow Stochastics still have room to move up before becoming overbought. However, the 8 day EMA is just shy of crossing above the 21 day EMA. Therefore, we are selling at resistance and covering at support until the SPX makes a good case for being in an uptrend.

[Image 5] Commodities

Crude oil has been on a sharp downtrend. Admittedly, I have been one of those traders that keep thinking it can’t keep going lower because of where it was a few months ago. Crude oil finally bounced today to close at $43.95. The chart above only shows the last month, but it does give us a sense of how volatile the price has been. The price per barrel was at about $65 a month ago and only $40.50 on Friday. Since the commodity closed up and allowed the RSI and Slow Stochastics to re-emerge from oversold territory, one could buy the futures or an ETF that tracks the commodity. I have mentioned USO as an ETF because it offers options as well as a close correlation to the commodity. Proshares has released some new commodity Ultra shares that move 2 times the daily percentage move of the commodity. If I think the market may move up as well as oil, the Proshares Ultra Long DJ Oil and Gas Index (DIG) can provide some good volatility to trade.

[Image 6]

I am going to stop at gold. For a couple of days, gold was trading alike the rest of the markets or more opposite of the US Treasury. Gold is usually a safe haven investment or an inflation hedge. Gold sold off as soon as the Federal Reserve actually confirmed that the US is in a recession and that we may see some continued deflationary pressures. Deflation puts a wrench in my call for inflation in the next couple of years. Gold ran up to the 89 day SMA and quickly turned down. I still think there is value in the hard asset and I am looking at using the SPDR Gold Shares ETF (GLD) and its options to add a little sparkle to the portfolio.

[Image 7]

For some reason, I think that the market will run up into the end of the year and then sell off just prior to the year end. Why do I make this statement? First, it just feels that way. Also, the sell off may be from last minute tax loss harvesting. Tax loss harvesting is a strategy to collect deep losses from the tumultuous conditions seen this year by selling one stock or ETF and placing the loss on the shelf for the potential tax increases coming. The rest of the strategy is to replace the sold stock/ETF with another stock/ETF in the same business or sector. That way, if the sector advances, you collect a loss for later use and maintain the sector weighting. I will send out the Contrarian Newsletter in the next day or so as the indicators actually change. Just to review, the overall signal is Neutral with a slight bias because the Put/Call ratio is Positive, the VIX is Positive but the Investors Intelligence is Negative. In summary, a Neutral signal with slight positive bias suggests that you have a market neutral with some positive bias to capture some limited upside move and a positive theta to profit from time decay. have a great week.

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