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Daily Newsletter, Monday, 05/20/2002

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The Option Investor Newsletter                   Monday 05-20-2002
Copyright 2001, All rights reserved.                        1 of 2
Redistribution in any form strictly prohibited.

Posted online for subscribers at http://www.OptionInvestor.com
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MARKET WRAP  (view in courier font for table alignment)
*******************************************************************
      05-20-2002          High     Low     Volume Advance/Decline
DJIA    10229.50 -123.58 10348.93 10211.72   994 mln   1199/1963
NASDAQ   1701.59 - 39.80  1726.89  1696.11  1.42 bln   1203/2321
S&P 100   545.28 -  8.02   553.30   544.41   Totals    3402/4284
S&P 500  1091.88 - 14.71  1106.59  1090.61             
RUS 2000  503.17 -  5.77   508.94   502.59
DJ TRANS 2761.37 - 36.99  2798.85  2745.85
VIX        21.13 +  0.85   21.95     20.96
VXN        42.84 -  0.10   43.95     42.48
TRIN        0.99
PUT/CALL    0.71
*******************************************************************

As The Market Turns
By Buzz Lynn
buzz@OptionInvestor.com

From a Go-Go's song reminiscent of the 1980's, it's just another 
manic Monday with all the positive action last week met with 
selling right from the start today.  Up, down, up, down - is there 
anyone that does not believe this market is rangebound?  I could 
just skip the news and go straight to the charts for more evidence 
of that, and will do just that in a minute.  But Fundamentals Guy 
cannot resist taking a vicious poke first at some of the news that 
many believe caused today's negative slide.  Hogwash.  It did not 
cause today's slide, but it does have implications for the economy 
and will affect investors' psychology as portrayed in this giant 
soap opera we call "The Market".  

Will Gold continue to rise?  Did OPEC lose its last hand to Russia 
as it begins to lose dominance in the world oil market?  Are we 
really in danger of more terrorist attacks?  Are these three 
premises merely coincidence? Stay tuned for the exciting 
conclusion, as it unfolds over the days, weeks, months and years 
ahead!  

As for Gold, the shiny, yellow metal reached its highest price 
level in 22 mos. finishing today at $316.  This is the first time 
that I can recall where the commercial shorts are actually losing 
theirs while betting that gold prices will fall.  $314 had been a 
previous level of resistance and a previous level of support back 
in 1998.  Once through $314, this has got to cause some shorts to 
rethink their position and perhaps cover.  With gold reaching a 
series of higher lows and higher highs since January, an uptrend 
has become pretty clear, which is well-noted in a stochastic that 
has failed to reach oversold since January.  Gold is clearly on a 
bull run but may need a few weeks to get its footing at these new 
levels.  While I'm not interested in buying every ounce in sight, 
Fundamentals Guy is moving out of financial assets into hard 
assets, which includes gold.  I'm inclined to spend some money on 
this stuff as an insurance policy against a sagging IRA (not a 
trade) every time the price dips under $314.

I'm not too worried about the world becoming a more stable place 
to live.  I don't think that's likely as long as fanatics, more 
fervent than ever, have publicly stated they want to kill me, and 
all of us engaged in the western way of life, as a badge of honor.  
Nobody knows that outcome, but I will not die today, and will 
likely still need grocery money even if dollars become less 
valuable and/or spendable.

More on that lack of stability thing. . .anyone catch Dick Cheney 
on Press the Meat on Sunday when he said, "A future attack against 
the United States is almost certain"?  The FBI also warns that 
suicide bombers performing homicide bombings in the U.S are 
"inevitable".  Not that it would surprise anyone with feet firmly 
planted on Earth, but these are credible people with the best 
means to know of which they speak.  Our fear of that unknown will 
tend to cause equity sellers to appear, hence negative price 
action.  

It's also worth noting that OPEC is losing its grip on oil prices.  
Iraq's proposed embargo of oil to the west failed, and now OPEC is 
trying every trick in the book to keep Russia from undercutting 
it.  Too late.  Russia is all too happy to supply all the oil the 
west wants for hard cash, thus ending the stranglehold OPEC once 
had.  

But watch out.  Hell hath no fury like an OPEC nation losing its 
cash cow.  I might point out too at the risk of much hate mail 
that most OPEC nations have little other resources than oil to 
trade.  These are not nations that embrace capitalism, but instead 
conspire to gouge money.  If they can no longer gouge it, they 
will likely resort to the barrel of a gun to preserve it.  Ever 
hear of Saddam Hussein?  It's tough to keep good trade partners 
using coercion and all the more reason to believe that 
destabilization in OPEC nations will continue to rise.  Hmmm -
another case for gold (that or buying Russian oil stocks, which 
also looks interesting to me).

But back to our own markets.  Merrill opined that we should sell 
tech stocks into strength.  Yet Salomon sees INTC benefiting from 
a positive pricing cycle born of higher PC demand (really???) and 
expects no price cuts in the coming five months (Again, really???  
Ever hear or Moore's law that doubles chip speed and halves price 
every 18 months?  Maybe the "halving price" law has been repealed 
at Solly.)  Merrill gets my vote on this one.

Finally, economic news saw our list of leading economic indicators 
decline by 0.4% rather than the expected decline of 0.2%.  Cause 
for concern?  In the grand scope of things, probably not, as this 
too is not a surprise, but merely a symptom of worldwide over-
production capacity.  China figures HUGE in that, but I have to 
save it for another column.  Meanwhile, recovery is slow and 
fleeting here at home.  Don't look for that to end anytime soon 
despite Washington's attempts to convince us otherwise.  We should 
be more concerned about the dollar's slide against other 
currencies, which could be put a big damper on the budding 
"recovery".

All that said, the charts fly in the face of the negative goings 
on.

Dow Industrial chart - INDU (weekly/daily/60):


 

Our first manic market indicator is the Dow.  Weekly chart is 
still bullish with stochastic divergence, and moving up.  The 60-
min chart is likewise slightly bullish having found support at 
10,225 with its stochastic just turning up form oversold.  Was 
buying calls at the close the right play?  I can't say, but 
stochastics suggest that's the case for a risk capital on a scalp.  
Still, not a very high odds play.  

On the other hand, the daily chart shows the 60-min chart gap that 
is ripe for the filling.  Also, the daily stochastic has just 
rolled over with plenty of room to fall to say 10,100 for 
starters.  But the bullish trending weekly chart should have the 
daily finding a higher low once it cycles to oversold.  Scalp 
calls if you must then consider puts on any bounce until the daily 
stochastic reaches oversold.

NASDAQ chart - COMPX (weekly/daily/60):


 

Similar stochastic story here, only more pronounced.  The daily is 
definitely bearish with gap just begging to be filled in.  Come to 
think of it, I'd pass on scalping calls on the 60-min chart.  
While stochastics have turned up, price action is failing to keep 
up.  Once the 60 rolls, the candles cannot likely hold altitude.  
This has all the makings of a very nice put play.

S&P 500 chart - SPX (weekly/daily/60):


 

Ditto on the granddaddy, but no quite as bearish.  Still, there is 
a big gap to fill to perhaps 1078 for starters and a daily 
stochastic that is signaling potential reversal to oversold.  
Perhaps scalping calls is possible for the nimble, but no for my 
money.  A 60-min chart break downward from overbought (wait 'til 
it gets there) coupled with a break under 1088 would get me in 
puts.

VIX?  VIXN?  There is no fear.  21 and 42 roughly, respectively, 
which tells us implied volatility is low and investor's belief in 
severe price moves in either direction is zilch.  Well, that's 
what we'd expect in a rangebound market.  Also worth noting is 
that while the A/D line was greatly negative and volume indicators 
gave no quarter to those wanting to buy calls, shear trade volume 
was pretty low and thus not the stuff huge selloffs are made of.  

For tomorrow, no economic news to upset the stomach.  I'll be 
watching the 60-min charts for a stochastic to cycle up with a 
continuation of flat price action.  On the rollover, hopefully, as 
the price begins breaking down to fill the gap, that's when I'd be 
looking at puts.  The daily chart should be pointing straight 
south by them across all major indexes, especially the NASDAQ.

See you at the bell.


********************
INDEX TRADER SUMMARY
********************

SLOW MO
by Leigh Stevens

TRADING ACTIVITY AND OUTLOOK - 
After such a past big week, with the best performing Nasdaq 
market up 141 points, it was not surprising to see the Composite 
momentum slow way down, then fall 2.3% in a 39.8 point drop, 
equaling 28% of last week's gain. Slowing upside momentum and 
partial retracements of major gains after a long bear trend is to 
be expected. Wonderment as to why it's happening can be left to 
the talking heads on CNBC. However, there are always reasons that 
come along to explain why investors are doing what they're doing. 

I felt this morning when I came in that all the coming from (Vice 
President) Chaney, about the potential for another terrorist 
attack on a large scale, would rattle investors and create an 
excuse for a market sell off.  Not yet a front and center worry 
in the U.S., but looming as one, is the seeming march toward an 
India-Pakistani war with the dangers that they will view nuclear 
weapons as battlefield choices; they in fact point to our 
administration's own talk and planning relating to an option of 
battlefield nuclear weapons in certain instances. 

The technical backdrops to the market are mostly bullish:
The market held near support levels, although I think there is 
still potential for a deeper drop. The Market is probably too 
overbought on a daily trend basis to rally straight away either.  

To cause a less overbought situation, either the market goes 
sideways some more, drops further, or a combination of both.  The 
other thing, as noted today on the Market Monitor, is what 
today's low volume might be telling us.  In an uptrend, if that 
is what we are in - my opinion is that we are in an emerging 
uptrend - volume will tend to expand on up days and decline on 
down days.  This is the pattern we're seeing over the past few 
sessions.  Time will tell, so stay tuned!  

I am still looking at the gap levels as places to buy on partial 
or full retracements of those areas, which I'll get to with a 
look at each of the major indices.  My downside targets would 
fill all or much of the gap areas from early last week. They are 
all also areas where I favor new index call purchases. 

I still see downside S&P 500 (SPX) potential to 1080, which would 
be a dip under the 21-day moving average, but would reach support 
implied by the low end of the hourly uptrend channel. Such a 
move, would get SPX back to the area where trading ended on 
Monday, before the sharp higher of last Tuesday.  This starting 
point for the second big back to back up day last week, is a 
natural or expected area to anticipate support. A price pullback 

that was a slow drift lower will do the most to "throw off" the 
overbought condition suggested by the 14-day stochastic.  
 
S&P 500 (SPX) Daily/Hourly charts: 


 

 
Note the differences in the daily and hourly stochastics - daily 
is in the overbought range and the hourly ones are at or 
approaching oversold levels.  I have found in past similar 
situations, that the market has limited further potential in the 
direction of the recent trend until there is enough of sideways 
move and/or price pullback, to cause a fall off from the daily 
stochastic extreme. 

SPX does not necessarily need to get fully oversold. A later 
correction from a higher level, say up near the upper envelope 
line on the daily chart, could be the correction that does that.

So as to account for a range of possibilities: if 1090 continues 
to hold as support and another good-sized rally develops, a move 
above 1103-1105 would suggest further rally potential.  The 
maximum upside that I would envision before another correction 
develops is to 1125.  A bullish upside breakout on the weekly 
chart only occurs on a weekly close above 1125.  

S&P 100 (OEX) Daily/Hourly charts: 


 

Downside potential in the S&P 100 is probably to 535, which would 
take the OEX a bit under the low end of its hourly channel and 
under the 21-day moving average.  This upside channel is in the 
formative stages and we'll have to see if the channel broadens 
further. 

I suggest call purchases in the 535-537 area, if reached. 
 
Hourly chart resistance is in the 552 area; then, 560, at the top 
end of the hourly channel.  560-561 is about the maximum upside 
potential I see without a deeper correction first.  Someway or 
another the overbought condition suggested by the daily 
stochastic model will likely be relieved. How deep the correction 
will be is hard to calculate. I can better say that OEX looks 
like it's headed lower based on what I see in the hourly chart 
pattern.  

There is potential of course in a downside play.  Not to 
discourage those with that trading sentiment.  However, I just 
feel it may be "easier" to wait for a deeper pullback and buy 
calls. Up around the upper envelope lines, the Index would offer 
a better risk to reward on the short side 

Rallies to the upper trend channel boundary, might offer a 
shorting opportunity, but one that is best assessed while 
watching intraday market action unfold.

Dow Industrials 1/100 Index ($DJX.X) Daily/Hourly charts: 


 

I assess DJX as having downside potential to 101 -- a further 
dip, with rally potential from there.  Working somewhat contrary 
to this view is the formation of the rectangle that has been 
traced out on the hourly chart. A sideways consolidation 
sometimes forms a rectangle pattern.  It is one of the more 
common continuation patterns; i.e., a sideways move that 
"consolidates" the prior move, before the trend continues. 
Usually the breakout will be to the upside.  

If instead, the break is below the line, this can suggest a 
deeper correction.  What I have outlined is a more shallow 
correction.  However, 100 is the lowest downside target I have 
currently. 

Conversely, a next move above the top of the hourly chart 
"rectangle" at 103.5 suggests an objective to 105.   

Nasdaq Composite Index ($COMPX) Daily/Hourly charts:


 


With the Composite, if 1700 is pierced and it looks today that it 
will, downside potential is to fill in some part of the 1653-1691 
chart gap left from the big run up of last week.  1677 or close 
by it, at the 21-day moving average, may offer support on such a 
move lower. 1680 is the low end of the emerging hourly uptrend 
channel. 

A fairly broad area, but I see 1680 as the "best case" pullback 
and 1655 as the worst case. On the upside, if the next surprise 
is in this direction, a move above 1740 suggests further 
potential up to the 1780 area, around the top end of the hourly 
uptrend price channel.  

On the Nasdaq 100 (NDX), 1288-1290 has been key near support - if 
penetrated, there is downside potential to as low as 1244, which 
would fill in all of NDX's daily chart gap from last week. Hourly 
trendline support looks like 1080. Hard to see what would propel 
it a lot lower than 1080, but the week is young!

Nasdaq 100 Trust Stock (QQQ) Daily/Hourly charts: 


 

In QQQ, support/buying interest has been surfacing in the 32 
area.  If this level is broken, downside potential is to the 31 
area, support implied by the low end of the upside chart gap.  I 
see this area as offering better support, than 31.5, at the 21-
day average.  I favor buying if there is a move to this area or 
slightly under, to 30.5. 

Resistance is apparent in the 32.7-33 area.  An hourly close over 
33 would suggest further upside potential.  If such a rally comes 
before any break of near support at 32, then watch the old high 
at 33.6 - if this old high is cleared, 34.5, at the top of 
uptrend channel, may define the next potential resistance.  


Leigh Stevens
Chief Market Strategist 
lstevens@OptionInvestor.com 


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***********************
INDEX TRADER GAME PLANS
***********************

THE SECTOR BEAT - 5/20
by Leigh Stevens


HIGHER ON THE DAY ON Monday - 

The top five sectors that were higher - in fact the only five 
that were higher are a mix of the old familiar "doom & gloomers" 
that accompany potential global troubles.  At least of the mid 
east variety.  

The higher Gold & Silver sector and the oil and natural gas areas 
of energy, gives me a strong feeling that NOTHING has changed in 
the market. Utilities are a safe haven and yield play, so they 
tend to fit the safety "theme". 



 


DOWN ON THE DAY on Monday  - 

Those old tech favorites that got blessed last week were on the 
hit list today.  And, what's this, the healthcare sector ($HMO.X) 
taking a big hit! - this, due to Prudential Securities downgrades 
on 2 of the 3 HMO stocks that got into my suggested buying zone. 
Maybe these two (HUM & WLP) were correcting ahead of this report 
as the information was known.  Seems funny, not ha-ha funny.  
 


 


SECTOR TRADING IDEAS - 

Healthcare Payors Index ($HMO.X): 

Corrective action sets in again.  This type of volatility is of 
course common on a sector, or stocks within it, that gets 
overbought - OVER, as in overdone, overripe, over our heads.   



 

Today's close on the low of the day, right at the trendline, 
suggests that the HMO index will penetrate its daily chart up 
trendline and head still lower.  A good guess for the extend of 
such a deeper correction, is to the 556 area, at the 50-day 
moving average and representing a 50% correction of the March to 
May advance.   

If so, I think this will be the extent of the correction and it 
would form the "typical" down-up-down pattern of a correction in 
an uptrend.  Especially after the big power move completed 
itself.  I had lower objectives for corrective pullbacks in some 
of the lead HMO stocks, so those objectives as possible entry 
points on the buy side come into view.  I still see another 
advance coming before these stocks top out at higher levels than 
seen already. 

PacifiCare Health Systems (PHSY) dropped twice into my 
suggested buying 23.5-24.7 zone at. Stock could drop back to the 
25.7 level and still not break its uptrend line.  



 

Wellpoint Health Networks (WLP) - Two price entry points were 
suggested with subsequent declines to and under these levels 
- at 72.00, then again at 70 or less. 



 

The steep break today compliments of the Pru (Prudential 
Securities) analyst who must have booked profits already - no, 
that's the old Wall Street!  

Stock needs to hold 65.30, at his 62% retracement, to keep within 
a bullish trend so to speak.  The stock has already broken its up 
trendline, but that is not that uncommon for a stock that had 
such a big up move already.  Will stay with what I own, call 
wise, and may price average (down), if the stock stabilizes at or 
above 65.   

HUMANA (HUM) - Purchase suggestion was at 15.60, and again in the 
15.00-15.15 area. 



 

The correction in Humana may have run its course already, but a 
period of some sideways consolidation may also be required before 
HUM is in a position to set up for another rally. As with the HMO 
sector overall, think that there is one more good-sized rally to 
come. The 50-day moving average now is a key number to watch.  

If HUM climbs back above 14.7 and stays there, it is bullish 
recovery type action.  Otherwise, we may be bouncing around 
between 13.75 and 14.75 for a while. I favor buying dips under 
14, with a stop at 13.5 on the stock and an equivalent risk point 
on calls.  

I'll take a look at the other HMO stocks tomorrow that have not 
dropped into my previously suggested buying range and see what 
today's and tomorrow's price action causes in terms of any 
reassessment or reiteration of a suggested play in them.


NOTE: RISK to REWARD guidelines -  
Determining an objective is important, even if it is a moving 
target, as this is the reward potential.   Determining reward 
potential is critical to establishing whether a stop that makes 
“sense” (e.g., a sell stop that was placed under a key support 
level) would, if triggered, result in a dollar loss that is in 
proportion to profit potential; e.g., 1/3 of it.  (On occasion, 
when the purchase price of call or put is equal to 1/3 or less of 
the estimated reward potential, there may not be a specific exit 
suggestion, as the cost of the option is equal to the amount that 
is being risked.)   


Leigh Stevens
Chief Market Strategist
lstevens@OptionInvestor.com


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The Option Investor Newsletter                   Monday 05-20-2002
Copyright 2001, All rights reserved.                        2 of 2
Redistribution in any form strictly prohibited.


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*****************
STOP-LOSS UPDATES
*****************

NVDA - call
Adjust from $33.75 up to $36

TEVA - call
Adjust from $60 up to $62.50


*************
DROPPED CALLS
*************

None


************
DROPPED PUTS
************

None


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**********************
PLAY OF THE DAY - CALL
**********************

TEVA - Teva Pharmaceuticals $65.18 +2.58 (+2.58 this week)

Teva Pharmaceutical Industries Ltd. is a fully integrated global
pharmaceutical company producing drugs in all major therapeutic
categories. In the area of proprietary drugs, Teva has focused
on products for central nervous system disorders, primarily the
development of Teva's first globally marketed branded drug,
Copaxone, a treatment for relapsing-remitting multiple sclerosis.
Teva also possesses significant manufacturing operations for
active pharmaceutical ingredients (API). Teva Pharmaceuticals USA,
Inc., Teva's principal United States subsidiary, is a generic
drug company in the United States.

Most Recent Write-Up

Teva announced last Friday morning that through one of its
subsidiaries in Latin America would market and distribute two
of Immunomedics (NASDAQ:IMMU) products.  The deal calls for the
selling and distribution of diagnostic products throughout
Latin America.  That news, along with the strength in the AMEX
Biotechnology Sector Index (BTK.X), helped TEVA to yet another
new relative high in the stock's recently established ascending
trend.  The stock traded as high as the $63.25 level before
profit takers decided to take some gains off the table ahead of
the weekend.  For the week, the stock finished more than $3
higher, reinforcing the relative strength that has been at play
since earlier this month.  The big run in the stock recently may
necessitate a pullback and consolidation in the week ahead, but
not if the broader biotechnology group continues moving higher
like it did during last Friday's session.  The BTK.X powered
higher by more than 2 percent during the day, and the move
higher in this group could just be getting underway.  Bulls on
biotechs should look to the BTK to further lift TEVA over the
short term.  Use intraday pullbacks to support followed by
bounces to enter new call positions, then look for sector upward
momentum to push TEVA to new relative highs in its trend.  Use
a strong rally to take profits from entries on weakness.

Comments

Starting the week out right, TEVA shot higher at the opening
bell on news that the company received tentative FDA approval
for its Pravastatin Sodium Tablets, the generic equivalent of
BMY's Pravachol.  That initial pop came to a halt near the
$65.60 level, and the stock traded essentially flat for the
remainder of the day.  But that in itself is impressive, given
the broad market and Biotechnology weakness.  TEVA appears to
be building some intraday support near the $64.75 level and a
renewed bounce from this level could make for a decent entry
point.  Of course, that gap down to the $62.60 level will be
begging to be filled if the BTK weakens further this week.  That
would set up a truly attractive entry on a volume-backed rebound
from that level.  Note that we are raising our stop tonight to
$62.50, just below the bottom of the gap.  Momentum traders
looking for bullish follow-through before playing will want to
see a strong push through the $66 level.

BUY CALL JUN-65*TVQ-FM OI=1045 at $2.25 SL=1.00
BUY CALL JUN-70 TVQ-FN OI= 376 at $0.50 SL=0.25
BUY CALL SEP-65 TVQ-IM OI= 986 at $4.40 SL=2.75
BUY CALL SEP-70 TVQ-IN OI= 308 at $2.15 SL=1.00

Average Daily Volume = 936 K
 


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**************
TRADERS CORNER
**************

Are You Mis-Using Yesteryear's Trading Strategies?
by Mark Phillips
mphillips@OptionInvestor.com

Those of us that cut our teeth in the runaway bull market of
the late 1990's did quite well playing the consistent uptrend
while it lasted.  Those that recognized the sea change in early
2000 made money hand over fist playing the downtrend.  After so
much historical evidence in the recent past showing that jumping
into a trend and riding it higher (or lower) can be profitable,
it is no wonder that a large percentage of today's traders (those
with less than 10 years experience) still prefer to apply these
techniques.  Trend following is still a great trading strategy,
but if it involves buying breakouts and selling breakdowns, I
fear it is a recipe for disaster.

Critical self-evaluation is the cornerstone of successful
investing.  So let's ask a simple question -- are we in a
trending market?  If we are, then applying the momentum
techniques that worked so well in the recent past should continue
to serve us well.  But if we are not in a trending market, then
using momentum techniques is the functional equivalent of trying
to force a square peg into a round hole.

I pointed out in my commentary in the LEAPS column over the
weekend that we are still in a bear market, and without a
significant catalyst, I don't see it changing anytime soon.
Recent market action (since 9/11) demonstrates that there is a
level below which buyers will emerge to support stocks, just as
there is a level above which buyers are reluctant to commit
fresh capital to the market.  Inflows to mutual funds have been
notably tepid in recent months and without a surge of fresh
capital to fuel a bullish move, we just have the same money
chasing whichever sector is "HOT" this week or this month.

For educational purposes today, I'm going to use the Dow Jones
Industrials (DJIA) for our discussion example.  Sometimes it
makes sense to step back and look at the long-term picture to see
what the primary tides or currents are before we drill down to
look at the daily or intraday patterns that most of us use in our
trading.  I pulled up a weekly chart (not shown) of the DJIA and
except for the euphoric rally in early 2000 and the event-driven
decline last fall, it has traded in a broad range between
9400-11,400 for the past 3 years.  Granted that is a 2000-point
or roughly 20% range, but it is range bound.

Long-term investors that have bought the DJIA through Diamonds
(DIA) or trading long-term options on the DJX index whenever it
reaches the lower end of the range have done well over the past
3 years.  Likewise, those that have played the downside whenever
the upper end of the range has been tested (particularly near
11,000) have had a winning track record.  The process is simple,
referred to as buying support and selling resistance.  That is
the high-odds way to play ANY rangebound market.

But we're traders and we want to target the shorter-term moves,
right?  Then let's dial down to the daily chart and look at the
action since the DJIA clawed its way back over the 9400 level
last November.  That put the index right back in its historical
trading range, and looking back at resistance just prior to the
September terrorist attacks, we can make a strong argument for
strong resistance in the 10,600 area.



 

Sure enough, the 10,600 resistance level held and buying the
attempted breakout over that resistance level turned out to be
a losing proposition.  But taking advantage of the dips into the
9600 and 9800 levels in the February and late-April/early May
timeframes, respectively, turned out to be good bullish entry
points.  Note that these are buy-and-hold position trading
actions and to do so requires some intestinal fortitude in the
volatile and uncertain markets that we have seen over the past
6 months.  But you can see how it is far easier to manage risk
when buying support and selling resistance.

A trading range is not restricted to horizontal levels of support
and resistance.  As Leigh Stevens has pointed out repeatedly over
the past several weeks, the DJIA had been in a broad descending
channel since topping out in mid-March.  Look at the chart below
and you can see the clearly defined action points on the
240-minute chart.



 

Let me ask you this question.  How many times would it have been
profitable over the past 10 weeks to buy when the DJIA hit the
lower channel line and sell when it hit the upper channel line?
A lot!  And how many times would it have been profitable to trade
a breakout of the top of the channel or a breakdown below the
bottom channel line? Once!  Herein lies the wisdom of the trading
adage, "The trend is your friend".  It is a lot easier to be
successful by following the prevailing trend, changing your
approach when that trend comes to an end, as they all do.

That most recent trend change took place in volatile fashion (as
most of them do) with a double bottom at 9800, previous support
and at the time, the bottom of the channel.  We didn't know for
sure that the trend was changing until we saw the index break out
above the top of the prevailing channel and then retrace to find
support at the top of that channel.  Then we had a higher low
from which we can draw a new channel, that is likely to define
price action over the near term.



 

Notice that I left the old channel (blue) in place and then drew
a new one (red) using the lows from May 6-7 to define the lower
channel line.  Then I just cloned that line and moved it up to
the highs of May 2-3.  That leaves us with a new channel to trade
(the new range) and the testing of resistance (10,350) last week
provided a high odds entry point for playing the downside.  Leigh
has pointed it out numerous times and likely will in his Index
Wrap again tonight, that the way to trade these channels is to
target calls near the lower channel line (10,100 currently) and
puts near the upper channel line (now up at 10,400).

As I've said many times over the past several months, this is
still a bear market.  That means breakouts (except in select
sectors/stocks) will be few and far between.  Current resistance
will likely give way in the weeks ahead as the DJIA works higher
on hopes of a recovering economy.  Afterall, the next bear-market
rally appears to be underway.  But I would be extremely surprised
to see it bust out of the top of this channel and run straight
to 11,000.  There just isn't enough gas in the tank to get that
job done.  Rather, it will stair-step its way higher, using the
lower channel line as support.  Those bounces from support will
give us our solid entry points to the long side, while we can play
the downside for the expected profit taking whenever the upper
channel line is tested.

My intent here was to show that regardless of the market we trade,
the action will likely be defined by a range of highs and lows.
Selling at the top of that range and buying at the bottom of that
range is far more likely to meet with success than attempting to
chase the breakouts and breakdowns, especially in the broad
market indices like the DJIA.  Our job isn't to force the markets
to trade in a certain manner.  We must determine the manner in
which the markets ARE trading and position our accounts to profit
from that movement.  Trading the range takes patience and
discipline to wait for the solid entry points, but I believe
the rewards are worth it.

But don't just take my word for it.  Pull up the charts of your
favorite stocks or sectors and find all the profitable
breakouts/breakdowns of the prevailing trading range at the time.
Then look at the number of times that the extremes of the range
provided an entry point going the other way.  What I believe you
will find is that while there are breakouts and breakdowns from
the prevailing range, the number of these that play out in a
profitable manner are dwarfed by the number of successful trades
that present themselves as the stock bounces within the defined
trading range.

Hopefully this discussion has helped you to see how to define the
range of a market and trade accordingly.  Sadly, it appears that
the days of momentum trading are on an indefinite hiatus.  We
can either sit on the sidelines and wait for those days to return
(that's likely to be a VERY long wait, by the way), or we can
adapt our trading approach to match the market that we are
currently faced with.  Me, I'm listening to the market.

Best wishes for a profitable week.

Mark


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