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Daily Newsletter, Monday, 09/29/2003

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The Option Investor Newsletter                   Monday 09-29-2003
Copyright 2003, All rights reserved.                        1 of 2
Redistribution in any form strictly prohibited.


In Section One:

Wrap: Oversold, Window Dressing Bounce
Futures Wrap: Retracement
Index Trader Wrap: Bulls push for lucky #7
Traders Corner: Outside Bars – part deux


Posted online for subscribers at http://www.OptionInvestor.com
*******************************************************************
MARKET WRAP  (view in courier font for table alignment)
*******************************************************************
      09-29-2003           High     Low     Volume Advance/Decline
DJIA     9380.24 + 67.16  9395.32  9293.22 1.56 bln   1991/ 839
NASDAQ   1824.56 + 32.49  1824.59  1786.57 1.66 bln   1880/1195
S&P 100   505.02 +  5.41   505.03   499.23   Totals   3871/2034
S&P 500  1006.58 +  9.73  1006.89   995.31 
RUS 2000  492.71 +  7.42   492.86   482.13 
DJ TRANS 2710.29 + 46.46  2710.42  2660.66   
VIX        21.67 -  0.56    22.85    21.64   
VXN        30.66 -  0.22    31.88    30.62 
Total Volume 3,222M
Total UpVol  2,365M
Total DnVol    803M
52wk Highs      56
52wk Lows       68
PUT/CALL      0.84
*******************************************************************

Oversold, Window Dressing Bounce
by James Brown

The U.S. markets ended a three-day slide with a bounce as we step 
one day closer to ending the third quarter.  The morning session 
was actually rather weak as traders pulled back over concerns for 
the drop in the U.S. dollar.  The $INDU pierced the 9300 mark 
shortly after 11:00 AM ET before rebounding skyward more than 100 
points.  Many commentators remarked that after last week's 
painful sell-off the markets were short-term oversold and due for 
a bounce.  Combine that with the normal end-of-quarter window 
dressing by fund managers who sell some of their worst losers and 
buy recent market winners to improve the look of their portfolio 
and it's not much of a surprise to see the major indices green 
today.  

The bounce today was wide spread with every major sector index 
trading higher save for the RLX retail index, which closed down 
fractionally.  Wal-Mart continues to sing the same tune that 
weekly sales are ringing in at the high-end of their estimates 
but investors chose to react to negative news from J.C.Penney 
(JCP).  JCP said its department stores' same-store sales were 
coming in at the low-end of its forecast, while its catalog and 
Internet sales were doing better than expected.  The American 
consumer continues to endure the weak job market but they appear 
focused on stretching that dollar at the checkout counter.  This 
morning's economic reports showed that August Personal Spending 
rose 0.8 percent, which was in-line with expectations.  The 
August Personal Income data settled at +0.2 percent, below 
estimates of +0.3 percent.  

Speaking of the dollar, the U.S. greenback dropped to a new 
three-year low against the Japanese yen and a fresh three-month 
low against the euro.  Rumors were flying this morning.  One of 
them was that the Bush administration had changed their stance on 
a "strong" dollar.  Treasury Department spokesman Rob Nichols was 
widely quoted today with his comment, "We are not going to 
respond to every goofy market rumor on currencies...there is no 
change in policy."  Nichol's comments did little to stem the 
decline in the dollar, which dropped against 15 of the 16 most 
widely traded currencies.  Thus far the Bank of Japan has not 
intervened since the G7 meeting last week but word has it 
Japanese officials are blistering under the sudden rise in the 
yen against the dollar.  The dollar's move below the 111 level 
against the yen was also fueled by speculation that U.S. Treasury 
Secretary Snow is planning to be tougher on global trade issues 
with Japan.  Meanwhile the strength in the euro spiked higher on 
what many believed was a wave of short-covering when the euro 
passed $1.155 against the dollar.  The euro closed at $1.1608 
against the dollar.

This weakness in the U.S. dollar against the yen had Asian 
markets falling again.  The Japanese NIKKEI dropped 88 points to 
10,299 while the Hong Kong Hang Seng index fell 148 points to 
11,141.  European exchanges were also lower but the declines were 
shallow.  Market internals here at home were mostly bullish but 
not excessively so.  Advancing stocks beat decliners 19 to 8 on 
the NYSE and almost 19 to 12 on the NASDAQ.  Up volume was two to 
three times down volume on both exchanges but over all volume was 
modest.  The Dow Jones Industrials closed up 67 points to 9380.  
The NASDAQ Composite jumped more than 32 points to 1824 and the 
S&P 500 index added almost 10 points to 1006.  

Chart of the DJIA:


 

Chart of the NASDAQ:


 

The lion's share of gains today landed in the technology issues 
with the DDX disk drive index up 2.2%, the GHA hardware index 
+2.09%, the GSO software index up 1.95%, the INX internet index 
up 2.27%, the NWX networking index up +2.7% and the SOX 
semiconductor index bouncing +1.93%.  The chips were not the 
biggest winners today but they helped drive the rally with 
positive comments over the weekend and this morning.  The 
Semiconductor Industry Association (SIA) reported that August 
sales are up 4% and the SIA continues to see strength throughout 
the industry.  Monthly sales improvements have been a growing 
trend for the sector and helped power much of the February-
September rally.  This morning there were some analyst comments 
on the SIA report with a JPM analyst raising their 2003 industry 
sales growth forecasts from 12% to 15%.  Plus, another broker 
upgraded a slew of chip stocks in a morning report claiming a 
sustainable recovery for the chip equipment industry should 
happen in the next three quarters.

Of course it wouldn't be a Monday without some merger news.  Less 
than two weeks after French insurer AXA declared it had signed an 
agreement for its U.S. subsidiary to buy the MONY Group (MNY) for 
$1.5 billion in cash we have another insurance merger.  This 
morning Canada's Manulife Financial Corp (MFC) announced it would 
acquire John Hancock Financial Services (JHF) for $10.5 billion.  
The merger was announced on Sunday and investors reacted 
negatively to the news with MFC and JHF both down on the session.  
The initial reaction on the street was that JHF was being sold 
too cheap.  Terms of the deal will have JHF shareholders 
receiving 1.1853 shares of Manulife for each share of JHF.  The 
new company will be based in Toronto.

Influencing trading tomorrow will be a number of factors but most 
pundits expect the averages to be erratic.  First and foremost it 
is the end of the month for September.  The last 52 years have 
shown September to be the worst month of the year for equities.  
This month's losses have been rather mild given the gains in the 
first two weeks but we will still close in the red unless we see 
significant bounce tomorrow.  More importantly it is the last day 
of the quarter.  This is the last chance for fund managers to 
"dress up" their portfolio before they print your end-of-quarter 
statements.  Managers will be dumping their losers and buying 
some of the stronger performers to show you what a great job 
they're doing.  Hopefully, they've been at least tracking the 
market.  Currently, the U.S. is on track for its first back-to-
back quarterly advances since 2000.  As of Monday's close the 
NASDAQ is up 36.6 percent YTD while the DJIA is up 12.4 percent 
and the S&P 500 is up 14.4 percent (YTD).  

A potential stumbling block for tech traders tomorrow will be Sun 
Microsystems (SUNW) earnings warning tonight after the bell.  
SUNW will be replacing a $12 million profit with a $1.04 billion 
loss.  The company is writing down this non-cash charge for the 
fourth quarter of its FY '03.  The stock was down 9 percent in 
after hours trading.  A few years ago this would have cast a dark 
cloud over the entire sector and possibly the market as a whole 
but SUNW is just a shadow of its former self and investors may 
regulate the news as company-specific.  

Investors will also need to keep their eyes open for the 
September Consumer Confidence report due out shortly after the 
opening bell.  Economists expect the confidence number to dip 
from 81.3 to 80.6; if the report comes out any weaker it could 
undermine the markets after Friday's negative Michigan Sentiment 
data.  Economists are also expecting a small dip in the Chicago 
Purchasing Managers Index (PMI) but the report should still show 
an expanding manufacturing sector.


************
FUTURES WRAP
************

Retracement
Jonathan Levinson

I’m short of adjectives sufficient to describe plunge taken by 
the US Dollar Index this morning, as equities and gold bounced 
and treasuries retreated.  The chart below says it all.

Daily Pivots (generated with a pivot algorithm and unverified):



Note regarding pivot matrix:  The support, pivot and resistance 
levels above are derived from the high, low and closing price 
levels by a simple mathematical formula.  They are not intended 
to be predictive of market turning points or to serve as targets, 
but rather represent the range retracement levels as generated by 
the pivot algorithm.  Do not think of them as market "calls" 
or predictions.  Like any technically-derived indicator or price 
level, the pivot matrix values should be regarded as decision 
points at which to evaluate current market conditions.  Visit us 
in the Futures Monitor for our realtime views of the various 
markets covered here.


15 minute chart of the US Dollar Index




The US Dollar Index got croaked this morning, trapping bulls on 
an upside range break that was reversed in a precipitous plunge 
to new lows for the move at 93.  A feeble, dispirited bounce 
followed, as gold and the CRB made modest gains.  The CRB added 
2.46 to close at 242.43, led by natural gas, soybeans, cotton and 
sugar futures.

Daily chart of December gold


 

One would have expected a rally in December gold and silver to 
match the vertiginous drop in the Dollar, but it was not to be.  
December gold took out the 380 support on a stop-runner to 379.40 
before reversing.  It traded both sides of unchanged throughout 
the morning until the selloff on the Dollar began, at which point 
it made it to its session high of 386.20.  December gold was up 
1.80 at 383.60 as of this writing, with HUI up 2.03 close at 
193.71 and XAU +.96 to 90.62.  December silver dropped 4.7 cents 
to close at 5.098.

Daily chart of the ten year note yield


 

The TNX added 5.4 basis points to close at 4.077%, the yield 
closing at its high of the day after a lackluster session.  The 
move followed Friday’s break below the trendline and coincided 
with a bounce in gold and metals.  Factoring out action in the 
USD, we see a clear trend with treasuries trading inversely to 
equities and precious metals.  All retraced part of last week’s 
move, implying that Wednesday, Thursday and Friday set the trend 
and today corrected part of it.  If so, the next impulsive move 
lower in metals and equities and higher in treasuries should be a 
sight to behold.  However, note that the daily chart oscillators 
are getting bottomy on the ten year note yield, and it will take 
a trending move lower in the TNX to keep them from reversing. 


Daily NQ candles


 

Today’s retracement saw the NQ break Friday’s low, setting a new 
low for the move, but leading its peers to the upside, adding 25  
points to close at 1335.50, a 1.91% gain.  The gain caused an 
uptick in the stochastic downphase, but gave us no new buy 
signals and looks clearly corrective on the heels of last week’s 
strong decline.  Today’s gain retraced approximately 30% of the 
move off Wednesday’s high of 1393, printing a bullish engulfing 
candle for the day.  Volume was relatively light on the indices, 
with 1.65B shares traded on the Nasdaq and 1.47B on the NYSE.


30 minute 20 day chart of the NQ


 

Against the backdrop of the daily oscillator downphase, we had a 
bounce on the 30 minute chart oscillators underway from Friday.  
The lower low set shortly after today’s open was sufficient to 
scare a number of traders out of the long side, as it implied a 
trending move to the downside.  This did not occur in the end, as 
the bounce kicked in from there.  

The oscillator upphase continues, but is nearing the top of its 
range.  The downphase on the daily cycle chart implies that this 
bounce is already growing long in the tooth, and should fail near 
current levels. The lower descending trendline running parallel 
to the lower descending support line suggests that 1340 could do 
it, but we’ll wait for the charts to tell us tomorrow.  So long 
as the longer cycle daily chart oscillators are in downphases, I 
remain in sell-failed-rallies mode, with tight stops just in 
case.


Daily ES candles


 

The bounce was no less respectable on the ES, with a lower low 
and higher closing high printed on the daily chart for a key 
upside outside reversal.  Once again, the move retraced part of 
the losses for the move, but was insufficient to truncate the 
ongoing oscillator downphases.   Fibonacci resistance at 1008, 
which coincides with price confluence at that level, was not 
tested with an intraday high of 1005.50.


20 day 30 minute chart of the ES


 

As on the NQ, the 30 minute ES reveals an impressive bounce.  The 
oscillator upphase in this shorter timeframe is near the top of 
its range, and the level of the next price low at the bottom of 
the downphase to follow will tell us much about the shape of the 
weeks to come.  A lower low would confirm that the current bounce 
is a mere correction of a new downtrend as suggested by the 
rolling daily and weekly chart oscillators.

Note, however, that the daily candles are bullish, and the upside 
move today on the 30 minute chart is a bullish descending wedge 
breakout.  At issue now is whether the descending trendline on 
the bear flag will contain the bounce.  This trendline coincides 
with the toppy 300 minute stochastic, and looks like a good level 
for a short entry.  A break above the trendline would cause the 
300 minute stochastic to become pinned, and negate the short term 
bearish appearance of the chart. 


Daily YM candles


 

Nothing to add on the YM, which presents the same cycle picture as 
the ES and NQ. 


20 day 30 minute chart of the YM


 


The moves seen today in gold, bonds and equities all appear to 
have been corrections of last week’s trend, and if so, they 
should not carry much further.  The wildcard is the clearly 
anomalous selloff in the US Dollar Index, which indicates 
stronger, deeper currents in the much larger forex markets.  
For this reason, now is not the time to get married to your short 
term outlook.  Trade with stops and be willing to get out quickly 
if a trade starts to feel wrong.  The bulk of today’s movements 
took place suddenly, and being on the wrong side of these moves 
is dangerous to your accounts.  See you at the bell!


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

Bulls push for lucky #7

After throwing their hooves in the air late Friday as if to 
concede losses for the week, bulls battled back on Monday in an 
attempt to close the major indices in positive territory for a 
seventh-consecutive month, as August consumer spending data 
remained steady, rising 0.8%.

The broader S&P 500 Index (SPX.X) 1,006.58 +0.97% did gain back 
all of Friday's declines with a 9-point gain today, but a late-
morning decline to 995, which undercut Friday's lows came as the 
U.S. Dollar Index (dx00y) 92.89 -1.04% reversed lower after five-
weeks of declines on thought that U.S. Treasury Secretary John 
Snow would take a hard line on global trade with Japan and China 
after returning from the September 20 G7 meeting in Dubai.  

As the dollar continued to decline, stocks recovered from their 
late-morning retreat as Treasury Secretary Snow said that the 
U.S. continues to maintain a strong dollar policy, and that many 
of the G7 comments as well as his own regarding currency 
intervention by Asian governments had been blown out of 
proportion.

By session's end, the Airline Index (XAL.X) 61.67 +3.68% held the 
top stop on the sector winner list with discounter JetBlue 
(NASDAQ:JBLU) $62.13 +4.84% trading an all-time high.  Only the 
consumer sensitive S&P Retail Index (RLX.X) 348.08 -0.10 finished 
in negative territory, slipping fractionally lower, but well off 
its morning lows of 343.39.  Shares of Wal-Mart (NYSE:WMT) $57.23 
+0.75% gained 43 cents after it said September same-store sales 
were tracking near the high end of forecast.  Both the S&P Retail 
Index (RLX.X) and Wal-Mart (WMT) trade just below their starting 
to flatten out 50-day SMA's of 351 and $57.62.

With the major indices showing some intra-day swings on Friday 
and then again today, I get the feel the markets are trying to 
get a foothold and show some price stability, where last week's 
declines may have been some combined jitters from the weaker 
dollar and G7 meeting, but also some end of quarter asset 
allocation as the third quarter comes to an end tomorrow.

I think it fairly important for a rebound to take place, the 
today's lows hold into tomorrow's close.  After tomorrow's trade, 
we'll get new MONTHLY pivot levels, so right now, I think a pivot 
matrix trader is most likely monitoring DAILY/WEEKLY 
correlations, but making note of that the September MONTHLY 
pivots have been holding as support, and may indeed be a rather 
important near-term level of support.

Pivot Analysis Matrix


 

The Dow Industrials (INDU) 9,380.24 +0.72% gained 67 points 
today, but on Friday and again today saw trade at the MONTHLY 
Pivot of 9,304.  This might be an index that now trades closest 
to a level of support in the matrix, where a break much below the 
past two session's low would build lower to WEEKLY S1.  We see 
correlative near-term resistance in the INDU/SPX/OEX at their 
WEEKLY Pivots, and with Stochastics now "oversold" and looking to 
turn higher, would represent upside triggers for renewed strength 
after last week's pullback.

Dow Industrials (INDU) Chart - Daily Interval


 

The Dow Industrials (INDU) have come right back into what I would 
deem a strong level of horizontal support, based purely on the 
pullback to this summer's high, which were broken to the upside 
in mid-August, re-tested in late-August, where that test found 
the Dow ramping to new high found just over a week ago.  

While a weaker dollar should be favorable for U.S. exports, I do 
sense some concern among traders that the rather sharp decline in 
the dollar does have market participants here in the U.S., if not 
around the world somewhat hesitant and perhaps not as aggressive 
to throw caution to the wind and thought that new highs are a 
given.  I would maintain a bullish bias on the INDU above the 
9,300 level, but much of a giveback of today's lows will have 
9,200 in play, with some psychological damage being done and 
bears chanting... "9,000.... 9,000."  

I would add that the dollar looks just as, if not more oversold 
than the major equity indices, but today's rather sudden reversal 
from gains to losses and the U.S. Dollar Index (dx00y) now 
challenging its summers lows is starting to get some comment from 
currency watchers as to the rather sharp decline being 
potentially harmful to a global economic recovery.

Today's trade did see a net loss of 1 stock to a point and figure 
sell signal and this has the very narrow Dow Industrials Bullish 
% ($BPIND) falling 3.33% to 76.67% and now reading "bear 
confirmed" status.  This is the most defensive bullish % reading 
and at these high levels of bullish %, gives greater importance 
to 9,300.  I would not be opposed to put positions on the INDU 
should a trade at 9,290 be found.

S&P 500 Index (SPX) Chart - Daily Intervals


 

We can see how the SPX has had more of a pullback into its 
summer's base, but here's where I think this week's Pivot 
(1,009.74) does a very good job of matching some historical 
resistance from this summer, which may well become the trigger 
point for an SPX rebound, or signs of renewed strength to be 
found.  

I think it is also worth of note how the SPX may be slightly 
weaker on a technical basis than the Dow Industrials as it 
relates to this summer's highs and how important the Dow may be 
to investor psychology near-term.  For lack of a better phrase, I 
would think the SPX is counting on the Dow Industrials for 
strength in order to help pull the SPX above 1,010.

Today's trade saw a net loss of 4 stocks to point and figure sell 
signals in the broader S&P 500 Bullish % ($BPSPX).  Still "bull 
confirmed" and would take a reading of 76% to reverse back lower 
to "bull correction," and further internal damage to 72% to reach 
"bear confirmed" status like the Dow Industrials Bullish % 
($BPINDU).

S&P 100 Index (OEX) Chart - Daily Interval


 

In Thursday's wrap we laid out two envisioning trades for the 
S&P's.  One was bullish for the SPX, the other bearish for the 
OEX.  While the OEX did look vulnerable to the 493 level, bulls 
answered the call on Friday and again today and look to have an 
upside reversal session today.  The main near-term resistance for 
the OEX is not unlike that found in the SPX at the WEEKLY pivot, 
but an OEX move above 507 would have the OEX back on its 
aggressive trend and I would think a move to that level would 
have Stochastics kicking back higher from current "oversold" 
level, and have MACD rounding out just above its zero level.  

The S&P Banks Index (BIX.X) may become a key index if the OEX is 
to get back above the 513 level this week.  While just about 
every sector traded lower last week, I thought the BIX.X held 
tough, and perhaps hints of some strength as it relates to this 
WEEK's pivots, where bulls might just be BANKing on the banks for 
a rebound in the major indices.

On Friday, the narrower S&P 100 Bullish % ($BPOEX) reversed lower 
into "bull correction" status at 80% when it saw a net loss of 4 
stocks to point and figure sell signals.  That was the first 
reversal lower in the S&P 100 Bullish % since its reversal up in 
March at 28%.  Today's trade saw a net loss of 3 more stocks to 
point and figure sell signals as the bullish % fell to 77%.  New 
entry bulls can play long in here, but stop just below the 
September pivot of 498 at this point, and would play a rally to 
the 512 area.

NASDAQ-100 Tracking Stock (AMEX:QQQ) - Daily Interval


 

I think a QQQ bull needs to be patient with a QQQ entry here, and 
oscillator setup may begin looking to duplicate early August, so 
be prepared for some intra-day volatility, and might even expect 
some continued FRACTIONAL undercutting of previous days lows.

Still a large short interest in the QQQ's that was building in 
September, and I'd have to view a close above $33.22 as bullish.

Today's trade saw a net loss of 1 stock to a point and figure 
sell signal as the narrower NASDAQ-100 Bullish % ($BPNDX) slipped 
back 1% to 78%.  Still "bear correction" status and would take a 
reading of 82% to achieve "bull confirmed" or a reversal lower 
reading of 74% to turn back lower to "bear confirmed."

Jeff Bailey


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

Outside Bars – part deux

In my last article 
(http://www.OptionInvestor.com/traderscorner/tc_091503_1.asp) on 
developing a system from a pattern observation we noticed that 
outside days (high of today is higher than yesterday and low of 
today is lower than yesterday) could sometimes mark important 
market reversals. Using this observation we began the process of 
developing a trading strategy that would hold up under scrutiny 
and rigorous testing. 

In review, here are the criteria with which we ended Part 1.

We defined the bullish reversal bar as follows:

1. Close in upper 1/2 of the daily range
2. Close greater than the open
3. Close greater than the close of two days ago 
4. Occurs in a downtrend identified by 10 EMA of today is less 
than the 10 EMA of yesterday
5. Low of the day must be less than the 10 EMA.

We defined the bearish reversal bar as follows:

1. Close in lower 1/2 of the daily range
2. Close less than the open
3. Close less than the close of two days ago.
4. Occurs in a uptrend identified by 10 EMA of today is greater 
than the 10 EMA of yesterday 
5. High of the day must be higher than the 10 EMA.

The next step was to run tests on the above criteria with a time 
elapsed based exit strategy.

We will start with the bearish period of March 2000 to March 2003 
then test the three years prior, March 1997 to February 2000, in 
order to compare the results to a bullish period. The results, 
for all trades, from each time frame should almost match (albeit 
the short and long results should mirror each other). I will then 
compare the data to the timeframe March 2003 to present for an 
out of sample test and hopefully end up with a robust system. 

Trade size is 100 shares with no commission or slippage. I will 
start with exits at two-day intervals, win or lose. 

Here are the data:


 

From the table above you can see clearly the long trades were 
exited with the greatest profit after only a few days. As a 
matter of fact the profit factor almost steadily decreases, as 
the days get longer. On the other hand the best days to exit a 
short trade would have been 8, 10, 12 or 16, where the 5 trades 
were 100% profitable. This is not surprising because I have 
chosen 3 bearish years to test. 

So trading short from an outside day bar from March 2000 to March 
2003 you would have had 5 trades and they would have all been 
profitable if you exited on day 8, 10, 12 or 16. Unfortunately 5 
trades is not the basis for a trading strategy. 

The data from the bullish period March 1997 to February 2000 was 
dismal to say the least for this period only generated 2 long 
trades. I was expecting to get opposite data where the long 
trades outperformed the short but that was not the case. I quit 
my testing at 16 days because of the shortcoming of only 2 long 
trades.



 

So the initial tests have failed. This highlights the difficulty 
of translating what looks good to the naked eye to a consistently 
profitable strategy. The trade idea was based on observations, 
which were as we can see just coincidence, a phenomenon all-too-
common in system design and trading in general. 

Back to the drawing board and try to figure out where we went 
wrong. The first thing that stands out is the number of trades 
generated was terribly low. Trading strategies cannot be based on 
only 16 trades in 3 years. The pattern definitions used resulted 
in very few reversal signals and even those were not that good. 
Far more of the bars seemed to simply be followed by a 
continuation of the existing trend. This led to another trade 
idea; add a rule to trade outside day signals only in the 
direction of the shorter-term trend with the goal of capturing 
numerous short-term price moves while avoiding the exposure to 
being in the market all the time. Here are the new definitions 
for long and short outside bars that will trigger a trade. 

We will define the bullish reversal bar as follows:

1. Close in upper 1/2 of the daily range
2. Close greater than the open
3. Close greater than the close of two days ago 
4. Occurs in a uptrend identified by the 10 EMA of today greater 
than the 10 EMA of yesterday
5. Low of the day must be less than the 10 EMA.

We will define the bearish reversal bar as follows:

1. Close in lower 1/2 of the daily range
2. Close less than the open
3. Close less than the close of two days ago.
4. Occurs in an downtrend identified by the 10 EMA of today is 
less than the 10 EMA of yesterday
5. High of the day must be higher than the 10 EMA.

On visual inspection you can see this is starting to look better 
already. The Green bars (bullish outside days) are generally 
followed by prices moving up and the Red bars (bearish outside 
days) are generally followed by price moving down with a few 
exceptions. 



 

But as we know from past experience we can't rely only on visual 
inspection, we need to test to see if this observation holds up 
during the backtesting. 

I will leave the entry rules the same as before, enter at the 
open of the next day. But if we just leave it at that the 
strategy would be called an exit and reverse, that is exit a 
trade and immediately reverse, putting us in the market pretty 
much 100% of the time. This isn't what we are looking for; we are 
looking for a short term trading system. So we have to come up 
with an exit strategy.

A visual inspection showed once the low (or high) of the outside 
bar was violated the trade usually continued in the wrong 
direction. Using this to build our exit strategy, I will test a 
stop loss as follows:

Long trades are exited if the current bar's close is less than 
the low of the outside bar. 

Short trades are exited if the current bar's close is greater 
than the high of the outside bar.

The last and the most important part is where to take profits. 
Prior tests done on the outside bar revealed that using a 
percentage of the entry price seemed to work well, so I decided 
to test 1% through 10% profit ranges. 

I am going to use the same dates as the previous test, March 2000 
to March 2003 then March 1997 to February 2000 and will hopefully 
have enough trades to warrant moving to the next step, which will 
be testing in the current timeframe March 2003 to present to see 
if we can replicate the data in what is called out of sample 
testing. If we can, then we have a robust system. 

Here are the data:


 


First of all, we have more trades than our last test, which is 
good. Second, what stands out at to me is taking profits at 1%, 
2% or 3% during the last three years would have been a basis for 
a pretty good strategy but the rest of the data looks pretty 
dismal. Also notice the 3.54 profit factor for long trades at the 
0.02 level in the March 2000 to March 2003 data? Seems completely 
out of sync with the rest of the data, particularly since it was 
in a bearish three-year period. You would have to go back and 
look at this data to see why the results were so odd. But for now 
I am going test the March 2003 to present period and see what 
kind of results show up.



 


Of the percentages that did the best (1%, 2%, 3% and 4%), each 
had a period that did not perform well, typically in the bullish 
1997 to 2000 period. This along with the fact the present bullish 
time frame's number do not harmonize with the numbers we saw from 
1997 to 2000 make the tests disappointing to say the least.

One of the most frustrating parts of this analysis is the number 
of trades, or lack thereof. So what I want to test next is a 
relaxing of some of the filters and just go with:

1. Go Long at the close with an outside bar that closes in the 
upper 1/2 of the daily range 

2. Go Short at the close with an outside bar that closes in the 
bottom 1/2 of the daily range

But for now we have had enough testing. 

Hopefully this is showing you the work that goes into designing a 
good robust system that you can have confidence in. I am hoping 
we will end up with something we can hang our hats on (and also 
make some de niro) but we may not. If not we start over again 
with another pattern observation. Oh my aching hands.

Remember plan your trade and trade your plan (just if we could 
find one).

Jane Fox  


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The Option Investor Newsletter                   Monday 09-29-2003
Copyright 2003, All rights reserved.                        2 of 2
Redistribution in any form strictly prohibited.


In Section Two:

Stop Loss Updates: EXC
Dropped Calls: None
Dropped Puts: None
Play of the Day: Call - EXC
Watch List: Mix & Match

Updated on the site tonight:
Market Posture: Stocks Bounce Down Wall Street Like a Rubber Ball



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STOP-LOSS UPDATES
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EXC - call
Adjust from $60.25 up to $61.00


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DROPPED CALLS
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None


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

None


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

Exelon Corp. - EXC - close: 63.70 change: +1.06 stop: 61.00*new*

Company Description:
Exelon Corp. is the parent corporation for each of Commonwealth 
Edison Company (ComEd) and PECO Energy Company (PECO), which are 
electric utilities.  Exelon, through its subsidiaries, operates in 
three business segments: Energy Delivery, Generation and 
Enterprises.  The Energy Delivery segment consists of the retail 
electricity distribution and transmission businesses of ComEd in 
northern Illinois and PECO in southeastern Pennsylvania and the 
natural gas distribution of PECO in the Pennsylvania counties 
surrounding the city of Philadelphia.  Generation is made up of 
the electric generating facilities, energy marketing operations 
and equity interests in Sithe Energies, Inc. and AmerGen Energy 
Company, LLC.  Enterprises consists of competitive retail energy 
sales, energy and infrastructure services, communications and 
other investments weighted towards the communications, energy 
services and retail services industries.

Why we like it:
With the Utility index (UTY.X) making steady upward progress over 
the past several weeks, and avoiding most of the carnage seen in 
the broad markets last week, there just might be something there 
to catch a bull's attention.  What caught our attention was the 
very bullish action in shares of EXC, which broke out strongly 
over the $60.50 level a couple weeks ago before continuing upward 
into the $62-63 area.  Last week saw a bit of a pullback to fill 
in the 9/18 gap and it looks like the buyers are eager to see 
fresh 2-year highs.  Friday's action say the stock advance 1.5% on 
the best volume since early August (roughly 40% above the ADV), 
and that pushed the stock back into the upper half of the rising 
channel that has been governing price action since the low in the 
middle of August.  EXC is not a fast moving stock, but it does 
tend to trend rather well.  So as long as the stock remains in 
this bullish channel, we have a trend to ride.  According to the 
PnF chart, there's plenty of upside remaining, as EXC is still on 
a Buy signal, with a vertical count of $85.

We'll content ourselves with a more modest goal, looking initially 
for a move up to $66, with an optimistic target of $68-70, which 
would represent a retest of the 2000-2001 highs.  Either move will 
take awhile to unfold, unless EXC is able to break out of the 
channel to the upside.  Otherwise, by the time earnings roll 
around, the $66-67 area is probably all we can expect, as that is 
the projected top of the channel by late October.  Our preference 
for new entries is on intraday pullbacks near support, first in 
the $61.50-62.00 and then closer to $61, which happens to coincide 
with the rising 20-dma.  We're setting our initial stop at $60.25, 
just below the recent breakout, as well as the 30-dma.

Why This is our Play of the Day
The broad markets may have had a hard time deciding what to do on 
Monday, but not so with the Utility stocks.  The Utility Sector 
index (UTY.X) launched higher at the open, gradually worked higher 
throughout the session and the popped at the close to end at the 
high of the day.  Our new play on EXC behaved much the same, 
shooting higher at the open (breaking out over the highs from last 
week) and after some midday consolidation, pushed up to end just 
below the day's high.  Price is now pressing against the upper 
Bollinger band and is very close to the top of the ascending 
channel ($64.10), so new momentum entries above today's close do 
not look favorable on a risk/reward basis.  But a pullback into 
the $62.50-63.00 and rebound from the center of the channel 
($62.60) looks attractive for continuation entries.  The $61.50 
level (bottom of the 9/18 gap and support from last week) should 
now provide strong support, reinforced by the rising 20-dma (now 
at $61.25).  Raise stops to $61.00, which is currently the bottom 
of the channel.

Suggested Options:
Shorter Term: The October 60 Call will offer short-term traders 
the best return on an immediate move, as it is currently in the 
money.

Longer Term: Aggressive traders looking to capitalize on an 
extended rally will want to look to the January 65 Call.  This 
option is currently out of the money, but should provide 
sufficient time for the stock to move higher without time decay 
becoming a dominant factor over the short run.  More conservative 
long-term traders will want to use the January 60 Call.  There are 
November strikes available, but open interest is too low to be 
deserving of serious consideration.

BUY CALL OCT-60 EXC-JL OI= 1116 at $4.10 SL=2.50
BUY CALL OCT-65 EXC-JM OI=  205 at $0.50 SL=0.25
BUY CALL JAN-60 EXC-AL OI= 2982 at $4.70 SL=2.50
BUY CALL JAN-65 EXC-AM OI=  441 at $1.50 SL=0.75

Annotated Chart of EXC:

 

Picked on September 28th at  $62.64
Change since picked:          +1.06
Earnings Date              10/28/03 (unconfirmed)
Average Daily Volume =     1.16 mln



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**********
Watch List
**********

Mix & Match

Golden West Financial - GDW - close: 90.36 change: +1.12

WHAT TO WATCH: Showing great relative strength, shares of GDW 
climb back above the $90 level, building on its pattern of higher 
lows.  We've considered adding GDW to the call a couple of times 
last week and a breakout above $90.50 might do the trick.  GDW 
last split 3:1 on December 13, 1999 when shares were trading near 
$96.  It certainly looks like another split candidate.

Chart=


---

Merck & Co - MRK - close: 51.00 change: +0.17

WHAT TO WATCH: Major drug stocks have certainly under performed 
the markets the past few months but if the major indices continue 
to see more weakness then drug stocks could become havens of 
safety again.  MRK appears to be putting in a double bottom at 
support near $50.  Speculative bulls could bet on a move back to 
$54.00 but watch out for the declining 50-dma.

Chart=


---

Navistar - NAV - close: 36.65 change: -0.22

WHAT TO WATCH: Shares of NAV were hit pretty hard during last 
week's profit taking as the stock broke its 50-dma and the $40 
level.  Shares did bounce from the $36 level Monday morning but 
were unable to make it into the green.  We suspect that if the 
market continues to bounce, this might be a short-term bottom for 
NAV.  However, this is pretty speculative as we're essentially 
calling a short-term bottom, which tends to be dangerous.  Use 
very tight stops and look for some confirmation above $37.00, 
target $40.00.

Chart=


---


Sears & Roebuck - S - close: 44.25 change: -0.58

WHAT TO WATCH: Shares of S were weaker today as the RLX failed to 
participate in the broad market rally.  The stock dipped toward 
its simple 50-dma before bouncing midday.  Bearish traders may 
want to keep an eye on S for a break under the 50-dma or the 
$42.50 mark.  While there is some support at $40 a retracement to 
the $35 level would not be out of the question.

Chart=



----------------------------------
RADAR SCREEN: more stocks to watch
----------------------------------


CC $9.70 -0.50 - Ouch! Shares of CC dropped 4.9%, breaking the 
$10 mark and its simple 50-dma after word hit the street that 
CompUSA bought Good Guys (GGUY), which makes CC less of an 
acquisition target.

PGR $69.70 -0.31 - We're going to keep an eye on PGR as the stock 
has closed below the $70 level but still holding above its simple 
50-dma.  A breakdown under $69.00 might lead to a retest of 
support near $65.00.

ETN $89.69 +0.22 - Much like PGR, shares of ETN have broken 
round-number psychological support but remain above its 50-dma.  
A breakdown at $88 might lead to a retest of support at $85.00.


**************
MARKET POSTURE
**************

Stocks Bounce Down Wall Street Like a Rubber Ball

To Read The Rest of The OptionInvestor.com Market Watch Click Here
http://www.OptionInvestor.com/marketposture/mp_092903.asp


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