The Option Investor Newsletter Tuesday 03-04-2004 Copyright 2004, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: Inline Guidance? Futures Markets: See Note Index Trader Wrap: Market Sentiment: One Word: Cautious Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 03-04-2004 High Low Volume Adv/Dcl DJIA 10588.00 - 5.10 10603.25 10562.74 1.59 bln 1980/1227 NASDAQ 2055.11 + 21.80 2055.12 2031.84 1.80 bln 2091/1055 S&P 100 568.32 + 1.81 568.70 566.16 Totals 4071/2282 S&P 500 1154.87 + 3.84 1154.97 1149.81 W5000 11288.38 + 50.10 11288.44 11226.22 SOX 508.70 + 8.20 508.78 500.55 RUS 2000 598.38 + 7.06 598.39 589.52 DJ TRANS 2884.62 - 3.30 2888.27 2864.78 VIX 14.40 - 0.15 14.50 14.19 VXO (VIX-O)14.71 + 0.01 14.99 14.57 VXN 22.50 - 0.59 23.30 22.38 Total Volume 3,664M Total UpVol 2,450M Total DnVol 1,028M Total Adv 4599 Total Dcl 2593 52wk Highs 591 52wk Lows 9 TRIN 0.96 PUT/CALL 0.71 ************************************************************ Inline Guidance? After a day of mixed markets, sweaty palms and tension so strong you could smell it, Intel lowered its guidance ever so slightly. The initial reaction was negative until the spin doctors hit the airwaves and the damage was muted. The markets, except for the Dow, had ended the days at the highs on expectations of good news. Was it good enough to keep them there? Dow Chart - Daily Nasdaq Chart - Daily Economically it was a strong day that helped build the tension in front of the Intel news. The retail same store sales for February came in at +6.7% and that was the strongest gain since records were first kept in Nov-2000 according to Thompson First Call. The gain was attributed to tax rebates, weather and strong discounting. This trend should continue for the next three months as tax refunds hit mailboxes across the country. Good spring weather would also help the change of seasonal merchandise. Wal-Mart said same store sales rose +6.2% and raised its guidance for March to 4-6% from 3-5%. Its total sales from all stores rose +14%. Jobless Claims fell to 345,000 and a drop of -7,000 from the prior week. The prior week was revised upward to 352K. 39 states reported a decrease in claims for the week. Claims trending under 350K per week have historically been followed by job growth in the +150K per month range. That was the historical trend before three million jobs per year were outsourced overseas. We do not know what new level will be required to produce sustained U.S. job growth. The final Q4 productivity was revised downward to +2.6% and was slightly less than expectations but still strong. You might remember the Q3 productivity was a very strong +9.5%. The final productivity for the year was +4.4%. There was a strong revision to the hourly compensation to +1.4%. This was significantly higher than the +0.5% initial number. The increase in compensation is surprising due to the higher competition for available jobs and the current reduction in benefits trend. Despite the bear market or maybe because of layoffs prompted by it the last two years of productivity growth were the strongest on record since the government began keeping records in 1940. Ironic since it also contained some of the largest job losses in recent history. But, fewer workers is what raises productivity. Using that analogy corporations could fire everyone and raise their productivity to 100%. Be tough finding consumers to buy your products with everyone unemployed. Obviously I say this in jest lest anyone take it wrongly. Factory Orders for January fell -0.5% and slightly more than the estimates at -0.3% but the trend for increased capital spending is still up. The orders have been alternating up/down almost each month for all of 2003 and the minor drop after a +2.1% jump in December was nothing to worry about. December's numbers were revised up making the net change for January nearly flat. The biggest problem with the report was a -2.3% decline in durable goods but the non-durable continued to climb +1.6%. Much of the overall decline came from the transportation component which fell -10.3% but that component is normally discounted due to big swings. While the factory orders are showing overall uptrend improvement the gains are not as wide as analyst's would like. It suggests the recovery is narrower then previously expected and it will take a stronger surge going forward to keep the recovery on track. Analysts fear the narrow breadth could easily crumble if conditions stagnated even slightly. In stock news the mouse house fired half of Michael Eisner and took away his Chairman duties. He remains CEO of Disney. They gave the job to a career board sitter Senator Mitchell who coincidently had nearly as large a no confidence vote (23%) as Eisner. Not being a DIS stockholder I have no opinion other than image is considerably important to stock prices. If 43% of the stockholders basically voted to cut Eisner then what is the board thinking by replacing him with somebody else they don't like? Why does Eisner need this aggravation? Take the money and run and let the peasants have a new king. Dell Chairman and CEO Michael Dell must have seen the writing on the wall and he beat the rabble to the punch by resigning as CEO and appointing the President of Dell, Kevin Rollins, as CEO. Unfortunately Dell stockholders were not impressed and wanted Michael as the CEO and the stock fell on the news. Personally, if I were Michael I would give up both jobs and find a beach somewhere. He has turned a $1000 investment into an $85B company. Time to retire a hero Michael. Don't wait for the stockholders to give you a no vote when the next recession appears. (like they would really do that - grin) Dell has created more millionaires than almost any other company in history except maybe Microsoft. Michael Dell is following in the footsteps of Bill Gates who also stepped aside to let other run the company and give himself more time to be the visionary. The big news after the bell was the Intel mid quarter update. Intel lowered their revenue estimates from a range of $7.9B to $8.5B to a range of $8.0B to $8.2B. That is .3 knocked off the top side and only .1 added to the bottom. To be fair this is not a big deal but the dueling analysts were trying to out spin each other after the bell. Various spinsters were pointing out that Intel usually revises to the high side of the range and a low side revision suggests that business was lighter than expected. Duh! Lighter because Intel has various ways to "account" for revenue that would allow them to adjust to the center of the range if they could. The idea here is that the best they could manage was lighter than expected. The positive analysts were pointing out that Intel was only a "rounding error" away from their midpoint and it was confirmation that the business was still strong. The phrase you will probably hear the most tomorrow is "sales consistent with the lower end of normal seasonal patterns" with the emphasis on the word lower. Traders always want to hear that sales are coming in at the high end of estimates. Intel initially fell on the news but recovered somewhat later in the session. Considering the bullish tilt to the tech stocks during normal hours and seeing the futures recover in after hours I am not seeing any major impact to Friday's market. We still have a lot of darkness before morning and we did close near the highs. I suspect the Employment Report will take the spotlight more than the Intel news. The Intel weakness had been predicted by several analysts. There is apparently a short term glut of notebooks and the Banc America analyst today said it should only last 2-3 months. That glut came in a quarter that is not normally known for tech strength so it is being mostly ignored. HPQ also warned that things were not as hot in tech land as most expected when they said they were only seeing a +1% to +2% gain in IT spending for 2004. The Nasdaq has been listless and range bound for the last month as these factors have been digested. Flextronics also provided an update after the close and it left its forecast unchanged. They affirmed estimates of 9-11 cents and analysts are already expecting 11 cents. Could be a challenge there. FLEX traded down slightly in after hours. The next major hurdle is the Employment Report tomorrow morning. We finally saw some headline grabbing today with estimates well above the +125,000 consensus estimate. Those trying to grab the spotlight included Brian Wesbury a guest on CNBC who predicted +210,000 jobs. Steve Liesman then jumped out in front of the crowd with a size does matter +250,000 estimate in one spot and then declined to quote a number in another. Later an analyst on one of the later stock TV sound bites went all the way to 310,000. I did not catch his name. Thus it has begun. After a great deal of calm leading up to the event the expectations are finally being driven into a reporting frenzy. Fortunately this did not happen far enough in advance to build these expectations into the market. As it stands I think we are neutral and anything over +75K will be seen with some relief and anything over +125K could be greeted warmly. Anything under 75K should be seen progressively negative the closer to zero it gets. We have not had any Fedspeak about jobs this week. That worries me. In the recent past they actually went on the attack and talked up/down jobs with a full court press that was sometimes contrary to the actual numbers in order to juice the markets when the actual numbers were announced. It was deathly quiet this week. Either the numbers do not need any makeup to improve the reception or they are laying low after the Greenspan attack on social security and the dollar had adverse results on the markets. While techs were surging on Thursday the Dow was dormant for the entire day. It traded in a very narrow 40 point range and despite several tries was never able to hold over 10600 for more than a couple minutes. Except for the Monday bounce the Dow has been locked in a range from 10550 to 10650 and it is holding just under the midline at 10600. Trying to paint a technical picture of the Dow one would only need a piece of paper and a straight edge. Other than the Monday bounce absolutely nothing is happening. The one bright point is the ever rising 50dma currently at 10546. With current strong support at 10550 the addition of the 50dma support should make that level tough to break without a major Jobs failure. Dow Chart - 45 min The Nasdaq surprised everyone with a rise ahead of the Intel news and a gain of +21 points. The index rebounded from an early morning dip to 2031 and closed at 2053. There was a battle at 2050 most of the afternoon but short covering before the close finally broke the deadlock. The high on Tuesday before Greenspan tanked the markets was 2064. The rally this afternoon was a relief considering the -45 point drop from those highs to yesterday's lows. The Nasdaq rebounded to close right below the 50dma once again at 2059. That average is proving to be significant resistance. After the bell today there was news from Intel, FLEX, HLTH, TIVO and SBL. SBL, a tech stock that trades on the NYSE missed earnings by -2 cents and dropped -$2 in after hours. While not a Nasdaq stock it is still a tech. Intel was trading down about -60 cents, FLEX about -30 cents and AMAT -50 cents. HLTH and TIVO were up about +70 cents each. The net impact to the Nasdaq at the open should be a small negative bias and probably generate some profit taking from today's gains. Considering it closed on the upside of its recent range it is in no apparent danger. In advance of the Intel news the SOX rebounded off its support at 500 and turned in a +1.62% gain to close at 508. This should be high enough that any Intel/FLEX impact should fade before the 500 level is reached. (keyword = should) The Russell blew out, literally. The Russell moved over its Tuesday high and the highs for February at 597 to close at 598.38. This is only three points from the January highs and five points from an all time closing high and a very strong performance. We are likely to get some pullback at the open from the tech news but I view any dip here as a buying opportunity. The Russell-2000 Ishares (IWN) broke out to a new all time high at 173.00. (optionable) Russell-2000 Chart - Daily The Wilshire-5000 moved within 18 points of a post 9/11 high and being the broadest measure of the markets still suggests the bullish undertone is continuing. Taken with the Russell strength this is a clear signal that bears should take to heart. The Dow is the current dog and the most narrow of indexes. 18 Dow stocks failed to close in positive territory today. Considering the rally in small caps the Dow components could be suffering from the same rotation that sent it to the 10750 highs at the beginning of February. Money that went to the safety of big caps then is fleeing back to small caps as we move into the time for an April earnings run to begin. Internals were surprisingly strong today with advancers beating decliners nearly 2:1 and volume heavily weighted to the advancers. New highs are surging again and new lows are almost nonexistent. In late news tonight the Banking Index BKX is splitting 10:1. The Philadelphia Stock Exchange announced today that the index currently at 1017.77 was being split to improve liquidity of the instrument and make it more attractive to a diverse set of investors. The index is up nearly 50% in the last year and outperformed the S&P for the last four years. The BKX is comprised of 24 national and regional money center banks. The BKX is also optionable. The split is scheduled for March 22nd. For Friday our fate is tied to the Employment report and there is nothing we can do about it. Assuming the numbers are moderately decent I would continue to buy the dips in small cap techs as they have been the hot rods of late. Let the morning volatility fade and check the market direction before entering tomorrow. Remember, if the news is bad you can always wait for Monday and avoid the weekend event risk and let emotions die down. Cash is a position. Enter Passively, Exit Aggressively. Jim Brown Editor *************** FUTURES MARKETS *************** Futures wrap is not emailed due to the excessive number of charts. It may be read on the website at this address.
The Option Investor Newsletter Tuesday 03-04-2004 Copyright 2004, All rights reserved. 2 of 3 Redistribution in any form strictly prohibited. In Section Two: Dropped Calls: None Dropped Puts: None Call Play Updates: AET, AHC, ATH, CDWC, CFC, DHI, QCOM, RJR, RNR, RYL, SLB, UNH New Calls Plays: GS, MHK Put Play Updates: CHIR, CTSH, MMM New Put Plays: None **************** PICKS WE DROPPED **************** When we drop a pick it doesn't mean we are recommending a sell on that play. Many dropped picks go on to be very profitable. We drop a pick because something happened to change its profile. News, price, direction, etc. We drop it because we don't want anyone else starting a new play at that time. We have hundreds of new readers with each issue who are unfamiliar with the previous history for that pick and we want them to look at any current pick as a valid play. CALLS: ***** None PUTS: ***** None ************************Advertisement************************* Full Service Brokers Man Financial announces the formation of the OneStopOption Brokerage Group, addressing the demand for personalized, experienced service for both securities* and futures trading within the same firm. Licensed Option Principals Andrew Aronson and Alan Knuckman specialize in live assistance of stock*, option* and futures traders. The combination of the proven Man Financial global presence and the convenience of one group for all trading needs provide customers with the tools needed for success. Live Broker and Online Trading Available 888-281-9569 http://www.OneStopOption.com ************************************************************** ******************** PLAY UPDATES - CALLS ******************** Aetna Inc. - AET - close: 81.26 change: +0.26 stop: 77.50 AET's CEO reaffirmed their forecasts for 2004 today but the stock did not react very strongly. AET merely continued its slow drift higher after retesting very minor support at $80.50 early in the session. Hopefully the insurance sector will re-start its previous bullish trend if the jobs report delivers and AET, near all-time highs, should be a leader. AET's position above $80 remains an attractive entry point for bulls. Picked on February 29 at $80.79 Change since picked: + 0.47 Earnings Date 02/12/04 (confirmed) Average Daily Volume: 1.2 million Chart = --- Amerada Hess Corp. - AHC - cls: 65.09 chng: -0.34 stop: 63.00 Continuing its necessary consolidation following the strong move earlier this week above $66, AHC is actually holding up quite well, and a large part of that strength is due to a lack of weakness either in the price of crude oil or the Oil Services index (OSX.X), both of which are holding very close to their recent highs. AHC has spent most of the past two days trading inside the range of Monday and Tuesday and this looks like a healthy consolidation ahead of a renewed bullish move. Aggressive traders can use dips that find support above the 10- dma ($63.74) to establish new positions, while those looking to enter on renewed strength will want to see a breakout over $66.60 before playing. Note that our next upside target is the $68 resistance level, but as long as the stock and sector remain strong, a continued rally up to the $72-73 resistance area is possible. Maintain stops at $63. Picked on February 10th at $59.53 Change since picked: +5.56 Earnings Date 1/28/04 (confirmed) Average Daily Volume = 949 K Chart = --- Anthem, Inc. - ATH - close: 88.31 change: +1.01 stop: 84.00*new* Shaking off its lethargy, ATH is starting to pick up some momentum to the upside, blasting to new highs above $88 on Thursday and making rapid progress towards our initial target of $90. With the breakout over $85 now looking quite strong, a revisit to that level of support is looking less likely, giving us the ability to raise our stop to $84, which is now just under the 20-dma ($84.29). The consolidation just above $86 was probably the last chance we'll see to buy a dip before the $90 level is reached. Conservative traders will want to harvest some gains when that level is reached and then possibly look for a re- entry opportunity on the next pullback. With the proximity of that $90 target, momentum entries don't make much sense right here. Bottom line is that there isn't much that looks viable for near-term entry points, as the train has now left the station. Traders unwilling to use a stop at $84 and risk giving back all the recent gains can use a tighter stop just under the 10-dma ($85.84). Picked on February 26th at $85.37 Change since picked: +2.94 Earnings Date 4/28/04 (unconfirmed) Average Daily Volume = 1.43 mln Chart = --- CDW Corp. - CDWC - close: 71.63 change: -0.18 stop: 66.00 We were looking for some consolidation off of Monday's moon-shot rally in shares of CDWC and that's precisely what we're seeing the past few days, as the stock is coming back towards what should be strong support in the $70-71 area. We're already starting to see some intraday support build near $71, and aggressive traders can use this area as an entry point. Those with a more conservative approach can hold out for a test of strong support near $70, as former resistance is tested, backed up by the rising 20-dma ($68.93). Until we see from what level the next rebound begins, we're leaving a wide stop down at $66, which is just under the 50-dma ($66.37). If looking for a momentum entry, then traders will need to wait for a fresh breakout over $74.50, just over Monday's high. That would not be our preferred entry. Picked on March 2nd at $72.43 Change since picked: -0.80 Earnings Date 1/21/04 (confirmed) Average Daily Volume = 1.26 mln Chart = --- Countrywide Financial - CFC - cls: 92.64 chg: +0.54 stop: 86.99 As we suspected the pull back to $90.00 proved to be another entry point in CFC's bullish run higher. The mortgage lender looks primed for a run toward our target at the $100 level. Yesterday CFC announced that it would be presenting next Wednesday, March 10th, 2004 at the Sandler O'Neill West Coast Financial Services conference. Usually these conferences are a chance for management to offer positive comments that occasionally generate upward share price movement. CFC also release news today that it has created a new joint venture with Napolitano Homes. The new venture, NCL Mortgage, will provide homebuyers in Southeastern Virginia with various lending options. There is no change to our stop loss but more conservative traders might consider something closer to the $90.00 level. Picked on February 24 at $91.63 Change since picked: + 1.01 Earnings Date 01/27/04 (confirmed) Average Daily Volume: 2.3 million Chart = --- D.R.Horton - DHI - close: 34.27 chg: +1.34 stop: 32.00*new* Homebuilders surged to another new all-time high as the DJUSHB index added 2.57%. DHI helped lead the group higher with a 4.06% gain of its own and another new all-time high as well. DHI is very close to our profit target so we do not suggest new bullish entries at the current time. As a matter of fact we're going to set our official exit price at $34.75. If DHI trades there or above we'll close the play. If the jobs report disappoints tomorrow short-term traders might watch for a pull back to support near $32.00 as a possible entry. We're going to raise our stop loss to $32.00. In the news DHI announced that its CEO would be presenting next Wednesday at the JMP Securities Research Conference. Picked on February 08 at $30.00 Change since picked: + 4.27 Earnings Date 01/21/04 (confirmed) Average Daily Volume: 2.4 million Chart = --- Qualcomm, Inc. - QCOM - close: 62.57 change: +0.81 stop: 60.50 As expected, QCOM continued to consolidate on Wednesday, falling back to test the 10-dma ($61.77). Also as expected, that level provided support for the next bounce, which got underway this morning and it was a strong bounce too. QCOM appears to have put in another higher low in its aggressive upward trend and traders that took advantage of the dip and rebound over the past two days appear to have nailed a solid continuation entry. Another dip to test the 10-dma can still be used for re-entry, while momentum traders will need to see a push through the $64 level before adding to current positions. It still appears that $60.50 is the best level for stops, and we have the 20-dma ($60.19) rising rapidly to reinforce that level. Remember that our final target for the play is $67-68, so plan your exits accordingly. Picked on February 17th at $59.55 Change since picked: +3.02 Earnings Date 1/21/04 (confirmed) Average Daily Volume = 8.87 mln Chart = --- RJ Reynolds Tobacco - RJR - cls: 61.58 chg: -1.54 stop: 59.00 Ouch! RJR took a 2.43% hit today on some comments from Prudential Equity firm. The analyst there suggested that RJR and its soon to be partner Brown & Williamson may have to divest some of its cigarette brands to a third party in order for the FTC to approve its upcoming merger. RJR countered that they would not since their efficiencies between the two companies would help them better compete with larger-rival Phillip Morris (MO). However, the specter of RJR having to sell some of its brands would alter its revenue/profitability profile which would impact its share price. We would be cautious here and look for a bounce above the $60.00 level to reaffirm support. Picked on February 20 at $60.51 Change since picked: + 1.07 Earnings Date 01/27/04 (confirmed) Average Daily Volume: 699 thousand Chart = --- Renaissancere Ltd - RNR - close: 54.66 chg: -0.21 stop: 52.00 RNR turned in another strong session on Wednesday with the IUX insurance index following behind with its own bounce from the 21- dma. Yesterday's gains may have been sparked by news from RNR. The company raised its quarterly dividend 27% to 19 cents a share. Of course RNR has been strong the last few days prior to the dividend news so it could be a coincidence. Its next dividend is payable on March 15th, 2004 to shareholders on record as of March 9th. Readers should note that RNR is quickly approaching our first profit target range of $55 to $56. The recent highs the last two sessions have been $54.98. Short-term traders should be planning their exit strategies if they have not already taken profits. We're going to official exit the play on any move to $55.95. This is an amendment to Tuesday's exit plans in the 56-57 range. This close to our profit target we would probably not suggest new bullish positions. Yesterday we raised our stop to $52.00. Picked on February 15 at $50.83 Change since picked: + 3.83 Earnings Date 02/03/04 (confirmed) Average Daily Volume: 238 thousand Chart = --- Ryland Group - RYL - close: 90.60 chg: +2.78 stop: 84.99*new* Following in DHI's shadow, shares of RYL added 3.16% and out performed the DJUSHB homebuilding index on Thursday. Today's move is strong confirmation from yesterday's test of support near the $85 level. RYL has already achieved our short-term profit target of $90.00 and readers should already be planning their exit strategy if they have not already taken profits. We plan to officially exit RYL if the stock can traded at $92.00 and then look for another entry on an appropriate pull back. In the mean time we're raising our stop loss to $84.99. We would not suggest new bullish positions this close to our exit but the close over $90.00 is very encouraging. RYL did issue a press release stating that its management would be presenting next week at the Smith Barney Citigroup Global Industrial Manufacturing conference on Tuesday. Picked on February 24 at $83.96 Change since picked: + 6.64 Earnings Date 01/21/04 (confirmed) Average Daily Volume: 746 thousand Chart = --- Schlumberger Ltd - SLB - close: 65.37 change: -0.41 stop: 62.75 There hasn't been much weakness seen in the Oil Patch after the strong push upwards earlier in the week and with both crude oil and the OSX index holding near their highs, our SLB play is following suit, holding onto most of its recent gains and consolidating in bullish fashion above the 10-dma ($64.99). Below $65 support, there is stronger support near $64, the site of the most recent breakout, which is now reinforced by the 20- dma (currently $63.91). So long as the OSX remains strong, dips to either of those support levels can be used for pullback entries, while the next momentum entry will be seen on a breakout over the $66.75 high from Tuesday. Maintain stops at $62.75, just under the late February reaction low. Picked on February 24th at $64.47 Change since picked: +0.90 Earnings Date 1/23/04 (confirmed) Average Daily Volume = 3.59 mln Chart = --- UnitedHealth Group - UNH - cls: 62.50 chng: +0.18 stop: 59.00 We had to exercise a fair amount of patience, but UNH finally broke out over that pesky resistance near $62 yesterday and added to those gains today, ending the day at a new all-time high of $62.50. It is still a rather tenuous breakout, but it is clear that the bulls are still defending support at the bottom of the rising channel. Dips to that level (now near $61.40) can still be used for fresh entry points, while a breakout over today's highs can work for traders preferring to enter on strength. The next obstacle will be for UNH to get back into the upper half of its rising channel above $63.50 and then we can set our sights on the top of the channel near $66. The HMO index is continuing to push to new all-time highs (setting another one today at $919) and as long as that trend continues, we can expect UNH to continue its bullish trend. Maintain stops at $59, which is solidly below the 50-dma ($59.31). Picked on February 24th at $61.92 Change since picked: +0.58 Earnings Date 1/22/04 (confirmed) Average Daily Volume = 2.54 mln Chart = ************** NEW CALL PLAYS ************** Goldman Sachs - GS - close: 108.52 chg: +2.01 stop: 104.00 Company Description: Goldman Sachs is a leading global investment banking, securities and investment management firm that provides a wide range of services worldwide to a substantial and diversified client base that includes corporations, financial institutions, governments and high net worth individuals. Founded in 1869, it is one of the oldest and largest investment banking firms. The firm is headquartered in New York and maintains offices in London, Frankfurt, Tokyo, Hong Kong and other major financial centers around the world.(source: company press release) Why We Like It: Wow! Can you believe it? It seems like earnings season just ended and now we're already looking forward to the next batch of earnings from the broker-dealers. Granted they do announce earlier than the rest of the market but that doesn't mean we can't ride them for a good old-fashioned earnings run. GS is expected to announce in about two weeks but to be honest we can't confirm that date just yet. In the mean time we have a sector that is near all-time highs and looks ready to mount another attempt at a breakout over the 750 level. GS should lead the way with today's breakout over short-term resistance at $108.00. We do not plan to hold over earnings so if a two-week time period is too brief for you be sure to know your limitations and sit out. We're going to suggest longs on today's move over $108.00 with stops at $104.00 - that's where GS bounced about a week ago. The P&F chart suggests a price target of $120.00, which doesn't seem too unreasonable but we'll re-evaluate as GS approaches the $115 range. Suggested Options: Aggressive traders can speculate on March options. Even though we're not holding over the March 18th earnings date (estimated) we're going to suggest the April 105 calls. BUY CALL MAR 105 GS-CA OI=10759 at $4.60 SL=2.35 BUY CALL MAR 110 GS-CB OI= 4940 at $1.50 SL=0.75 BUY CALL APR 105*GS-DA OI= 8600 at $5.80 SL=3.25 BUY CALL APR 110 GS-DB OI= 9307 at $2.85 SL=1.45 Annotated Chart: Picked on March 04 at $108.52 Change since picked: + 0.00 Earnings Date 03/18/04 (unconfirmed) Average Daily Volume: 3.2 million Chart = --- Mohawk Industries - MHK - close: 84.53 change: +1.35 stop: 79.50 Company Description: Mohawk Industries and its subsidiaries, are producers of floorcovering products for residential and commercial applications in the United States. The company is the second largest carpet and rug manufacturer, and a manufacturer, marketer and distributor of ceramic tile and natural stone. Through its carpet and rug business, MHK designs, manufactures and markets carpet and rugs in a broad range of colors, textures and patterns and is a producer of woven and tufted broadloom carpet and rugs, principally for residential applications. Why we like it: There's no question that the strongest sector in the entire market right now is Housing, and the $DJUSHB index tacked on another 2.5% on Thursday to end at yet another new all-time high. But it isn't just Housing stocks that are performing well, as the entire food chain is getting in on the act. Floorcovering of some sort has to go into each and every new house and that fact hasn't been lost on MHK investors, as they aggressively bought the late-January dip and sent the stock soaring a month ago in approval of the company's earnings report. After consolidating the initial move, MHK found support above the top of its post- earnings gap and vaulted higher from the $80 support level. After a few days of consolidating just below the early February highs, MHK broke out strongly today, setting another new all-time high. The strength of the stock can really be seen on the PnF chart, with a long column of X last month, giving a fresh Buy signal and a vertical count of $115! That's obviously a far more aggressive target than we're going to pursue in this play, but a breakout over $85 (which will create another PnF Buy signal) should have a fairly easy time extending up to the $90 level. Once that initial target is reached, we can re-evaluate and see whether it seems reasonable to target a move up towards the century mark. Today's breakout looked pretty solid, but volume was less than convincing, leaving us with the suspicion that we'll see a near-term pullback to confirm support near $83 before MHK continues its upward climb. So long as the stock finds support above the 10-dma ($82.56), that dip can be used for an entry point. And of course, momentum traders can enter the play on a breakout over today's high, which will hopefully come on increasing volume. As a point of confirmation, monitor the $DJUSHB index for sector strength before playing. Set stops initially at $79.50, just under the late-February low. Suggested Options: Shorter Term: The March $85 Call will offer short-term traders the best return on an immediate move, as it is currently at the money. Longer Term: Aggressive longer-term traders can use the April $90 Call, while the more conservative approach will be to use the April $85 strike. Our preferred option is the April $85 strike, which is at the money and should provide sufficient time for the play to move in our favor. BUY CALL MAR-80 MHK-CP OI=110 at $4.90 SL=3.00 BUY CALL MAR-85 MHK-CQ OI=189 at $1.40 SL=0.75 BUY CALL APR-85*MHK-DQ OI= 46 at $2.70 SL=1.25 BUY CALL APR-90 MHK-DR OI= 21 at $0.95 SL=0.50 Annotated Chart of MHK: Picked on March 4th at $84.53 Change since picked: +0.00 Earnings Date 2/05/04 (confirmed) Average Daily Volume = 348 K Chart = ************************Advertisement************************* Live Securities Brokerage Service with Licensed Option Principals OCO Stop & Profit Orders OneStopOption All types of Spreads and Buy Writes 888-281-9569 Auto-Trade Market Monitor Signals Personal Service and Education **Services available for Foreign Traders including Canada** http://www.OneStopOption.com ************************************************************** ******************* PLAY UPDATES - PUTS ******************* Chiron Corp - CHIR - close: 49.02 chg: +0.00 stop: 50.51 Unfortunately we don't have anything new to report for CHIR. Actually we should probably be encouraged. As the BTK biotech index continues to hit new two-year highs shares of CHIR continue to churn sideways under resistance at $50.00. The intraday chart actually seems to be growing weaker with a minor trend of lower highs. CHIR actually hit a new relative low of $48.50 this morning before paring its losses. Considering the environment bears might want to wait for CHIR to trade under 48.50 before initiating new positions. Watch out for the Jobs report tomorrow. If there is any kind of upside surprise it may become a tide that lifts all boats, including CHIR. Picked on February 24 at $49.11 Change since picked: - 0.09 Earnings Date 01/28/04 (confirmed) Average Daily Volume: 1.7 million Chart = --- Cognizant Tech. - CTSH - cls: 45.77 chng: +0.57 stop: 49.00 It's hard to find a solid bearish trend in this market, but it looks like we found one in CTSH, as the stock continues delivering on its pattern of lower highs and lower lows. The $46 support level finally cracked yesterday with a close just over $45 and it was encouraging to see that even with the 1% gain in the NASDAQ, the stock couldn't get back over the $46 level today. That said, the stock is probably due for a bit of a bounce and a subsequent retest of the 10-dma ($47.12), which has been providing consistent resistance for the past several weeks. Conservative traders would not be foolish to harvest some gains near current levels and then look for re-entry on the next rollover near the 10-dma. We're maintaining our stop at $49, which is just over the intraday peak from 2/27, and is now above the 20-dma ($48.99). With all the congestion between $44-46 and our eventual target of $41 so close to the bottom of that range, we are not recommending momentum entries on a breakdown. Picked on February 19th at $47.49 Change since picked: -1.72 Earnings Date 2/10/04 (confirmed) Average Daily Volume = 1.31 mln Chart = --- 3M Company - MMM - close: 78.89 change: -0.06 stop: 81.50 Given the lackluster trading pattern in the DOW over the past 2 weeks, it is really no great surprise that MMM can't figure out what to do with itself. The downtrend is still intact, with a healthy pattern of lower highs, but there's not really any conviction to the downside yet, as the $77.50 support level is still holding firm. Remember that we really need to see the stock trade the $77 level to give us a PnF Sell signal and solidify the downtrend. Resistance has been consistently found just under the 30-dma ($79.78) for more than a month now, so the next test of that average could prove pivotal. A rollover below $80 still looks good for new entries, while those waiting for confirmed weakness will still need to see a drop under the $77 level first. Until that support gives way, we'll maintain our stop at $81.50, just over the mid-February peak. Picked on February 15th at $79.68 Change since picked: -0.79 Earnings Date 1/20/04 (confirmed) Average Daily Volume = 2.79 mln Chart = ************* NEW PUT PLAYS ************* None ************************Advertisement************************* No time to follow the Market Monitor? Tired of missing good Trades because you stepped away from your computer? OneStopOption Group can follow the Market Monitor for you. You choose the number of contracts, we take care of the rest!! Trade Stock Options, Stocks and ALL Futures with the same Group. 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The Option Investor Newsletter Tuesday 03-04-2004 Copyright 2004, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Watch List: Brokers, Education, Insurance and more Traders Corner: Ask And Ye Shall Receive – An Answer Traders Corner: Creation Out Of Chaos Traders Corner: TYPES OF CORRECTIONS AND OVERBOUGHT/OVERSOLD ********** WATCH LIST ********** Brokers, Education, Insurance and more ___________________________________________________________________ How to use this watch list: Readers can use the candidates below as a springboard for their own research. Many are in the process of breaking support or resistance or in the process of starting new trends or extending old ones. With your own due diligence these could be strong potential plays. ___________________________________________________________________ Merrill Lynch - MER - close: 64.23 change: +2.13 WHAT TO WATCH: Merrill Lynch added 3.42% today, breaking out over resistance at the $63.00 level on better than average volume. The entire broker-dealer group looks pretty strong and the sector index could challenge its all-time highs soon near 750. Investors could be betting on an earnings run as the brokers prepare to announce their latest profit numbers in mid to late March. MER's next resistance level is 67.50 to 70.00. Chart= --- Apollo Group - APOL - close: 80.08 change: +2.26 WHAT TO WATCH: Shares of APOL pulled back to their rising simple 50-dma while rival educator ITT Education (symbol: ESI) plummeted on news of a federal investigation. Brave traders who bought the dip have been rewarded as APOL has now broken out above resistance at $80.00 to hit another new all-time high. The recent rallies have been fueled by strong volume and APOL looks like a decent candidate for long positions. Chart= --- American Intl Group - AIG - close: 74.98 change: +0.28 WHAT TO WATCH: The IUX insurance group has recently bounced from its rising 21-dma after a couple of weeks of much needed consolidation. Likewise we see AIG, one of the largest insurers, bouncing from its own 21-dma and preparing to breakout to new highs. Traders can use a move over $75.50 as a trigger to go long AIG and target $80.00. Chart= --- Mobile Telsys - MBT - close: 114.40 change: +4.39 WHAT TO WATCH: Shares of MBT, the largest mobile phone operator in Russia and Eastern Europe, hit another new high today after announcing that its subscriber base jumped 4.6% in February. We can't find an earnings date for the company but traders may want to watch MBT for a pull back to the $110 level or a dip back toward its simple 21-dma. Chart= ----------------------------------- RADAR SCREEN - more stocks to watch ----------------------------------- LAB $12.10 +1.42 - Labranche soars 13% on very strong volume as the company agrees to a settlement over the SEC's investigation in improper trading by specialists. The stock may be reacting to the settlement news and hopes that LAB, as a company, can put it behind them. X $38.63 -0.15 - United States Steel recently broke out above resistance at the $37.50 level and shares have dipped backward to retest this mark as support. Unfortunately volume was excessively high on today's 15-cent drop, which might suggest big investors taking profits. Look for a bounce. Homebuilders: Keep an eye on the homebuilders. Many of the players are breaking out to new all-time highs. A few stocks to watch in the group: LEN, PHM, KBH, SPF, HOV, CTX, TOL, HOV, BZH, WLS. ************************Advertisement************************* Live Securities Brokerage Service with Licensed Option Principals OCO Stop & Profit Orders OneStopOption All types of Spreads and Buy Writes 888-281-9569 Auto-Trade Market Monitor Signals Personal Service and Education **Services available for Foreign Traders including Canada** http://www.OneStopOption.com ************************************************************** ************** TRADERS CORNER ************** Ask And Ye Shall Receive – An Answer By Mike Parnos, Investing With Attitude Among our CPTI couch potatoes, there are a few new spuds in need of a little clarification on the bull call spread strategy we discussed last Sunday. The Trend Is Your Friend – Or Is It? The momentum monkeys are scratching their heads (among other things) because the markets are no longer trending. They spend hours looking for moving average crossings, for volume/price divergences, and for news that will inspire trading opportunities. CPTI students spend hours scouring the TV Guide and Tiffany ads. We, at the Couch Potato Trading Institute, do indeed welcome back a churning, range-bound market that’s going nowhere in particular and is taking it’s own sweet time getting there. Why? Because time is on our side. Fortunately, markets only trend about 15% of the time. The rest of the time, they’re playing in our ballpark. Once again, when we use our neutral strategies with comfortable cushions, we have the odds in our favor. The momentum monkeys had their banana. Now, as the market stalls, it’s time for CPTI students to enjoy a feast. _____________________________________________________________ Mike, Hi and thanks for the awesome content! I attended a very expensive seminar and I’m confused. Your example scenario was: With the stock at $41.98, you said to buy 1 contract IMCL April $35 call for $8.10 and sell 1 contract IMCL April $40 call for $4.40 for a total debit: $3.70. Question (1) – At the seminar, we were taught that a $5 spread should cost less than $1.60 or sell for less than $3.40... This Bull Call Spread appears to be (selling?) a "credit spread" for $1.30. How can you figure out what is acceptable to pay for / receive on this kind of trade? Question (2) -- Max profit occurs at expiration when the time value extrinsic evaporates, but the SHORT $40 is ITM and I'm probably going to get assigned - - correct? Will buying back my short ITM call for a nickel, two days prior to expiration, prevent this? (I've never been assigned). Steve. Steve, Question (1): Years ago I monitored a similar seminar. Some of the information was valuable, but some was . . . misleading. The further you go out of the money, the less the spread will cost you. But, the stock will have to move a lot further to become profitable. Last Sunday, we examined a few scenarios: a) when the stock needs to move up to be profitable, and b) when the stock doesn't need to move at all to be profitable. I'm lousy at predicting direction. The markets, like people’s emotions, can turn on a dime – euphoria one day and depression the next. One thing, however, is constant in the markets – the regression to the mean. In lay terms, that means that, over time, and regardless of the chaos, the markets will settle down and trade in a range. Supposedly, the markets only really trend 15% of the time. That’s why neutral (directionless) strategies are most successful – and less risky. So, for me (and traders like me), it may worth the risk of $3.70 to make the $1.30. I can always exit the trade if the value goes down and limit my risk to whatever figure I'm comfortable with. The whole thing is based on risk tolerance. How much of a credit is acceptable for the in-the-money bull call spread? That’s a personal decision. It depends on how much of a cushion you will have, how much premium you take in, the support and/or trend lines, your account size and how you sleep at night. As you discovered, there are those who promote the concept of placing the trades far out of the money so they can say you only having to be right one out of four times to be profitable. Hey, the numbers work. Why stop there? If we go further out of the money (buying the $50 calls and selling the $55 calls), one would only have to be right about one out of seven times to be profitable. That’s a lot of room for error, but the stock would have to make a huge move. Once again, it’s a matter of personal preference. I'd rather position myself to make money if the stock goes up, stays the same or even comes down a bit – even if it means making less. Question (2): You're not likely to be assigned as long as there is still time value in the short option ($40 call). If the stock moves so far to the point where the time value is gone, you should have closed the position earlier once you achieved about 75% of your potential profit. If the stock is trading above $40, you won’t be able to buy the short $40 call back for a nickel because it will still have some intrinsic value. If we’re wrong about the bull call spread and the stock goes down dramatically, you will need to buy back the short call before you can sell the long call to salvage some of the initial cost of the spread. Buying back a short call (or put) is valuable when you’re using credit spreads. In a credit spread, when the underlying moves far in the right direction, it’s wise to buy back an almost worthless short option to free you from your obligation. _____________________________________________________________ Hi Mike! I enjoyed your article this weekend on the bull call spread. One question that I have though -- is there any maintenance requirement since this is a debit spread? I don't believe you mentioned any. Thanks! JK JK, There really shouldn't be any maintenance requirement because you are not exposed for losses over and above what you paid for the spread. Remember, the bull-call spread is an interesting strategy – but used primarily by those who want to choose a direction. _____________________________________________________________ Hi Mike, Instead of paying $3.70 for the bull-call spread, wouldn’t you be able to accomplish the same thing by using a bull-put spread? What’s the difference? Lisa Lisa, Yes, Lisa, you can. Obviously you’ve been around the block a few times. You’re ahead of the curve. A bull-put spread is a credit spread. That means that we’re taking money INTO our account. We’re still picking a direction (bullish). We might be able to take in the same $1.30 of credit with a bull-put spread using strike prices BELOW where IMCL stock is trading. The object will then be for IMCL to finish above the short strike price (out-of-the-money) and for both put options to expire worthless. Should that happen, we save two commissions. _____________________________________________________________ MARCH CPTI POSITIONS Position #1 – OEX (S&P 100 Index) Iron Condor – 568.32 We sold 12 OEX March 595 calls and bought 12 OEX March 605 calls (Bear Call Spread). Then we sold 12 OEX March 540 puts and bought 12 OEX March 530 puts (Bull Put Spread). The total net credit was $1.20 ($1,440). Maximum profit range: 540 – 595. Maintenance: $12,000. Position #2 – RUT (Small Cap Index) Iron Condor – 598.38 We sold 8 RUT March 610 calls and bought 8 RUT March 620 calls (Bear Call Spread). Then we sold 8 RUT March 550 puts and buy 8 RUT March 540 puts (Bull Put Spread). The total net credit was $2.75 ($2,200). Maximum profit range: 550 - 610. Maintenance: $8,000. Position $3 – MNX (Mini-NDX Index) Iron Condor - $148.14 We sold 20 MNX March $157.50 calls and bought 20 MNX March $160 calls (Bear Call Spread). Then we sold 20 MNX March $142.50 puts and bought 20 MNX March $140.00 puts (Bull Put Spread). The total net credit was $.90 ($1,800). Maximum profit range: $142.50 - $157.50. Maintenance: $5,000 less $1,800 = $3,200. Position #4 – BBH (Biotech Index) - Siamese Condor - $150.35 We sold 10 BBH March $145 calls and sell 10 BBH March $145 puts for a credit of about $6.95. Then we bought 10 BBH March $160 calls and buy 10 BBH March $130 puts for a debit of about $.70. The total net credit is $6.25 ($6,250). Our profit (safety) range is $138.75 to $151.25. These are also our bailout points. The closer BBH finishes to $145, the more money we will make. ______________________________________________________________ ONGOING POSITIONS QQQ ITM Strangle – Ongoing Long Term -- $36.76 We bought 10 contracts of the 2005 QQQ $39 puts and 10 contracts of the 2005 QQQ $29 calls for a total debit of $14,300. We make money by selling near term puts and calls every month. Here's what we've done so far: October: Oct. $33 puts and Oct. $34 calls – credit of $1,900. November: Nov. $34 puts and calls – credit of $1,150. December: Dec. $34 puts and calls – credit of $1,500. January: Jan. $34 puts and calls – credit of $850. February: Feb. $34 calls and $36 puts – credit of $750. March: Mar. $34 calls and $37 puts – credit of $1,150. Total credit: $7,300. Note: We haven't included the proceeds from this long term QQQ ITM Strangle in our profit calculations. It's a bonus! And it's a great cash flow generating strategy. ZERO-PLUS Strategy. OEX – 568.32 In my Feb. 8th column, I outlined a strategy based on an initial investment of $100,000. $74,000 was spent on zero coupon bonds that will mature in seven years at a value of $100,000. In essence, that guarantees the principal $100,000 investment. We are trading the remaining $26,000 to generate a “risk free” return on the original investment. We bought 3 OEX Jan. 2006 540 calls at a cost of $24,300. Then we sold 3 OEX March 2004 585 calls for a credit of $930. We also put on a bull put spread, selling three OEX March 535 puts an buying three OEX March 525 puts for a credit of $330. Our total credit is $1,260. Our current cash position is $2,960 ($1,260 plus the unused $1,700). This one is going to drag on for seven years, so get comfortable. We’re going to make some money. _____________________________________________________________ New To The CPTI? Are you a new Couch Potato Trading Institute student? Do you have questions about our educational plays or our strategies? To find past CPTI (Mike Parnos) articles, look under "Education" on the OI home page and click on "Traders Corner." They're waiting for you 24/7. ____________________________________________________________ Happy Trading! Remember the CPTI credo: May our remote batteries and self- discipline last forever, but mierde happens. Be prepared! In trading, as in life, it’s not the cards we’re dealt. It’s how we play them. Your questions and comments are always welcome. Mike Parnos CPTI Master Strategist and HCP _____________________________________________________________ Couch Potato Trading Institute Disclaimer All results reported in this section are hypothetical. While the numbers represented here may have been achieved or beaten by our readers, we make no representation that any individual investor achieved these exact results. The tracking for the plays listed in this section uses closing prices for the day the newsletter is published and it is not meant to imply that any reader actually received those prices or participated in these recommendations. The portfolio represented here is hypothetical and for investment education purposes only. It is only an illustration of what type of gains a knowledgeable investor might receive utilizing these strategies. ************** TRADERS CORNER ************** Creation Out Of Chaos by Mark Phillips mphillips@OptionInvestor.com Any application of intellect to the solution of a vexing problem must by definition require the use of the creative centers of our brains. I'm an analytical person and struggle when I have to operate in this mode. My brother on the other hand is entirely creative and is in his element when trying to fuse seemingly disparate pieces together. The one general statement I can make is that the process of creation is ugly. Partway through the process, we can expect to see bits and pieces of whatever we're trying to create strewn about the desk/workbench/room/house and at first glance it would appear nothing more than a haphazard collection of stuff. It is at the core of what we call creativity that all of these disparate pieces are fused together, creating a whole that is greater than the sum of its parts. I suspect even the Almighty had a couple moments where the whole creation of the world was looking pretty chaotic. Say what you want about it, I think he did a good job -- the platypus and emu notwithstanding. Unfortunately, we don't have omniscience or omnipotence going for us, when we're trying to create a trading system out of thin air. If we did, then I certainly wouldn't have fallen victim to technology issues and this article would have been posted last night in its usual time slot! GRIN Alright, last week we laid out most of the basic parameters which a good trading system must adhere to and it is time to now delve into the meat of the matter -- what actually goes into our trading system. By now, we've defined the goals of our system. Now we need to see if we can create one that satisfies those goals. To keep things simple in the early going, it is easiest to build our trading model applied to just one symbol and then after we're happy with the first iteration, we can apply it to other symbols to determine how robust it is. For no particular reason, I'm going to use CSCO (from last week's initial list) as our case study for our efforts here together. Now I need to clarify what my purpose is in this series of articles. Recall that I'm not trying to build a successful system in these pages -- if I was, we'd be hashing this out well past Memorial Day due to the space limitations we must work with. Instead, I'm endeavoring to do something much more valuable -- show the steps involved in building a solid trading system so that anyone that is interested in creating one of their own will have a roadmap to follow. Our starting point must be in the application of some technical studies, which we then observe how they behave in terms of generating profitable trade signals. If the success rate is sufficiently high, then we have a rule (or set of rules) that we can incorporate into our overall system definition. Some of the more common tools that can be brought to bear on this thorny problem are various oscillators, moving averages, chart patterns and we can even incorporate candle patterns and chart patterns from the PnF world. There is a virtually endless series of combinations that can be applied to price action in the pursuit of a profitable trading system. What we must keep in mind at all times is the requirement that if we want an automated trading system, any rule must be capable of being translated into computer language. Strong signals and weak signals cannot be differentiated by the computer unless we give it some way of making a cold and calculating decision. As you can see, if we are successful in our venture, we will have an end product that will have removed much if not all subjectivity from the equation. Let's assume that we want to keep our system simple and we will use only moving averages and oscillators for defining entry and exit criteria. That still leaves the field wide open, as we have to determine so many settings. How many moving averages will we use? Simple or exponential? What periods seem to work the best? On what timeframe chart do we find the most reliable signals? Can different timeframes be combined to enhance results, or should we just stick with a single timeframe? How about oscillators? Which one or ones provide the cleanest and most reliable signals? What settings are optimal -- giving signals on a regular basis (remember we're looking for at least 2 trades per month) without excluding the big potential winners, while at the same time avoiding the trap of getting caught in too many small losers? These are all great (and necessary questions) and the process can be a bit daunting at first. We can peruse chart after chart and each snapshot can give us a different setup that seems to work. What we have to do is observe what we see on the charts, then translate that to some initial 'rules' and then test those rules against price action and see if they yield profitable results. If not, then we discard or modify that potential 'rule'. If it provides a sufficiently high success rate, then we file it away as a viable system rule. Then we go back to the charts, make more observations, build another test 'rule' and test it for viability. When we've finished this process, we have a set of rules that on their own appear to have favorable results. The next step is to see if results are improved or diminished by any combination of the rules that passed the first test. As you may quickly infer, this process is prohibitively time-consuming without a computer program like Trade Station in which we can program the system rules and let it run unemotionally through historical data and give us the hard data. Just the definition of one successful rule is more involved than we can possibly cover in sufficient detail here, but let's begin the process so you can see how it works. Let's start with a very simple approach, that of the application of the 50- and 200-pmas on various timeframes. We know that the cross of the 50-pma over the 200-pma on the daily chart is one of great technical significance, as it often marks the transition between a bullish and bearish trend. So let's start with the premise of trading crossovers of these two moving averages and then successive tests of the 50-pma on various time-frames. Applied to the daily chart, there will clearly not be nearly enough trade signals to satisfy our requirement for a minimum of 2 trades per month. That leaves us with no choice but to dial down to shorter time- frames and see if there is something viable. Since not all charting programs will allow us infinite flexibility in setting our chart time-frames, let's start with an eye towards the more common values of 60-min, 30-min, 15-min, 10-min and 5-min charts. Obviously, the first step is simply to pull up charts of CSCO using each time-frame, with only a 50-pma and a 200-pma shown and look at both the crossovers and the retests of the 50-pma and ask ourselves if it appears (strictly from inspection) that a viable rule can be written. If price just chops through the moving averages with an apparent lack of consistency, obviously this moving average rule will not work on that time-frame. By going through this process, we should be able to formulate a rule that specifies over what time-frame(s) work best and how we can best manage entries and exits. Just detailing that simple exercise with annotated examples will require another whole article and that will be the topic of conversation for next week. In the meantime, let me invite those of you that are interested to embark on this little research project so that we can compare notes in the next installment of this series. I can promise you that if you go through the exercise on your own, and then come back to the discussion next week, it will be infinitely more valuable to your understanding of this overall process. So here's my challenge. Look at CSCO on each of the chart time- frames listed above, applying just these two moving averages and observing (I would highly recommend taking notes as you do) what appears to work and what doesn't. Look at enough data so that in each time-frame you have observed several transitions (at least 4- 6) between the bullish and bearish alignment. Remember bullish is with the 50-pma over the 200-pma and bearish is with the 50-pma below the 200-pma. This is at the very heart of what we must do in the early stages of system development. Just plunging blindly into programming a system without going through this process of discovery will be both frustrating and unproductive. On the other hand, actually going through this exercise will provide many insights into the interrelationships between the different time-frames, as well as technical analysis as it applies to system development. So have fun perusing the charts this week and we'll have some fun with lots of charts next week! Mark ************** TRADERS CORNER ************** TYPES OF CORRECTIONS AND OVERBOUGHT/OVERSOLD By Leigh Stevens lstevens@OptionInvestor.com OIN SUBSCRIBER QUESTION: In your recent Index Trader article you said that if rallies can't get above the 21-day moving averages, it would suggest that the indexes might fall to the lower moving average envelope you were using. I noticed the S&P got above this average but then fell back but not by much. The Nasdaq couldn't get above its average but hasn't fallen a whole lot either. Both are staying close to the average. Is there something that this tells you about the direction in the next month? RESPONSE: Yes. The market is now going sideways or has become "trendless" as some would call it. I consider a sideways trend to be a trend, but others would say that it's the absence of a trend. The market goes into these sideways moves fairly often after an initial sustained advance or decline. When this happens, I figure that this situation is telling us a couple of things: 1. The sideways move appears to be a "consolidation" (of the 2. prior price swing) rather than a reversal of the dominant 3. trend even in the case of the Nasdaq it seems – holding its 4. own above 2000 in the case of the Composite (COMPX). A reversal usually begins with a move that "retraces" more of the prior trend - for example, a third to half or even as much as two thirds of the previous move. That has happened in the case of the Nasdaq 100 (NDX), which has retraced more than 50%, but not quite 62% of the move from the double bottom low to the peak of the rally, as you see here. In the S&P segment of the market, it is more of a sideways trend, not much of a retracement at all. This situation also demonstrates that buyers and sellers are pretty well in balance. The market is marking time, waiting for more influences or market moving reports or for earnings season, etc. It also says, selling premium as in short options is going to be better than being long calls or puts. The time premiums start eroding as a sideways trend continues and volatility dries up. 2. The market is also showing us that its "overbought" situation – and you may recall me saying that the market had gotten too overbought to continue to go further up without a correction setting in first – might be offset by a "time" correction or sideways price movement. Corrections can be in price or time – or some of each. PRICE: the index retraces some portion of the prior move but less than two thirds (Nasdaq) OR prices mark time and go sideways (S&P) – you'll notice that as far as stochastic or RSI type indicators, the results are pretty much the same, just not as quick. The lines being to move down again, away from the high extremes. "OVERBOUGHT" AND "OVERSOLD" - You see these terms bandied about all the time, especially by the talking heads on CNBC and in the other market media. The first I try to point out is that "overbought" and "oversold" are ALWAYS RELATIVE terms or concepts. Overbought or oversold means that a stock or index is thought to be at an extreme (on the downside or upside). But a stock or an index is only "over"- bought or "over"-sold in terms of TIME and CONDITION. TIME – By time I mean - are you talking about intraday, on a 2-3 day, 2- 3 week or 2-3 month time frame? A stock or index is thought to be at an extreme only relative to, or in terms of, a certain period of time. For example, the OEX might be thought to be quite oversold because it went down sharply down for 5 straight days. However, this might be in the context that the index went up strongly for 5 straight weeks or, 5 consecutive months. In this example and its shown below with the S&P 100 or OEX, on a longer-term basis the index is not oversold, and may in fact be considered to be still "overbought" after even a period when the index has fallen, at least from its peak. When you hear someone say the market is overbought or oversold, you should next think about what time frame they are they talking about – assuming they KNOW what they are talking about and not just repeating something that they have heard. CONDITION – By "condition" I mean that the relative terms overbought and oversold mean different things in different market conditions or different types of markets. By this is meant that overbought and oversold are best defined in a market that is in a fairly defined trading range; for example, take a cyclical stock like Alcoa (AA) for the period shown - When the stock has been in the 20-24 range is was "oversold" – when it’s been at 40-44 it has been "overbought" and sold off quite substantially from there – again, for the period shown. I am not trying to make too sweeping of a statement here. In a strong bull or bear market on the other hand, the overbought/oversold concepts, especially in the indices, are less meaningful as they will tend to go up and keep going up and stay "overbought", according to the conventional technical indicators for these things (e.g., MACD, Stochastics or RSI), for lengthily periods of time. The same is true in a bear market and we don’t have to search far for examples in this last year! The conventional technical indicators that attempt to define the relative concepts overbought and oversold are going to say that the market is oversold, and oversold and again, oversold! SOME BASICS – An index, or an individual stock, is commonly thought to be overbought or oversold when prices have an advance or decline of a degree that is greater than what is normal or usual relative to its past price behavior for a certain time frame and condition. Take, for example, the case of a stock that for five months, or 5 years even, has never traded at a price that was greater than 10% of its closing average for the prior 200 days. Then comes a period when there is such a steep advance that the stock reaches a price that puts it 20-25% above this same average – this stock may be considered to be "overbought". Overbought here implies simply that any surge in buying well in excess of what is usual on an historical basis, also creates a likelihood that the stock price will correct. Another example of an overbought condition might make an assumption about a stock that has closed higher for 10 days straight – if this price behavior is "over" or beyond what is usual for this item, the assumption is that prices are vulnerable to snapping back – a rubber band analogy is a good one, as market valuations get stretched, so to speak, but then tend to also come back to a mean or an average. The concept of overbought and oversold refer to rallies or declines that are steeper than usual, but the degree of this can vary a good deal in terms – there is no precise, objective or agreed upon measurement. The first example mentioned of overbought is a more objective measure in that it examined the close in relation to an average close of the prior 5-years. The second example given of overbought was based on more subjective criteria -- 10 days of consecutive up closes resulted in an extreme reading on an oscillator or type of technical indicator that "oscillates" between 0 and 100 like the Relative Strength Index (RSI) or between certain levels in the context of its past range in values like the MACD indicator. A central important aspect of overbought or oversold is that the concepts relate to a situation where there is a preponderance of hours, days or weeks, over some specified period of time, where prices are moving strongly up or down. The concept of a specific price area that represents a level that is overbought or oversold does not normally come into play – only that price momentum or the rate (speed) at which prices change, is stronger than usual and predominately in one direction and experience suggests that at some point, after a market gets into the overbought or oversold ranges, there is an increased likelihood that there will be a price correction or counter-trend move. USE IN TRADING – The "best" or most effective use for oscillator type indicators is in a trading range market. More on this in another Trader's Corner – meanwhile, please e-mail any questions of a technical sort. I don't do advice to the lovelorn, love-worn, etc. ************************Advertisement************************* Full Service Brokers Man Financial announces the formation of the OneStopOption Brokerage Group, addressing the demand for personalized, experienced service for both securities* and futures trading within the same firm. 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