The Option Investor Newsletter Thursday 07-15-2004 Copyright 2004, All rights reserved. 1 of 3 Redistribution in any form strictly prohibited. In Section One: Wrap: No Surprise Yet Futures Wrap: See Note Market Sentiment: No Conviction Posted online for subscribers at http://www.OptionInvestor.com ************************************************************ MARKET WRAP (view in courier font for table alignment) ************************************************************ 07-15-2004 High Low Volume Adv/Dcl DJIA 10163.16 - 45.60 10235.65 10162.94 1.70 bln 1686/1426 NASDAQ 1912.71 - 2.20 1925.76 1910.13 1.64 bln 1479/1512 S&P 100 537.88 - 3.91 542.81 537.84 Totals 3165/2938 S&P 500 1106.69 - 4.78 1114.67 1106.60 W5000 10792.14 - 29.38 10861.07 10790.07 SOX 418.53 - 2.20 425.49 416.75 RUS 2000 562.16 + 2.42 564.35 559.74 DJ TRANS 3125.39 + 40.20 3141.32 3084.24 VIX 14.71 + 0.95 14.73 13.60 VXO (VIX-O)15.73 + 0.71 15.75 14.96 VXN 21.68 + 0.04 22.14 20.96 Total Volume 3,603M Total UpVol 1,531M Total DnVol 1,985M Total Adv 3536 Total Dcl 3364 52wk Highs 148 52wk Lows 181 TRIN 1.61 NAZTRIN 1.13 PUT/CALL 0.83 ************************************************************ No Surprise Yet by Jim Brown As the earnings momentum increases the markets continue to trade sideways as investors hold their breath expecting big surprises. So far those surprises have not appeared and we are seeing earnings much like the economics, mixed. After the close today we had an almost equal amount of earnings warnings, earnings misses and companies beating the street. Dow Chart Nasdaq Chart SPX Chart Recent economics have resembled a box of chocolates, you never know what you are going to get. It started with the Jobless Claims this morning spiking to 349,000 once again and completely erasing the one week drop to 309K last week. Continuing claims moved closer to the three million market with a jump to 2,971,000. While the government and analysts speculated that last weeks low number was an anomaly, nobody expected a jump right back to the 350K level. Last weeks low number is being attributed to incorrect July-4th seasonal adjustment factors. The jump this week is being attributed to a shutdown in automakers to retool for the 2005 production year. Most notable for me is the flat trend for claims. They have quit falling over the last six weeks and have stabilized just under the 350K level. This is troubling but it could be just the summer doldrums of hiring. Business Inventories rose a smaller than expected +0.4% in May. Retail inventories were flat for the month and the first time they have not risen since August 2003. Concern about the direction of the economy and early warning signs about the slowing consumer trend probably kept retailers from stocking up. Business Sales rose +0.7% and when coupled with low inventory levels keeps exposure to potential economic risks at a minimum. The inventory to sales ratio remained at its record low of 1.30 for the third month. That means there is only 1.3 months of inventory on hand. Any further increase in sales should force a continued uptick in manufacturing or eventually there will not be any product to sell. The NY Empire Manufacturing Survey jumped to 36.5 from 29.9 in June. This was well over consensus estimates of only 28.3. Shipments, orders and back orders all posted large gains. Even employment eked out a small gain. Unfortunately Prices Paid rose while Prices Received dropped. This shows inflation pressures building but could also be a reflection of higher energy prices. The Philly Fed Survey jumped to 36.1 from 28.9 and echoed the same theme as the NY Survey. This was well above consensus estimates of 26.3. Employment in the Philly Survey jumped to a very strong 24.6 from 16.8. The various Fed surveys have been mixed of late. Different regions are showing different stresses and this is normal for a slow growth environment. The current expansion signals are very positive for future non inflationary growth. The main inflation gauge for this week the PPI posted a surprising -0.3% drop. This was directly related to the drop in oil prices last month and this is good news for the Fed. Unfortunately with the oil spike to $41 this week this brief drop in the PPI may not last. This report produced a spike in the futures on the headline number but that spike did not hold once the cash market opened. There were lots of positive internals but they were mostly related to the drop in oil so I will not dwell on them. More important to the economic picture was the drop in Industrial Production by -0.3% when expectations were for a small gain. May's gains were also revised down slightly. Capacity Utilization dropped to 77.2, a drop of -0.4% from the prior month. Consumer goods production dropped -0.7%. This does not bode well for the retail inventory buildup I discussed above. For the Fed this was a very good day. Headline inflation falling and manufacturing still expanding but enough slack in the industrial production to prevent a resumption of that inflation any time soon. The chances for a 50 point rate hike in August have dropped to only 15% according to the Fed Fund futures and this is a statistically insignificant chance. There is still a good chance for a 25 point hike in August and that meeting is only three weeks away. Sure seems like we just had one but that is what the calendar is saying. Time sure flies when you are having fun. The big news for the day was earnings and Nokia headed the morning list with another warning that future profits were threatened by increased competition, lower prices and a lack of popular new models. Nokia has been the poster child for the problems in the cell phone industry of late and today's whining is no different. Yes, we know it is a tough market and the easy money has been made. Suck it up and forge ahead. The other market mover was oil topping $41 a barrel this morning and the cancellation of the OPEC meeting next week. They instead believe they can implement the increase in production without impacting prices. Let's see. They are already pumping well over their stated levels even after the "formal" production increase. Oil prices are $41 today and rising despite this increase in production. It does not take a rocket scientist to figure out that the "proposed" increase already in effect will not impact prices. Yep, no reason for a meeting. After the close today the big numbers came from IBM which posted earnings that beat the street by +4 cents. This should have produced a rousing reception but the lukewarm guidance poured cold water on the flames. IBM repeated its guidance word for word from the previous quarter saying "analysts estimates were reasonable." They were right on the mark on their revenue with only a miniscule miss of $20 million on total revenue of a whopping $23.15 billion. They said spending was continuing to improve led by growth in emerging markets like China. I am not normally a fan of IBM earnings due to the game they play each quarter. Like other quarters they bought back $1.3 billion in shares which raises their earnings per share. They also received a currency benefit of 2-7% depending on the division and type of sale. Still IBM did post an increase in revenue, profits and said they expect margins to improve going forward. There was nothing really negative in this report. This alone may not be enough to produce an earnings bounce on Friday but there is nothing here to really push us lower. Helping the markets in addition to the IBM news was earnings wins for PMCS and RMBS after the bell. PMCS beat by a penny and RMBS by two cents. PMCS talked up the future prospects but suggested that summer revenue could be flat to +7% for the quarter. PMCS fell about -50 cents in after hours but the overall outlook was very positive. Offsetting the PMCS weakness was RMBS which doubled its earnings and grew revenue by +20% to a new record. Rambus was bubbling with excitement and the stock jumped about +12% in the after hours session. The reason I am thinking we could see a relief rally tomorrow is two fold. First we had a fear of IBM crash at the close where the major indexes tanked as investors bailed rather than be long over their earnings. This created an artificial oversold bias. Secondly, IBM, PMCS and RMBS were all making bullish comments about chips. Considering the two day drop in the SOX to 420 support any good news should be a reason for a rebound. The SOX is very oversold and due for a rebound off that 420 support which dates back to September of last year. In addition to the IBM comments about spending increasing we had the CEO of Eaton (ETN) saying this was the strongest economy on all fronts he had seen in years. Eaton is a diverse manufacturer and like GE they are saying business is good. Offsetting that warm feeling was NFLX, which missed estimates by -2 cents and failed to impress investors with their story. The stock dropped -$4 in after hours. HOTT warned after the close but that is old news as we already know the retail sector is under pressure. SOX Chart The drop in the SOX and fear of IBM sent the Dow back to its monthly lows at 10162 just before the close. It did not recover. This is a little more than -20 points below its 200dma at 10189 and right on the edge of a real breakdown. It is time for the bulls to make a stand if they are going to rescue the markets from a retest of the May lows this summer. The Nasdaq has slowly inched down to its lowest close of the month at 1912 but it appears the decline is slowing as we near support at 1900. I have speculated before that 1900 would be a good bottom for a summer trading range and I would really like to see a relief rally on Friday give us a little more breathing room before the Democratic convention on the 26th. Our best chance of a rebound comes from the SPX which is about to test its 200dma at 1102 after closing at 1106 on Thursday. This is a critical test of market support and one that should hold. The S&P futures hit 1102.50 in after hours and have rebounded slightly already. We may need the cash test to trigger the buy programs (speaking optimistically here) and that could come at Friday's open. It is an option expiration day and sharp volatility at the open could be the key to the test. The focus on Friday will be on Martha Stewart and the betting line is 10 months in a minimum security prison. The sentence will be given at 10:00 tomorrow and you can bet all eyes will be watching whether they really care about the outcome or not. Volume on Wednesday's Intel led dip soared to 4.239B across all markets. This was the highest volume since June-25th and the Russell rebalance. Unfortunately it was 2:1 negative. Thursday's volume was only slightly lower at 3.651B but the ratio was only slightly negative. New 52-week highs have been rising daily since last Friday's low. That low capped a two-week slide since June 23rd. What I am suggesting is that the internals are not quite as negative as the indexes and we could easily rebound from the IBM dip at the close. However, with the Dow teetering on the cliff at 10162 this is a do or die situation. A failure to rally here could setup a quick retest of Dow 10000 or even the May lows at 9900. The major problems still ahead are the Democratic convention only one week away. I believe any rally will be short lived as investors take protective positions ahead of that event. Earnings will continue to increase next week and there will be plenty of companies to cuss and discuss. The setup for Friday sees markets at their lows and right at critical levels. It would be a good place for a major move in either direction and I am hoping it is up but ready to react in either direction. I suggest you do the same. 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. http://www.OptionInvestor.com/indexes/futureswrap.asp ************************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. Call us 888 281-9569 to see if you qualify to have us rebate your subscription cost. http://www.OneStopOption.com ************************************************************** **************** MARKET SENTIMENT **************** No Conviction - J. Brown We appear doomed to watch stocks slowly slip away or at best remain within their trading range. Wall Street is turning up its nose to lackluster economic reports while investors seem to be focusing on the earnings misses and not the earnings hits. Nokia (NOK) was the big disappointment this morning with a sales shortfall due to rising competition in the handset market. Yet we saw individual stock gains in flash memory maker SanDisk (SNDK) and iPod wonder Apple Computer (AAPL) after their impressive earnings numbers but it wasn't enough to juice up the technology sector. Traders were too worried that Big Blue might miss when it announced after the close. Fortunately, IBM managed to beat analyst profit estimates but revenues came in a little light and could spoil investors' reaction. What I find strange is that the Industrials have been slowly fading lower throughout the month while the NASDAQ Composite is down more than 6.5 percent for the month yet the volatility indices continue to hover near their lows when they should be climbing. Another technical/sentiment indicator the TRIN or ARMS index is showing several moving averages near bullish levels, which should coincide with the market's short- term oversold status. Maybe the Dow needs to hit 10,000 and the NASDAQ needs to hit 1900 before investors feel brave enough to buy the dip. On the other hand a breakdown below these psychological levels could lead us into a very bearish third quarter for stocks. We don't have any super big earnings reports tomorrow so Wall Street will focus on the CPI and Michigan Sentiment economic reports due out tomorrow. Oh, I'm sorry, what was I thinking? The financial media is going to focus on the Martha Stewart sentencing (as if it matters). ----------------------------------------------------------------- Market Averages DJIA ($INDU) 52-week High: 10753 52-week Low : 8996 Current : 10163 Moving Averages: (Simple) 10-dma: 10250 50-dma: 10228 200-dma: 10193 S&P 500 ($SPX) 52-week High: 1163 52-week Low : 960 Current : 1106 Moving Averages: (Simple) 10-dma: 1115 50-dma: 1117 200-dma: 1103 Nasdaq-100 ($NDX) 52-week High: 1559 52-week Low : 1204 Current : 1415 Moving Averages: (Simple) 10-dma: 1443 50-dma: 1448 200-dma: 1445 ----------------------------------------------------------------- CBOE Market Volatility Index (VIX) = 14.71 +0.95 CBOE Mkt Volatility old VIX (VXO) = 15.73 +0.71 Nasdaq Volatility Index (VXN) = 21.68 +0.04 ----------------------------------------------------------------- Put/Call Ratio Call Volume Put Volume Total 0.83 935,067 771,837 Equity Only 0.62 708,886 436,307 OEX 1.51 34,399 51,887 QQQ 1.22 37,454 45,693 ----------------------------------------------------------------- Bullish Percent Data Current Change Status NYSE 64.8 - 1 Bear Confirmed NASDAQ-100 45.0 - 3 Bull Alert Dow Indust. 66.7 + 0 Bear Confirmed S&P 500 60.4 - 1 Bear Correction S&P 100 62.0 - 2 Bear Correction Bullish percent measures the number of stocks in an index currently trading on a buy signal on their point and figure chart. Readings above 70 are considered overbought, and readings below 30 are considered oversold. Bull Confirmed - Aggressively long Bull Alert - Cautiously long Bull Correction - Pause or pullback in upward trend Bear Alert - Take defensive action if long Bear Confirmed - High risk if long, good conditions for shorting Bear Correction - Pause or rebound in downtrend ----------------------------------------------------------------- 5-dma: 1.28 10-dma: 1.74 21-dma: 1.36 55-dma: 1.17 Extreme readings above 1.5 are bullish, and readings below .85 are bearish. These signals don't occur often and tend be early, but when they do, they can signal significant market turning points. ----------------------------------------------------------------- Market Internals -NYSE- -NASDAQ- Advancers 1497 1506 Decliners 1272 1499 New Highs 102 37 New Lows 39 97 Up Volume 663M 736M Down Vol. 1033M 839M Total Vol. 1712M 1629M M = millions ----------------------------------------------------------------- Commitments Of Traders Report: 07/06/04 Weekly COT report discloses positions held by small specs and commercial traders of index futures contracts at the Chicago Mercantile Exchange and Chicago Board of Trade. COT data can be found at www.cftc.gov. Small specs are the general trading public with commercials being financial institutions. Commercials are historically on the correct side of future trend changes while small specs tend to be wrong. S&P 500 Commercial traders continue to sit tight without much change in their bearish sentiment. Retail traders aren't changing their bullish tune much either but they have grown a bit more optimistic Commercials Long Short Net % Of OI 06/15/04 428,905 444,197 (15,292) (1.8%) 06/22/04 407,842 415,462 ( 7,620) (0.9%) 06/29/04 405,273 413,351 ( 8,078) (0.9%) 07/06/04 402,952 416,526 (13,574) (1.7%) Most bearish reading of the year: (111,956) - 3/06/02 Most bullish reading of the year: 23,977 - 12/09/03 Small Traders Long Short Net % of OI 06/15/04 169,595 115,336 54,259 19.0% 06/22/04 124,985 89,934 35,051 16.3% 06/29/04 129,978 94,535 35,443 15.7% 07/06/04 132,423 90,748 41,675 18.7% Most bearish reading of the year: (1,657)- 5/27/03 Most bullish reading of the year: 114,510 - 3/26/02 E-MINI S&P 500 Now we are seeing some money shuffling in the e-minis. Commercial traders have reduced their shorts and raised their long positions but remain overwhelmingly bearish. Small traders have pared back their bullish sentiment. Commercials Long Short Net % Of OI 06/15/04 440,867 522,546 (81,679) (8.5%) 06/22/04 229,290 446,974 (217,684) (32.2%) 06/29/04 258,443 447,505 (189,062) (26.7%) 07/06/04 287,442 423,583 (136,141) (19.1%) Most bearish reading of the year: (354,835) - 06/17/03 Most bullish reading of the year: 133,299 - 09/02/03 Small Traders Long Short Net % of OI 06/15/04 216,759 147,247 69,512 19.1% 06/22/04 243,444 58,389 185,055 61.3% 06/29/04 236,492 47,780 188,712 66.3% 07/06/04 219,321 58,567 160,754 27.9% Most bearish reading of the year: (77,385) - 09/02/03 Most bullish reading of the year: 449,310 - 06/10/03 NASDAQ-100 Commercial traders remain somewhat bullish on the NASDAQ 100 but only by a small margin. Small traders are much more bearish on technology. Commercials Long Short Net % of OI 06/15/04 78,542 54,341 24,201 18.2% 06/22/04 40,397 37,413 2,984 3.8% 06/29/04 41,078 37,194 3,884 4.9% 07/06/04 42,245 37,343 4,902 6.2% Most bearish reading of the year: (21,858) - 08/26/03 Most bullish reading of the year: 25,160 - 06/01/04 Small Traders Long Short Net % of OI 06/15/04 15,794 35,880 (20,086) (38.9%) 06/22/04 9,311 9,950 (639) ( 3.3%) 06/29/04 7,437 11,904 (4,467) (23.1%) 07/06/04 9,345 16,527 (7,182) (27.8%) Most bearish reading of the year: (20,270) - 06/01/04 Most bullish reading of the year: 19,088 - 01/21/02 DOW JONES INDUSTRIAL Commercial traders continue to snooze with little change in their Dow Jones Industrials positions. Small traders have reduced their bearish attitude some but remain negative. Commercials Long Short Net % of OI 06/15/04 30,438 24,766 5,672 10.3% 06/22/04 26,808 19,752 7,056 15.2% 06/29/04 27,278 20,512 6,766 14.1% 07/06/04 27,214 20,775 6,439 13.4% Most bearish reading of the year: (8,322) - 1/16/01 Most bullish reading of the year: 15,135 - 10/16/01 Small Traders Long Short Net % of OI 06/15/04 13,942 20,953 (7,011) (20.1%) 06/22/04 5,626 7,798 (2,172) (16.2%) 06/29/04 4,930 7,682 (2,752) (21.8%) 07/06/04 5,969 8,227 (2,258) (15.9%) Most bearish reading of the year: (12,106) - 3/09/04 Most bullish reading of the year: 8,523 - 8/26/03 ----------------------------------------------------------------- ************************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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The Option Investor Newsletter Thursday 07-15-2004 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, ATK, HUG, ITT, PD, SUN New Calls Plays: ZBRA Put Play Updates: DISH, IRF New Put Plays: MGA, PGR **************** 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 - AET - close: 87.82 change: +1.42 stop: 82.99 *new* AET is following our script perfectly. We were triggered on Wednesday when AET traded through our entry point at $86.55. Thursday produced a strong midday rally that carried through the afternoon while the Dow was sinking. The next test will be the $90.00 level. We're going to raise our stop loss from $81.99 to $82.99. Picked on July 14th at $86.55 Change since picked: + 1.27 Earnings Date 07/29/04 (confirmed) Average Daily Volume = 1.44 mln Chart = -- Alliant Tech - ATK - close: 65.68 chg: -0.04 stop: 62.99 ATK has been very strong the last couple of weeks and we've been expecting some profit taking. On Tuesday we suggested a pull back would be the better entry point. It looks like we got our request. Traders jumped in on the dip and the $65.00 level acted as support just as it should have. Our only concern is the weakness in the broader indices. If the Industrials and NASDAQ take a plunge then ATK may retest the $64 level as support. We're keeping our stop loss at $62.99. Picked on July 11 at $ 65.03 Change since picked: + 0.65 Earnings Date 08/05/04 (confirmed) Average Daily Volume: 335 thousand Chart = -- Hughes Supply - HUG - close: 60.15 change: +0.15 stop: 57.00 We added HUG to the call list last night with a trigger to go long at $60.51. HUG traded at that trigger (and higher) early this morning opening the play for us. Unfortunately, HUG seemed to struggle with maintaining its breakout over the $60.00 mark. We will continue to suggest longs here but more conservative traders may want to look for a little more conviction and wait for a new high above $60.71. If the broader indices sink tomorrow HUG could drift back toward the $59 area. Picked on July 15 at $ 60.51 Change since picked: - 0.36 Earnings Date 08/24/04 (unconfirmed) Average Daily Volume: 288 thousand Chart = -- ITT Industries - ITT - close: 81.74 chg: -0.81 stop: 80.95 Uh-oh! It could be time to head for the exits in ITT. The stock has slipped back through several minor support levels and pretty much erased its recent rally above the $84 level. Today's close under the $82.00 mark is discouraging and ITT is likely to test the simple 50-dma at $81.25 or support at the $81.00 level. If we don't see a bounce tomorrow (or if we don't get stopped out) we may close ITT anyway. Picked on July 11 at $ 82.86 Change since picked: - 1.12 Earnings Date 07/23/04 (confirmed) Average Daily Volume: 532 thousand Chart = --- Phelps Dodge - PD - close: 80.70 chg: +2.10 stop: 75.49 Metal and mining stocks continued to shine today and PD soared 2.67% to close above $80.00 for the first time since early April. Another rise in copper prices didn't hurt either. Remember that we're targeting a move to the $84-85 range. No change in our stop but more conservative traders might consider placing theirs under the simple 10-dma where PD bounced from this morning. Picked on July 07 at $ 78.75 Change since picked: + 1.95 Earnings Date 07/27/04 (confirmed) Average Daily Volume: 2.6 million Chart = --- Sunoco - SUN - close: 67.26 change: -0.14 stop: 63.99 So far so good. SUN has bounced from the $65.00 level as expected and we witnessed a decent follow through yesterday. We're a little surprised that SUN couldn't break through minor resistance at $68.00 today with the strength in oil stocks but we still have time left before its earnings report. We are beginning to wonder if SUN is a stock split announcement candidate. The only data we could find showed SUN last split 2- for-1 back in 1988 but we didn't know at what price. Its earnings report next week could be a good time to announce a split but it's pure conjecture at this point. Picked on July 08 at $ 66.67 Change since picked: + 0.59 Earnings Date 07/22/04 (confirmed) Average Daily Volume: 973 thousand Chart = ************** NEW CALL PLAYS ************** Zebra Tech - ZBRA - close: 82.90 chg: +2.51 stop: 79.85 Company Description: Zebra Technologies Corporation delivers innovative and reliable on-demand printing solutions for business improvement and security applications in 90 countries around the world. More than 90 percent of Fortune 500 companies use Zebra-brand printers. A broad range of applications benefit from Zebra-brand thermal bar code, "smart" label, receipt, and card printers, resulting in enhanced security, increased productivity, improved quality, lower costs, and better customer service. The company has sold more than three million printers, including RFID printer/encoders and wireless mobile solutions, and also offers software, connectivity solutions, and printing supplies. (source: company press release) Why We Like It: We are adding ZBRA to the call list because shares have finally pulled back to the bottom of its rising channel near its simple 50-dma. Actually, it's more than that. Yes, we've been waiting for the appropriate entry point but ZBRA's 3 percent gain today is a nice rebound from the $80.00 region and produces a bullish engulfing candlestick. Furthermore the gain was produced on almost double the average volume. On top of ZBRA's bullish performance when the Industrials and NASDAQ were sinking into the close the company announced a 3-for-2 split after the closing bell. Shares aren't trading too much higher after hours so we should still be able to get a decent entry point tomorrow. Our initial target is the $90.00 region and we need to get there before ZBRA's earnings report on July 28th. We'll start the play with a stop loss at today's low. Suggested Options: We're going to suggest the August calls. Our favorite is the August 80s. BUY CALL AUG 80 ZBQ-HP OI= 177 Current Ask $5.00 BUY CALL AUG 85 ZBQ-HQ OI= 424 Current Ask $2.25 Annotated Chart: Picked on July 15 at $ 82.90 Change since picked: + 0.00 Earnings Date 07/28/04 (confirmed) Average Daily Volume: 401 thousand 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 ******************* EchoStar Comm. - DISH - close: 29.32 chg: -0.29 stop: 31.01 DISH managed a decent bounce yesterday after CSFB started coverage on them with an "out perform". Fortunately for the bears the rally failed at the $30.00 mark, which should act as psychological resistance. DISH continued to drift lower today. This may be a play that takes patience to ride out. Picked on July 09th at $28.99 Change since picked: + 0.33 Earnings Date 08/11/04 (unconfirmed) Average Daily Volume = 2.5 mln Chart = --- Int'l Rectifier - IRF - close: 34.58 chg: +1.28 stop: 36.01 We noticed a number of smaller semiconductor stocks tried to bounce today. IRF was one of them as it charged to an intraday high at $35.40 before slipping back under the $35 level before the closing bell. We're obviously not happy with the 3.8% rebound but IRF has been very oversold and due for a bounce. Traders might want to consider new positions on a drop through the $34 mark. Picked on July 6th at $37.00 Change since picked: - 2.42 Earnings Date 07/29/04 (unconfirmed) Average Daily Volume = 1.07 mln Chart = ************* NEW PUT PLAYS ************* Magna Intl - MGA - close: 81.53 change: -1.35 stop: 84.51 Company Description: Magna, the most diversified automotive supplier in the world, designs, develops and manufactures automotive systems, assemblies, modules and components, and engineers and assembles complete vehicles, primarily for sale to original equipment manufacturers of cars and light trucks in North America, Europe, Mexico, South America and Asia. Magna's products include: automotive interior and closure components, systems and modules through Intier Automotive Inc.; metal body systems, components, assemblies and modules through Cosma International; exterior and interior mirror and engineered glass systems through Magna Donnelly; fascias, front and rear end modules, plastic body panels, exterior trim components and systems, greenhouse and sealing systems, roof modules and lighting components through Decoma International Inc.; various engine, transmission and fueling systems and components through Tesma International Inc.; a variety of drivetrain components through Magna Drivetrain; and complete vehicle engineering and assembly through Magna Steyr. Magna has approximately 75,000 employees in 212 manufacturing operations and 47 product development and engineering centres in 23 countries. (source: company press release) Why We Like It: We like MGA because it's giving us another chance to play the trading range. Shares have been oscillating in a very wide channel since last August. Now MGA is rolling over again so it's a simple play the move to the other side of its range. Yes, there are a host of moving averages between here at $81.53 and our target near $75.00 but MGA has been virtually ignoring them for months. Furthermore today's high volume drop looks like a good starting point for what could be a relatively quick trip lower. Please see the chart so further understand this play. Suggested Options: We're going to suggest the August puts. The August 85s or 80s could work well. BUY PUT AUG 85 MGA-TQ OI= 20 Current Ask $4.80 BUY PUT AUG 80 MGA-TP OI=203 Current Ask $1.75 BUY PUT AUG 75 MGA-TO OI= 20 Current Ask $0.65 Annotated Chart: Picked on July 15 at $ 81.53 Change since picked: - 0.00 Earnings Date 08/05/04 (unconfirmed) Average Daily Volume: 182 thousand Chart = -- Progressive - PGR - close: 79.00 chg: -2.50 stop: 82.35 Company Description: The Progressive group of insurance companies ranks third in the nation for auto insurance based on premiums written, offering its products by phone at 1-800-PROGRESSIVE, online at progressive.com and through more than 30,000 independent agencies and insurance brokers. (source: company press release) Why We Like It: Ouch! Earnings rise by 35 percent compared to a year ago but it's not enough to satisfy investors. PGR reported earnings on July 14th and only beat estimates by a penny. As usually Wall Street was looking for more. After the report UBS came out to reiterate their "reduce" rating. Traders immediately sold the stock this morning and PGR broke through major support at the $80.00 mark on big volume. This produced a new triple-bottom breakdown on its P&F chart with a $69.00 target. Recent reports suggest that auto insurance rates are going down or at least rising at a slower pace across the country. Investors may take PGR's recent results as a sign that business really could be slowing. After all there is a lot of room left for profit taking when we're talking about a stock that was trading at $15.00 in March of 2000. It wouldn't surprise us to see a bounce but as long as it trades under the $82.00 level and its 200-dma we should be okay. Patient traders can wait for a potential bounce to initiate plays on (preferably when the rally starts to fail). For the rest of us we'd consider positions as long as PGR trades under $80. There could be support at the $75.00 mark but we're going to target the $71-72 region. Suggested Options: We're going to suggest the August or November puts but our favorites would be the August 80s. BUY PUT AUG 80 PGR-TP OI= 574 Current Ask $2.55 BUY PUT AUG 75 PGR-TO OI= 440 Current Ask $0.80 Annotated Chart: Picked on July 15 at $ 79.00 Change since picked: - 0.00 Earnings Date 07/14/04 (confirmed) Average Daily Volume: 655 thousand Chart = ************************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 Thursday 07-15-2004 Copyright 2004, All rights reserved. 3 of 3 Redistribution in any form strictly prohibited. In Section Three: Watch List: Brokers, Oil, Transports Option Spread Strategies: Our Monthly Peek Into The Future – August “Hypo” Positions Traders Corner: A Little Guidants Please? Traders Corner: Dow Theory and Technical Analysis: Tres (3) ********** WATCH LIST ********** Brokers, Oil, Transports ___________________________________________________________________ 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. ___________________________________________________________________ Goldman Sachs - GS - close: 88.33 change: -1.56 WHAT TO WATCH: This could be it! We've been watching GS for a possible short play for weeks. The recent drift through support at the $90.00 level has been slow but today's 1.7 percent drop looks like a decisive blow by the bears. Even so GS still has a trendline of support from its various lows dating back to June 2003. Thus we'd probably wait for a new relative low, a drop under $87.60, before considering new short positions. Our immediate target would be the $82.50 region. Chart= --- ChevronTexaco - CVX - close: 94.79 change: +0.04 WHAT TO WATCH: We strongly considered CVX as a potential call play this evening but the failure to hold the breakout over its $95.00 level was discouraging. Yet overall the strength in the energy/oil sector makes this stock attractive and we could see a run to the $100 level yet. Its P&F chart is bullish and points to a $108 target. Earnings are expected on July 30th. Chart= --- Fedex - FDX - close: 81.30 change: +1.30 WHAT TO WATCH: The Dow Transports did relatively well today and FDX has broken out of its recent consolidation. Yet FDX still has resistance at the $82.00 mark. We'd consider new bullish positions on a breakout. Currently its P&F chart is bullish with a $97 target. Chart= ************************ Option Spread Strategies ************************ Our Monthly Peek Into The Future – August “Hypo” Positions By Mike Parnos, Investing With Attitude Guess who’s coming to dinner? It’s the CPTI and we’re getting ready to feast on the market again. Do you like steak? Get you knife and fork ready and let’s dig in. I hope you like it well done, because everything we at the CPTI do is – well done. Are we getting overconfident? I don’t think so. I’ll put up our results against other traders. Any takers? Remember, August is a five-week option cycle. There may be a little more premium available, but we’re also exposed for another week of market action. Be careful. Remember, our “hypothetical” butts are on the line. Don’t get aggressive. The market has been in a range and it has been pretty darn good to us. Sooner or later, either the Viagara or the alcohol will kick in – and we may face having to make adjustments. We always have a Plan B. August Position #1: SPX Iron Condor – 1106.69 Sell 5 SPX August 1050 puts Buy 5 SPX August 1025 puts Credit of about: $1.90 + $.50 bid/ask shaving = $2.40 ($1,200) Sell 5 SPX August 1155 calls Buy 5 SPX August 1180 calls Credit of about: $1.30 + .30 bid/ask shave = $1.60 ($800) Potential profit of $2,000. Maximum profit range: 1050 to 1155. Breakeven points: 1046 & 1159. Maintenance: $12,500. August Position #2 – RUT Iron Condor – 562.16 Sell 10 RUT August 520 puts Buy 10 RUT August 510 puts Credit of about: $1.10 + .10 bid/ask shave = $1.20 ($1,200) Sell 10 RUT August 600 calls Buy 10 RUT August 610 calls Credit of about: $.65 + $.10 bid/ask shave = $.75 ($750) Potential profit: $1,950. Maximum profit range: 520 to 600. Breakeven points: 518.05 & 601.95. Maintenance: $10,000. Note: When you look at the bid/ask prices on RUT options, it would seem we could shave a little more from the bid/ask spreads of each option. But, recently, it’s become increasingly difficult to get fills on the RUT. They have a bad attitude or a bug buzzing where the sun don’t shine. So, the idea is to not get too greedy. It’s better to get filled than to spend half the day cursing at the market makers. August Position #3 – BBH Iron Condor - $140.90 Sell 10 BBH August $130 puts Buy 10 BBH August $120 puts Credit of about $.50 + $.10 bid/ask shave = $.60 ($600) Sell 10 BBH August $150 calls Sell 10 BBH August $160 calls Credit of about $.65 + $.05 bid/ask shave = $.70 ($700) Profit potential: $1,300. Maximum profit range: $130 to $150. Breakeven points: $128.70 & $151.30. This is a nice wide range for the conservative investor. Maintenance $10,000. August Position – SPX Don’t forget that our “Credit Spread Boogie” position was rolled out to August (see below). That should be fun to watch. And, be alert. We have to be prepared to adjust when necessary. That’s all for now. Perhaps I’ll come up with another position for the Sunday newsletter. Let’s see what the market does on Friday. ___________________________________________________________ July Trade Results We still have to endure the Friday settlement prices for SPX and RUT, but we have plenty of cushion in each direction. This is another month I’m looking forward to writing the Sunday column. I just love adding up those hypothetical profits. July Quickies Looks like the RUT quickie will work out beautifully. The OEX still has all Friday to trade, but we’re in pretty good shape there too. Isn’t it nice when you can have your money working for you? I know my money has been a lot more productive than I was – when I was working. ___________________________________________________________ JULY POSITIONS Position #1 – SPX Iron Condor – 1106.69 We sold 10 July SPX 1170 calls and bought 10 July SPX 1180 calls for a credit of about: $1.10 ($1,100). Then we sold 7 July SPX 1075 puts and bought 7 July SPX 1060 puts for a credit of about: $1.20 ($840). The total net credit of was $1,940. Maximum profit range of 1075 to 1170. Breakeven points of 1072.23 to 1171.94. Maintenance: $10,500. Potential profit: $1,940. Position #2 – RUT Iron Condor – 562.16 We sold 10 July RUT 600 calls and bought 10 July RUT 610 calls for a credit of about: $1.00 ($1,000). Then we sold 10 July RUT 530 puts and bought 10 July RUT 520 puts for a credit of $1.30 ($1,300). Our total net credit was $2.30 ($2,300). Maximum profit range of 530 to 600. Breakeven points of 527.70 to 602.30. Maintenance: $10,000. Profit potential $2,300. Position #3 – SPX Credit Spread Boogie – 1106.69 – See Adjustment We haven’t done this strategy is quite some time. To review, it consists of establishing a 25-point credit spread and taking in $6-7 of premium (as much as possible). If the trend continues, you keep the premium. If the trend reverses, you close the trade for double the premium amount. Then, you open a credit spread in the opposite direction, using enough contracts to replenish what you spent to close the initial spread. We sold 3 SPX July 1125 puts and bought 3 SPX July 1100 puts for a total credit of about: $6.30 ($1,800). Our profit potential: $1,800. Maintenance: $7,500 (initially). We’ll need to keep a close eye on this one. We have to be alert – plus, we have to have a large enough account size to accommodate trading an increased number of contracts if adjustments become necessary. Position Adjustment: As the market went down, so did the S&P. It was time to dance, and dance we did. I closed out the 3 contracts of the July 1125/1100 bull put spread for $12.60 and rolled out to 5 contracts of the August 1125/1150 bear call spread for $8.70. That put an additional $570 potential profit into our pocket – making a total of $2,370 ($1,800 + $570). Our new maintenance is $12,500. Position #4 – SOX (Semi-Conductor Index) – Iron Condor – 418.53 We sold 10 SOX July 490 calls and bought 10 SOX July 500 calls for a credit of about: $1.10 ($1,100). Then we sold 10 SOX July 420 puts and bought 10 SOX July 410 puts for a credit of about: $1.30 ($1,300). Our total net credit of: $2.40 ($2,400). Maximum profit range: 420 to 490. Breakeven points: 417.60 & 492.40. Maintenance: $10,000. Potential profit: $2,400. Position Adjustment: I’m a chicken -- and I’m not ashamed to admit it. Today, with the SOX bouncing around the short 420 strike price, I decided not to take my chances on Friday’s settlement price. Around 2:30 p.m., the SOX 420 put was trading at 1.00 by 1.10 (SOX was at about 423+). I had the chance to close out the position and lock in $1,300 profits. So, that’s what I did. Earlier in the day (when SOX was trading at 424+), I could have even closed it out for a little less. Once the price gets down near the short strike price, you no longer have a cushion. It’s a coin flip. I like to keep percentages on my side as much as possible. When they’re not there any longer, it’s time to make a move. I had the opportunity. $1,300 in the hand is better than $2,400 in the bush -- though it sometimes depends on the bush in question. Watch. Some employment number or some earnings report will come out and the SOX’s opening settlement number will be over 420. Will I be pissed? No, because I’m going to sleep very well tonight – and I made a logical decision – not an emotional one. ONGOING POSITIONS QQQ ITM Strangle – Ongoing Long Term -- $35.07 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: Oct. $33 puts and Oct. $34 calls – credit of $1,900. Nov. $34 puts and calls – credit of $1,150. Dec. $34 puts and calls – credit of $1,500. Jan. $34 puts and calls – credit of $850. Feb. $34 calls and $36 puts – credit of $750. Mar. $34 calls and $37 puts – credit of $1,150. Apr. $34 calls and $37 puts – credit of $750. May $34 calls and $37 puts – credit of $800. June $34 calls and $37 puts -- total net credit of $750. We rolled out to the July $34 calls ($.20 credit) and $37 puts ($.60 credit) and took in a net credit of $.80 ($800). Our new total credit is now $10,400. Position Adjustment: Last Thursday, I rolled out the July $37 puts to the August $37 puts and took in $.40. Today (Thursday), I rolled out the $34 July calls to the August $34 calls and took in $50. That’s a total of $90 or $900 to add to the kitty. 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 – 537.88 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 maturing in seven years at a value of $100,000. The principal $100,000 investment is guaranteed. We’re trading the remaining $26,000 to generate a “risk free” return on the original investment. Our current position: We own 3 OEX December 2006 540 calls @ $81 (x 300 = $24,300). Our cash position as of May expiration was $4,390 plus unused $1,700 = $6,090. From the June option cycle, we are able to officially add $1,175 to our cash position – that now stands at $6,265 ($4,565 plus unused $1,700). New July Zero Plus Positions. July bull put spread 535/525 for credit of $1.30 x 5 contracts = $650. Short 570 call for credit of $1.40 x 5 = $700. If all goes well, we’ll be able to add $1,350 to our cash position as we wait for the market to move up. ________________________________________ 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, first look under "Education" on the OI home page and click on "Traders Corner." For more recent columns, you can look under "Strategies" and click on "Spreads & Combos." 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 Options Therapist and CPTI Master Strategist 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. ************************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 ************** A Little Guidants Please? by Keene Little I thought I'd take a look at a chart that a reader asked my opinion on and it looked interesting enough to share with all. I think this chart has some interesting features that are useful for showing some various technical studies, including Elliott Wave of course, and how combining these studies can be useful in analyzing a stock's potential move. The stock is GDT, Guidant Corp., a medical equipment company I believe. I don't trade a lot of individual stocks but even when I do I rarely research a company or its fundamentals. This is because I believe fundamentals follow technicals, not the other way around as most traders believe (that's the EW theorist in me). I've put some EW labels on this weekly chart that shows the rally from the end of Sept 2002 to the Jan 2004 high in order to show the EW count for the rally. I've labeled this rally as the 5th and final wave of the rally but I don't have enough price history on the stock to know whether or not that's true. For this exercise, and trading it for the next few years, I don't think it will matter. What matters is that it was an impulsive move up that is now being corrected (next chart). Each impulse wave consists of its own 5 waves and I've labeled them on the chart as waves 1 through 5, creating wave-(5), the rally from 2002 to 2004. Normally in an EW pattern the 3rd wave (up in this case) is the strongest and longest wave. Sometimes the 1st or the 5th wave is the strongest and it usually has to do with the sentiment in the market and even what you're trading. For example, commodities often exhibit strong 5th waves. The big rally in the equity markets in the 1990's was an extended 5th wave of the rally that started back in 1982. Extended 5th waves often give the impression of a parabolic rise that flames out and crashes back to earth (think tech bubble). Anyway, it looks like this stock had an extended 5th wave that ran from June 2003 to the Jan 2004 high. I mention this because a little later I'll show a support level that is derived from this wave. This second weekly chart shows the price peak and subsequent price action this year, and even where I think price might be headed on this stock. There is a head and shoulders pattern around this price peak and the pattern projects down to about 45 for the pullback. Its current price is around 53 and it had peaked out at 73.70. So maybe it's due for another $8 haircut. If you'll notice the count in the extended 5th wave--the rally from June 2003 to January 2004--you can see where I've labeled its 5 waves as wave (i) through (v). Each impulse wave can be broken down into its own 5 waves right down to tick charts. This is because EW patterns are a study in fractals that repeat in different time frames. And these fractals are based on fibonacci ratios that can also be seen in most everything from tiny sea shells to major galaxies. Fascinating to study if you're interested. So, for the rally up to the January high, the 5th wave of that rally, starting in June 2003 "extended" in EW terms and became the longest wave of the move up from 2002. When this happens, price will typically then pullback and find support at the 2nd wave low of this extended 5th wave. So that would be the wave-(ii) low in Oct 2003. Notice that the H&S projection is right on top of this EW projection. And then both of the above projections come very close to the 62% retracement of the rally from 2002, at 44.45. The current leg down from the January high looks to be bouncing in the 4th wave of an expected 5-wave move down. So it would look like GDT needs just a little push higher to finish the correction and then roll over into its 5th wave down. One of the reasons I'm expecting a flat correction here and not much higher is because of the EW rule of alternation. It is very common to see the form of 2nd and 4th waves alternate in form. If one is spiky the other will likely be flat, and vice versa. Look at the 2nd and 4th waves on these charts and you'll see what I mean. This rule can often help you identify the kind of bounce to expect. So if we see confirmation of a 5-wave move down like I've depicted, it will be confirmation of a long term top having been put in. The new impulse wave to the downside will tell us we have a trend change-- follow the impulse waves because they are pointing in the direction of least resistance. But it's also possible the entire pullback is finished at the last low of 51.50 on May 23rd which would be a 3-wave a-b-c move down, instead of (i), (ii), (iii) as I've labeled it, and GDT could be getting ready to rally back up more strongly than I show on the chart. That's what I'd be watching for currently. Confirmation of a 3-wave corrective move would be a rally above the high at 69.50 on April 18th (where I have a wave-(ii) label). A corrective pullback after an impulsive rally into the January high says stick with the impulsive direction which is up because new highs are likely on their way. But if it follows through as I've depicted, we'll see one more drop lower to finish 5 waves down, to that 44.50-45.00 target area. If we see 5 waves complete to the downside as I show, then we should see the start of a long correction back up in a 3-wave pattern (a-b-c on the chart) that could take us well into 2005. A typical retracement for this correction back up would be 50-62% so potentially as high as the high 50's/low 60's. And then another roll over in the big 3rd leg down, taking us to new lows and well into 2006. How's that for a projection! By the way, this same analysis on the general equity market is what has many Elliotticians chomping at the bit to get short. Many believe the rally from October 2002 to this year's high was a big 3-wave correction to the decline from 2000 to 2002. I'm not sure we've topped out in the market yet and am inclined to think we'll go sideways for many years before we get another leg down. I don't think the bear market is over, but I don't believe we're headed for the basement yet. A big correction down that starts after a new high? Yes. But not yet. Again, this chart's purpose was more to show how the various technical studies combined can give one a greater level of confidence in taking a position, and then how to use the various EW levels to control risk and identify potential targets. This kind of analysis can be done right down to tick charts as the timeframe has no meaning, except in your trading style of course. These projections are of course never guaranteed but that's what stops are for. Let me know if you have any questions on this. Keene Little ************** TRADERS CORNER ************** Dow Theory and Technical Analysis: Tres (3) By Leigh Stevens lstevens@OptionInvestor.com This last and final part of my discussion of Charles Dow's stock market theory focuses on defining market trends as to importance and duration. And, I'll say some more about how technical analysis has broadened the concept of divergence by relating this principle to the idea of price/indicator divergence as also signaling possible upcoming trend reversals. Most of what I see written about Dow theory is about the two Dow averages moving in tandem or not. There is a lot more to what Dow wrote about. He by the way never put his ideas forward as a (unified) "theory". Dow's writings were a series of editorial articles in his Wall Street Journal related to his unique observations about how the Market worked. For myself, having worked for Dow Jones for a few years in their market data services division, Telerate, I was struck as to how, when genius goes away, a dull bureaucracy may take its place. Where are the replacement visionaries? There is was no one at the Journal any longer that provided any ongoing commentary about the market in terms of Dow's principals, which always struck me as odd. Hey, I'm available! Part 1 on Dow Theory was on Dow's idea that the Market discounts everything, the Dow Averages need to confirm each other and the concept of divergence: this Trader's Corner article is at - http://www.OptionInvestor.com/traderscorner/tc_062904_2.asp Part 2 was on the phases of Bull and Bear markets; and, on the concepts of accumulation and distribution – http://www.OptionInvestor.com/traderscorner/tc_070604_2.asp TRENDS ARE OF THREE TYPES - Just as the market tends to have three phases related to mood or market sentiment, Charles Dow divided market trends into three types. The most important trend for investors, those who look to buy and hold stocks for as long as stock prices are rising over time – is the primary or major trend. The primary trend is one lasting a year or more – up to several years. However, there are inevitably price movements that are counter to the direction of the major trend and prices move in the opposite direction to the primary trend - Dow called these secondary price movements. Secondary or countertrend price swings occur when bullish or bearish expectations for the market gets overly one-sided and ahead of the fundamentals related to earnings prospects. Eventually a reaction develops that causes prices to correct back to a more realistic price level. For example, a bull market trend reaches levels where price to earnings (P/E) ratios get too high to reasonably expect future earnings growth to keep up and still (more or less) match historical P/E's. The result is that enough knowledgeable investors take enough money out of stocks and curtail their buying enough to knock prices down to more "realistic" levels. So, countertrend moves – often called reactions or (trend) corrections - are price swings that are in the opposite direction of the main or major trend and comprise secondary trends. Their duration is months at most, never years. Once one of these movements runs its course, the primary trend resumes. Smaller segments that make up the price swings that are both in, and against, the direction of the primary trend are also often referred to today as intermediate price swings/moves and are best defined as lasting only the few weeks to few months of secondary trends. However, there are a lot of careless descriptions made. Within these secondary/intermediate price moves are day-to-day price fluctuations Dow called minor trends. These can be as short as a few hours to a day or days, mostly and typically contained within a week or month time span. Both intermediate and minor trends are mostly of importance to traders – minor trends are all that concern a day trader who will likely complete every trade within the same day. Intermediate trends are usually only of importance to investors when they are looking for the best point to enter the primary trend or to add to their position(s) in a stock or the market. Investors are mostly concerned with the major trend – the trend lasting a year or more. In terms of Dow Theory, as I read it, a primary bear market ended about a year ago, in late-May/early-June 2003, when both Dow averages exceeded their prior closing highs from a few months earlier. Interestingly, the 10,607 closing weekly high of March '02 was just recently exceeded by a weekly close at 10,627 from earlier this month (July, 2004). Dow used Monthly closes: by this measure the February closing monthly high (10,583) of the Dow 30 Industrials (INDU) this year was above its prior peak, the 10403 monthly close of March '02. The Dow Transportation average (TRAN) recently cleared an even higher monthly TRAN close going back to early-2001. At times recently it may not feel to you like a bull market, but according to Dow's Theory, it is one. THE PRIMARY TREND - The primary or major trend as said already, is a price movement lasting a year or more. Exceptions to this time duration can happen if we look at what happens to price alone; e.g., the 1987 decline, which was severe but of relatively short duration. A widely accepted measure of what constitutes a bear market is when there is a decline that takes prices more than 20% below the high point reached in the prior advance. Dow however, didn’t have a "rule" or guideline on this subject. An essential guide as to a trend being a primary bull market is that each advance within the advancing trend should reach a higher close than the rally that preceded it. And, each reaction or counter-trend move should stop at a level that is above the prior major downswing. The reverse would need to hold true to be considered a primary bear market trend as it relates to lower closing lows. An analogy to the primary trend is that it is like the tide of the ocean. In the rising tide, each wave comes in to a higher and higher point. And, just as the rising tide lifts all the boats, a bull market will mostly take all stocks higher. The waves in an outgoing tide gradually recede away from a high point and all boats fall with it. A primary up trend is considered to be a bull market and primary down trend, a bear market, according to Dow. If you are an investor in terms of your time horizon and investment goals, you want to buy stocks as soon as possible after a bull market has begun. Some investors will anticipate areas where stocks are undervalued and while still in a bear market, but savvy knowledge and experience is required, as is apparent with Warren Buffet. And example in the chart below – one that I've used before – taken from 1990 – 1991, shows both a primary down trend/bear market and the primary up trend/bull market that developed following it – You can see in the above chart that the duration of the primary bear market trend was relatively short compared to the duration of the primary uptrends. On average this has been true since the 1950s due to the longer periods of economic expansion and shorter periods of recession – there is more urgency to end a recession. The 2000 – 2003 bear market lasted not quite 2 and half years – compare this to the multiyear bull market that preceded it - from at least 1994 to 2000. The relative duration of bull and bear markets also has to do with the fact that investors tend to stagger their purchases over the duration of bull markets, providing ongoing buying power, whereas selling out is often a one time decision and would be buyers stay away and don’t "support" the market on the declines, especially in a panic phase. SECONDARY TRENDS The secondary trends as said already is of shorter duration – typically, 3 weeks to 3 months and interrupts the major direction of stock prices with a countertrend movement. These are the declines or corrections in a bull market (i.e., they "correct" a situation where prices have risen too far, too fast) or are the bigger rallies in a bear market. Frequently these secondary countertrends retrace anywhere from a little over a third to as much as two thirds of the prior advance or decline. Very common is to see retracements of 50% (up or down) of the prior price move in the direction of the primary trend. To continue the ocean analogy, the secondary trend is like the waves of the ocean. They can be big and they can knock you over, but they will come in and go out within the bigger movement of the tide – the primary trend. MINOR TRENDS - The minor trends are the price fluctuations that occur from day to day and week to week, although a minor trend will rarely last more than 2-3 weeks. In terms of the overall market trend these are just "noise" and relatively unimportant. They can be compared to the ripples on a wave. The wave being the secondary trend - together the minor trends make up the intermediate trend. The minor trend is the one that could be set off by the actions or words of an individual – for example, the chairman of the Federal Reserve, when that individual makes a statement hinting at the direction of policy regarding Fed bias toward raising or lowering of interest rates. Or, the precipitating action might be a statement from a key company in a key industry about their actual or expected earnings or profit trends. MORE ON CONFIRMATION AND DIVERGENCE - I discussed Dow's ideas on "confirmation" and "divergence" in my prior article on Dow Theory. From this concept that the averages should confirm each other, came what followed relating to technical Indicators like the RSI as "confirming" or not confirming (i.e., diverging) price moves that take an Index or stock to new highs or lows. A recent example of a price/Indicator divergence on an hourly (chart) basis, was provided by the Nasdaq 100 Index (NDX), when several new hourly highs were not accompanied by similar higher RSI readings - this lack of an RSI confirmation, this divergence of the RSI, relative to the higher price peaks, was a strong warning of an impending trend reversal – see this highlighted below. Now even more recently with the NDX, there has been a series of lower lows but with the RSI trending higher per the chart highlights below. Stay tuned! on whether this price/RSI divergence here signals an upcoming and possibly sharp upside reversal – We don't have volume indicated for the above chart of course, but we can also look at volume in the tracking stock for NDX – QQQ, or on any stock – as to whether volume is confirming the price trend or diverging from it. Volume diverging from the price trend would be when volume does not expand in the direction of the trend. In a bullish trend, generally, average daily volume should rise in rally phases and decline on price pullbacks. In a bearish trend, volume will or should tend to rise on declines as selling picks up. When there is a divergence from this principle – e.g., in rally phases of a bullish trend, average daily volume starts falling – this divergence is a warning of a possible reversal. However, this is only something to be alert to. Dow felt that volume was a "secondary" indicator to price but could be watched for its confirming aspect. On balance, Charles Dow made a huge contribution to the understanding of market behavior or "human" behavior as it manifests in trading and investing in stocks. ************************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. 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