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Daily Newsletter, Monday, 02/14/2005

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews
  4. Trader's Corner

Market Wrap

Mixed Finish on Light Volume

Mixed Finish on Light Volume

Stock indices traded an excruciatingly narrow range today, and did so on light volume across the board. The Nasdaq-100 tracking stock, QQQQ, barely eked out half of Friday's volume, and just over half of its average daily volume.

With no major economic reports released today and a plethora of data scheduled during the remainder of the week, including 2 days' worth of Greenspan testimony, it's unsurprising that the heavy hitters stuck to the sidelines. It was a light news day, and with the indices stuck at the top of a 2 week long daily cycle upphase, the markets had little impetus to drive them in either direction.


Daily Dow Chart



The Dow traded a high of 10802, just 29 points above its session low, closing lower by 4.88 points at 10791.13. Today's high came within 95 points of the 52 week high printed on December 26. As appears from the daily chart, the daily cycle oscillators are in overbought territory, with the 10 day stochastic at levels that often coincide with multiweek tops to within a few days. Exceptionally, the indicator will become buried in overbought territory as a bullish trending move asserts itself. With all the news due for the rest of the week, it was clear that no one was going to bet heavily that dilemma in either direction. The Dow remains bullish above 10770, while a close below 10640 should be sufficient to roll the daily cycle over and kick off the next downphase. Below 10710, the upphase should stall.


Daily S&P 500 Chart



The SPX fared fractionally better than the Dow, adding .84 of a point to close at 1206.14, failing at a high of 1207 and bouncing from 1204. The 52 week high is at 1218, and like the Dow, the daily cycle upphase could well have enough gas in the tank for one last hurrah. 1205 and 1195 are immediate support, with stronger support at 1189 and the previous daily cycle low at 1160-62. A break below 1189 should stall the upphase, while I would expect a close below 1179 to kick off the next downphase.



Daily Nasdaq Chart




The Nasdaq rose .3% or 6.25 points to close at 2083. Despite the relatively stronger showing, the Nasdaq remains the farthest from its 52 week high. The bounce of the past 2 sessions has avoided what appeared to be an imminent and early failure in the weak upphase of the past 2 weeks. A close below 2070 should be enough to bring the daily cycle back to the do-or-die point, and below 2050 I'd expect to see a new downphase in place. Today's low printed at 2075, the high 2085.


Weekly TNX Chart



Banc of America reduced its recommended allocation of bonds from 10% to zero, with its weighting of cash rising from 25% to 35% on the firm's expectation of higher yields in the coming months. Citing broadly bullish sentiment for bonds, the bank's analyst Thomas McManus expressed a contrarian position, noting further that he sees the Fed already beginning to "sop up" excess liquidity. This matches recent observations of the Fed's daily open market operations in the Market Monitor since the Fed's most recent rate announcement. The Fed's open market desk has been displaying a notably tighter bias since the announcement, with a higher number of successive daily net drains overall.

The treasury auctioned 37B worth of 3 month and 6 month notes today, of which indirect bidders (foreign central banks) took 7.2B or 19.5% of the total. The bid-to-cover ratio was a respectable 2.19 for the 3 month notes and 2.3 for the 6 month notes.

Ten year treasuries began rising today from unchanged shortly before the auction results were released at 1PM and finished the day in positive territory. The ten year note yield (TNX) closed lower by 2.2 bps at 4.073%. On the daily TNX chart, we see that the daily cycle downphase is in the process of turning up from oversold territory toward first resistance of 4.12% below the key 4.16% resistance level. A break above 4.16% will target minor next resistance at 4.18%, but would also represent a potential upside bull wedge break. The upside implied target on that wedge could be as high as the 4.4% level. Support is immediately below at 4.03% and 3.98%.


Weekly chart of Crude oil



There was little news on the oil front today, with March crude oil futures trading both sides of unchanged in a whippy session. For the day, crude oil finished higher by 30 cents per barrel or .64% at 47.45. On the daily chart, this worked out to a bullish engulfing doji hammer, with Friday's low and high exceeded and a close above Friday's range. The market is coiling into a pennant here, between 45.5 and 49. A daily cycle upphase is kicking off from a higher price and oscillator low, and the outlook is bullish above 45.00-45.50 confluence.

There were no major US economic reports released today, and with earnings season winding down it was a relatively quiet session. The bigger news was in the currency markets following the release of Japanese economic data relating to that country's current account surplus. As analyst Linda Piazza reported in the Market Monitor, Japan's December current-account surplus rose 28%, representing a 35.1% increase from December 2003's figure and blowing away estimates in the 6% range. That caused a rally in the yen and a sharp drop in the US Dollar Index back below the key 84 support level as gold, silver and crude oil rallied.

Mere weeks after the AT&T-SBC deal, Verizon (VZ) has announced plans to acquire MCI for $6.763 billion, lowballing Qwest's rival bid by roughly $500M. The purchase price is to be paid with 5.3B in VZ stock and the remainder in cash via dividends from VZ. MCI's investors reportedly preferred to be paid in VZ shares than in Q's stock, given Q's own accounting issues and higher debtload, and VZ's status as a top cellular provider and top local provider in the Northeast. Under the deal, VZ will also assume MCI's debt of approximately 4B, and the company estimates that the acquisition will yield roughly 7B in new revenue and savings. The deal values MCI at $20.75 per share, matching Friday's closing price. Fitch Ratings placed VZ's A+ debt rating on Rating Watch Negative and MCIC's B rating on Rating Watch Positive following the announcement. VZ lost .33% to close at 36.19, while MCIC rose .85% to close at 59.31. Q closed lower by 4.1% at 3.98.

Herbalife (HLF) announced that it has pulled one of its products from shelves in Israel after that country's health ministry launched a probe due to customer complaints of liver problems. HLF is cooperating with authorities, and maintains that the unidentified product has not been proven to cause liver disorder. HLF lost 3.52% to close at 15.90.

European oil refiner TOT announced strong Q4 results, with sales rising 34.8B euros from Q4 2003's 27.5B level. The company attributed the rise to higher oil prices. For the year, sales rose 17% to 122.7B euros. TOT closed higher by .61% at 111.38.

AIG announced that it has received subpoenas from NY-AG Eliot Spitzer and the SEC in connection with investigations of its non-traditional insurance products and certain of its reinsurance transactions, and its accounting for same. The company said that it will cooperate in responding to these subpoenas, and will separate "traditional" from "non-traditional" earnings. However, CEO Greenberg refused to answer questions in a morning conference call, sticking to a prepared statement. In particular, he would not comment as to whether the 53M settlement already paid by the company for its nontraditional insurance deals was related to the round of subpoenas announced today. Spitzer and the SEC are investigating, among other things, whether these insurance products have or could be used to help companies hide losses or earnings weakness. A 10-K filing is expected from AIG within the next 3 weeks. For the day, AIG lost 2.23% to close at 71.49.

Discovery Labs (DSCO rocketed in the premarket on news that the FDA has issued an approval letter for its Surfaxin drug, which will be used to prevent respiratory distress in infants. Rising over 20% to clear the $7 level before the bell, DSCO closed higher by 10.88% at 6.42.

Office equipment retailer OMX announced the resignation of its president and CEO Christopher Milliken, and the firing of 2 employees in connection with its ongoing accounting investigation. The company also announced that it overstated its operating income for Q1 of fiscal 2004 in the amount of 5M-10M due to unrecorded rebates. However, this error also resulted in the understatement of income in Q2 and Q3. Today's news followed the resignation of OMX's CFO last month as the company delayed the release of its Q4 earnings report due to accounting problems. The 2 employees terminated in today's release allegedly fabricated documents to justify approximately 3.3M in claims billed to a supplier. The company expects to conclude its investigations by the end of this month. However, S&P announced that it is reviewing OMX's current BB credit rating in light of these developments, with a view to a possible downgrade. OMX closed lower by 5.45% today at 30.02.

After the bell, Agilent (A) reported Q1 earnings of 21 cents per share or 103M, which, excl;uding restructuring charges and tax benefits came to 20 cents per share or 100M. Revenue rose from 1.64B last year to 1.66B. The stock closed higher by 1.26% at 24.02.

Following Ameritrade's news last week of a slowdown in retail trading activity, SCH reported similar findings today. Schwab's January client daily average revenue trades came in at 186,000, which was down 14% from January 2004 levels and 1% lower than December 2004. NITE reported a 20% drop from January 2004's levels and a 6% drop from December's. As noted in the weekend Market Wrap, if not for program and mutual fund trades, the markets would be very quiet. Retail traders are indeed leaning back toward an "investor" posture.

For tomorrow, we can look forward to a more active newsday, with the Empire State Index for February, Retail Sales for January and December Business Inventories all scheduled to be released in the morning, followed by the $19B 4-week treasury bill auction at 1PM. With important reports scheduled for the remainder of the week, not to mention Greenspan's Wednesday and Friday testimony, the markets will have to run a veritable gauntlet of data from here. On the one hand, prices have been firm for the past two weeks, following the daily cycle upphase in the stock indices. On the other, that upphase is rapidly running out of racetrack, particularly for the Dow and SPX, and in this key timeframe the balance of risks is shifting in the bears' favor. Until clear sell signals appear, generated by a break of the support levels discussed above, the trend will remain up. However, bulls will want to snug up their stops as the daily cycle upphase begins to wane.
 

 
 




New Plays

New Option Plays

Call Options Plays
Put Options Plays
NONE NONE

New Plays

None Today.

New Puts

None Today.


Play Updates

In Play Updates and Reviews

Call Updates

eBay Inc - EBAY - close: 84.32 chg: +2.25 stop: 77.95*new*

We cannot find any specific news to account for EBAY's strength today. The stock added another 2.74 percent to out perform the tech sector and most of its peers in the Internet group. We are raising our stop loss to $77.95.


Picked on February 10 at $ 81.22
Change since picked: + 3.10
Earnings Date 01/19/05 (confirmed)
Average Daily Volume = 13.8 million
 

Put Updates

Nike Inc - NKE - close: 85.21 chg: +0.56 stop: 87.01

NKE pushed to the $86 level this afternoon, which effectively "filled the gap" from last week. If you look at the intraday chart you'll see the late afternoon pull back. The $86 level should be resistance. Aggressive traders can use today's move as a new bearish entry point. We'd prefer to wait for another drop back under the $85 level and ideally back under the $84.50 mark before initiating new bearish positions.

Picked on February 08 at $ 84.55
Change since picked: + 0.66
Earnings Date 12/16/04 (confirmed)
Average Daily Volume = 1.1 million
 

Drops

None today.


Trader's Corner

Trader's Corner

Tighten up that Wedgie

There are three forms of triangles - symmetrical, ascending and descending. Symmetrical triangles have a resistance line that slopes downward and a support line that slopes upward and the slope of each line is equal. The top resistance line in an ascending triangle is flat, while the support line slopes up to meet it. Descending triangles have a flat support line as their base while the top resistance slopes downward. Lines connecting the boundary regions intersect at the triangle apex and generally have diminishing volume over time. However, one of the most powerful triangle price patterns in technical analysis is a triangle but does not have any of the characteristics I just described. This triangle is called a wedge. No not the kind that you get when your pants are too tight but the kind that can tell us a story of possible future price movement.

There are two kinds of wedges, the falling bullish wedge and the rising bearish wedge. Let's look at each one of them.

Bullish Falling Wedge

The falling wedge is a bullish pattern that begins wide at the top and contracts as prices move lower. This forms a cone that slopes downward as the swing highs and lows converge. This wedge is different from the symmetrical triangle, which has no definitive slope and no bias, whereas falling wedges definitely slope down giving it a bullish bias.

The falling wedge can be a continuation pattern or a reversal depending on the previous trend. If the slope is against the prevailing uptrend it is a continuation pattern but a reversal pattern if the slope matches the prevailing trend. Regardless of the type (reversal or continuation), falling wedges are considered bullish.

Lets look the characteristics of a falling wedge:

1. Prevailing Trend: If a falling wedge forms after a market decline then the wedge is a reversal pattern. If it forms after a rally then the wedge is a continuation pattern. If you encounter a falling wedge after a decline, the preceding trend should be at least 3 months old and in an ideal world, the falling wedge will mark the final low.

2. Resistance Line: is formed from at least two swing highs and the second lower than the first, ideally you will see three or more.

3. Support Line: is formed from at least two swing lows and the second lower than the first, ideally you will see three or more.

4. Cone: Both the upper resistance line and the lower support line are trending downwards but the slope of the resistance line is greater than the slope of the support line. Eventually these two lines converge on one another to form a cone.

5. Pattern Confirmation: You will not get a confirmation of this pattern until the upper resistance line is broken. It is sometimes prudent to wait for a break of the previous swing high because once resistance is broken there can be a reaction decline to test the newfound support level.

6. Volume: An essential ingredient to this bullish pattern is volume. You need to have volume expanding as the pattern forms then drop off as it matures.

7. Other Indicators Confirm: Although this pattern by itself is powerful, if other indicators are bullish as well it becomes all the more potent.

The DX is the U.S. Dollar Index computed using a trade-weighted geometric average of six currencies and gives us an excellent example of a falling wedge so let's use it to examine each of the criterion for the falling wedge.

1. Prevailing Trend: The preceding trend should be at least 3 months old and ideally, the reversal falling wedge will mark the final low. The wedge on the DX chart is after a market decline so is a reversal pattern. The decline started in July 2004 and was 6 months old by the time the wedge started its formation. The last swing low of the pattern was the final low.

2. Resistance: You need to see at least two swing highs and the second lower than the first, ideally you will see three or more. I see at least 6 touches of the upper resistance line and four swing highs each one lower than the previous one.

3. Support: You need to see at least two swing lows and the second lower than the first, ideally you will see three or more. I see three swing lows.

4. Cone: Upper resistance line and the lower support line converge on one another to form a cone. From the chart above the cone is pretty obvious. Notice the slope of the resistance line is greater than the slope of the support line.

5. Pattern Confirmation: You will not get a confirmation of this pattern until the upper resistance line is broken. On January 3rd DX breaks the resistance line and the pattern is confirmed. The fact that it did not retest the resistance line is a testament to the strength of the move.

6. Volume: You need to have volume expanding as the pattern forms then drop off as it matures. As you can see from the chart above the volume expanded while the pattern was forming but dropped off dramatically as the pattern matured.

7. Other Indicators Confirm: If other indicators are bullish as well this pattern becomes all the more potent. Notice the bullish positive MACD and RSI divergences giving you more reason to believe the bottom of this decline was coming to an end.

The falling wedge can be difficult chart pattern to recognize but I think relatively easy to trade. The difficulty arises when lower highs and lower lows form a downtrend and your eye picks up on the downtrend. But the falling wedge is designed to identify a decrease in the downside momentum and alerts us to the potential trend reversal. But even though selling pressure may be diminishing, the pattern itself is not confirmed until resistance is broken. As with most patterns, it is important to wait for a breakout and combine other aspects of technical analysis to confirm signals.

Bearish Rising Wedge

The rising wedge is a bearish pattern that begins wide at the bottom and tapers as price moves higher and the trading range narrows. The rising wedge is both a reversal pattern and a continuation pattern as well. As a continuation pattern, the rising wedge will still slope up, but the slope will be against the prevailing downtrend and as a reversal pattern, the rising wedge will slope up but with the prevailing trend. Whichever type you encounter - reversal or continuation - the rising wedge is bearish.

Lets look the rising wedge's characteristics:

1. Prevailing Trend: If a rising wedge forms after a market advance then the wedge is a reversal pattern but in order to qualify as a reversal pattern, there must be a prior trend to reverse. This trend should be at least 3 months old and ideally, the wedge will contain the final high. If it forms after a decline then the wedge is a continuation pattern.

2. Resistance Line: is formed by joining at least two swing highs and the second higher than the previous, ideally you will see three or more.

3. Support Line: is formed by joining at least two swing lows and the second higher than the previous, ideally you will see three or more.

4. Cone: Both the upper resistance line and the lower support line are trending upwards but the support line's slope is greater than the resistance's line giving the wedge the upward slope. Eventually these two lines converge on one another to form a cone.

5. Pattern Confirmation: You will not get a confirmation of this pattern until the lower support line is broken. It is sometimes prudent to wait for a break of the previous swing low because once support is broken there can be a reaction rally to test the newfound resistance level.

6. Volume: Ideally volume will contract as the wedge matures then expand on the support line break.

7. Other Indicators Confirm: Although this pattern by itself is powerful, if other indicators are bearish as well it becomes all the more potent.

So let's look at the rising wedge a little closer. The best example I could find was the wedge that formed on the total market index, $DWC. For most of 2004, DWC was making lower highs and lower lows then on July 13th it hit a bottom and started a bullish rally that many thought could challenge 2000 highs. But if you were a wedge watcher you would have known this rally was going to be cut short at least for a while. Here's the rest of the story.

1. Prevailing Trend: If a rising wedge forms after a market advance then the wedge is a reversal pattern but in order to qualify as a reversal pattern, there must be a prior trend to reverse. The prevailing trend started in July of 2004 and the wedge formed in December.

2. Resistance Line: You need to see at least two swing highs and the second higher than the previous, ideally you will see three or more. There were multiple touches of the resistance line and each one a tad higher than the last.

3. Support Line: You need to see at least two swing lows and the second higher than the previous, ideally you will see three or more. I see 3 swing lows forming the support line and each low higher than the last.

4. Cone: The upper resistance line and the lower support line trend upwards and eventually converge on one another to form a cone. Looking at the chart the support line's slope is definitely greater than the resistance line and eventually they converge to form a cone.

5. Pattern Confirmation: You will not get a confirmation of this pattern until the lower support line is broken. January 3rd DWC breaks the pattern to the downside however not on real heavy volume but heavier than the volume in the apex of the cone.

6. Volume: Ideally volume will contract as the wedge matures then expand on the support line break. Towards the apex of the cone the volume drops off dramatically telling you the pattern is in its final stages.

7. Other Indicators Confirm: Although this pattern by itself is powerful, if other indicators are bearish as well it becomes all the more potent. Both the MACD and RSI have bearish negative divergences confirming the bearish rising wedge.

The rising wedge can be one of the most difficult chart patterns to accurately recognize but like the falling is easy to trade. The loss of upside momentum on each successive high gives the pattern its bearish bias however, the series of higher highs and higher lows keeps the trend inherently bearish. The final break of support indicates that the forces of supply have finally won out and lower prices are likely.

A final word, always be careful when analyzing price charts using technical analysis and be selective in labeling a particular area of prices as a wedge. The pattern should meet all of the criteria discussed above. When first learning about these shapes, it is easy to make the mistake of seeing wedges everywhere.

Remember - plan your trade and trade your plan.
 

Today's Newsletter Notes: Market Wrap by Jonathan Levinson, Trader's Corner by Jane Fox, and all other plays and content by the Option Investor staff.

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