Crude oil, bonds, yield, the dollar and the gold are all been blamed for today's bearishness in the stock market. Crude oil rose, bonds fell, yields rose, the dollar fell against foreign currencies and gold rose. However, I think the market was due for a short-term pullback and we are just in a mini correction for now and that we will see a higher high later on - but more on that later. However, anyway you look at it today was not a good day for the bulls. Bonds and index futures took an unexplained fall during the overnight session and never seemed to gain their footing once the cash markets opened at 9:30EST. Rising crude oil prices and a 10-year yield making new yearly highs certainly didn't help anything. The Dow Industrials lost 107 points (-0.98%) closing at 10805.62, giving the bulls a pretty big scare. The Nasdaq Composite Index slipped 12.26 to close at 2061.29. The S&P 500 index declined 12.42, almost as much as the Nasdaq, to close out at 1207.01. On the NYSE 1.7 billion shares traded and 683 stocks rose and 2,699 fell. On the Nasdaq Stock Market, where 1.9 billion shares changed hands, 1,047 issues rose and 2,059 declined.
Investors may be coming to grips with our huge deficit and debilitating trade gap and decided to just sell everything - stock and bonds. Of course a more immediate factor weighing on bonds and giving yields a significant boost could have been the sale of $24 billion in new five- and 10-year notes by the Treasury Department on Wednesday and Thursday. Here is a daily chart of the 10-Year yield hitting new yearly highs.
The 5-year yield hit a high not seen since last July.
A $2.57 trillion budget was proposed by House Republicans that would help cut $69 billion in spending. The committee said its plan would cut the federal budget deficit to $229 billion by the year 2009, compared with about $412 billion last year. The House plan includes the cost of increased military spending in Iraq and Afghanistan but does not include the cost of changing Social Security.
The plan also looks to delete $69 billion from benefit programs over the next five years and accrue savings from Medicaid, student loans, farm programs, veterans and perhaps welfare and unemployment insurance. The proposed plan would allow benefit programs to continue accommodating for inflation but at a slower rate. Programs such as national parks and food safety protection will be cut by 8%. Final decisions on exactly where the cuts will fall will be made in later bills.
Federal prosecutors arrested two friends of former chief executive of ImClone Systems, Samuel Waksal. Zvi Fuks, chairman of the department of radiation oncology at New York's Memorial Sloan Kettering Hospital, and Sabina Ben-Yehuda, who worked at an investment vehicle set up by Mr. Waksal, are accused of selling their ImClone stock in December 2001 after learning the Food and Drug Administration would not be approving the company's cancer treatment.
Today's Economic Reports
The first report out this morning at 8:30EST was the MBA's Mortgage Applications. This report is not usually a market mover but a very interesting one to watch. It is a leading indicator of home sales and consequently gives the financial markets an indication of where the housing market is heading. It is also used for gauging refinancing activity, which has a direct correlation to consumer spending.
The report for the week ending March 4, 2005 showed the MBA index decreased by 0.7% to 704.8. The composite index is 4% below its four-week-ago reading, and 21% below its year-ago reading as the demand for mortgages declined driven by the decline in refi applications. The refi index declined by 4.6% to 2,176.8 and is now 39% below its one-year-ago reading however, the purchase applications index increased by 2.7% to 451.7. Last week's decline in the 30-year fixed mortgage rate may account for some of the rebound in the purchase index but the most likely factor is just plain noise or weekly gyrations.
The next report was the Oil and Gas inventories out at 10:30EST. This report put out by the American Petroleum Institute (API) and the Energy Information Administration (EIA) has taken on a new importance since the price of oil has been mentioned almost every time you hear the words 'stock market.' But in particular this report is scrutinized by the Crude Oil market for unexpected changes in crude oil and gasoline inventories indicate changing market conditions and can provide insight into crude oil prices in the future.
Both the EIA and API reported a sizable build in crude oil stocks for the week ending March 4. The API report showed crude oil inventories increased by 6.247 million barrels to 304.295 million barrels. The EIA reported a build of 3.2 million barrels to 302.6 million barrels. The API reported an increase of 239,000 barrels of distillate stocks to 114.518 million, while the EIA reported a draw of 800,000 barrels to 109.2 million barrels.
With inventories this strong you would expect the price of crude to fall but Crude-oil futures briefly spiked to $55.65 a barrel on the New York Mercantile Exchange, matching an intraday record, before settling just below $55.
Speaking of oil I would like to interject my own opinion here. Although we hear a lot of rhetoric about oil and the price of crude oil I don't think it had a lot to do with today's market swoon. Crude Oil, adjusted for inflation, is nowhere near as important or expensive as it was in the 1970s. And the price of oil has been high for months now so don't you think this has already been absorbed into prices.
Then last but certainly not least was the U.S. Department of Treasury's Beige Book out at 2:15EST. Economists analyze this report for future monetary policy by the FOMC. In particular economists and market watchers look for comments regarding regional labor markets, retail sales, real estate, banking and energy. The Beige Book can provide some of the timeliest data on the economy at the regional level.
The report revealed that after a record deficit of $413 billion in fiscal year 2004, which ended on September 30, it is possible this fiscal year's deficit will be somewhere near $400 billion, a slight improvement. This is due to personal income tax revenues starting to grow from the stronger economy and an end to legislated tax cuts. Also corporate income tax receipts are up sharply and should see continued gains due to the expansion and the expiration of the accelerated depreciation allowance. The report also revealed strong growth in spending, however, mostly for defense and healthcare based on a new transportation bill, the Medicare prescription drug benefit and Iraq and Afghanistan wars.
On February 14th I posted an article in the OptionInvestor Newsletter called "Tighten that Wedgie." It was a piece on how to spot and then trade a bullish or bearish wedge. Here is what I said about the bearish 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.
I would now like to take a look at the SPX daily chart and use the criteria from the article to first of all see if the formation I am seeing has the potential for a bearish wedge and if it does then how to trade it. (This chart was created on Tuesday so does not show the bearish day today)
We definitely have the potential for a bearish wedge so I have drawn some red arrows within the green cone to show you where I think SPX will need to trade to complete the formation. Here is where I see the higher high I talked about earlier.
But even if it does complete 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.
Here is a chart of the DOW and as you can see it has a similar pattern.
Do you also see the MACD negative divergence (marked in red) giving us more bearish information. A slight bearish divergence appears on the SPX chart as well (not shown).
Now take a look the charts of the Russell 2000 and the NDX.
Both are in neutral wedges that don't give a lot of hints as to direction but we can use them for trading the SPX and the DOW. Since SPX and the DOW are building bearish wedges I expect these two neutral wedges to break to the downside. But if they don't then it puts a little bit of a crink in the bearish picture I am building and I would not be as ready to open bearish positions on these SPX and the DOW. But on the other hand if they break downward in conjunction with the SPX and DOW bearish wedges breaking downward you have a very good confirmation and all the more confidence in your bearish positions.
Unfortunately trading is never this simple but this does give you a roadmap to follow albeit a bearish roadmap. If you are bullish you probably don't want to follow this roadmap.
Tomorrow's Economic Reports
Tomorrow's economic reports start with the Bureau of Labor Statistics' weekly Jobless Claims 8:30EST report. This report is watched as a secondary indicator of labor market conditions and as an advance indicator of the more widely monitored monthly payroll employment situation report. Consensus 310,000 and previous weeks 310,000.
Next we have the Bureau of Census' 10:00EST report on wholesale trade inventories and the inventories to sales ratio. These are important indicators of current consumption and of future manufacturing activity.
Then we have the 2:00EST Treasury Budget that is not a market mover but watched because longer term trends in the Federal Budget are important to financial markets.
Remember plan your trade and trade your plan.
Google Inc - GOOG - close: 181.35 chg: -3.85 stop: 185.01
Why We Like It:
BUY PUT APR 185 GOU-PQ OI=1722 current ask $12.60
Picked on March xx at $xxx.xx <-- see TRIGGER
Ishares Dow Jones US Energy - IYE - cls 76.25 chg: -2.35 stop: 80.01
Why We Like It:
BUY PUT APR 80 IYE-PP OI= 10 current ask $5.00
Picked on March 09 at $ 76.25
Oil Service Holders - OIH - close: 96.10 chg: -2.44 stop: 100.01
Why We Like It:
BUY PUT APR 100 OIH-PT OI= 3610 current ask $6.40
Picked on March 09 at $ 96.10
Alliance Resource - ARLP - cls: 79.75 chg: +1.73 stop: 74.49
ARLP is pulling back with the market's decline but then we expect ARLP to consolidate some. We were looking for the stock to find support near the $75.00 level but it looks like the $76 mark might hold. We're not suggesting new bullish positions until we see a bounce.
Picked on February 27 at $ 75.01
Hartford Financial - HIG - cls: 71.76 chg: -0.62 stop: 69.95
Traders need to be cautious here. The market decline is weighing on the IUX insurance index and shares of HIG are following suit. The stock has broken below its simple 21-dma and we would expect it to pull back toward support near the $70.00 level and its rising 40 and 50-dma's. We would not suggest new bullish positions until we see a significant bounce. We'll be watching for a bounce near $70.25.
Picked on February 06 at $ 71.17
Ingersoll-Rand - IR - cls: 84.60 chg: -1.55 stop: 82.49
When the Dow starts to produce triple-digit declines traders start to profit take in their recent winners. IR certainly qualifies as a winner given the previous two-week rally. We are watching for the stock to find support in the $83-84 range. We would not suggest new bullish positions until we see a significant bounce.
St Joe Co - JOE - close: 73.90 chg: -1.75 stop: 72.49
This afternoon JOE's management reaffirmed their full-year earnings outlook. We do not believe this was the cause for this morning's sudden decline but we do note that volume was a little above average. Our stop loss may be a little tight here at $72.49. More aggressive traders who believe in JOE's bullish trend may want to consider putting their stop under the 40-dma near $71.00 or even under round-number support at the $70.00 mark.
Picked on March 07 at $ 75.51
Nova Chemicals - NCX - close: 50.84 chg: -0.79 stop: 47.95
After two days of trying to push past the $52.20 level NCX finally succumbed to a little bit of profit taking. Fortunately, the stock has found minor support at the simple 10-dma. However, it would not surprise us to see NCX test the $50.00 level as support. Yesterday the company announced it would present at the upcoming Merrill conference on March 15th.
Picked on February 22 at $ 48.01
Parker-Hannifin - PH - close: 67.15 change: -1.27 stop: 63.99
It's time to turn cautious on PH as well. The stock gapped down this morning under the $68.00 level (possible support) and under the simple 50-dma (what should have been technical support). Normally that's bad news if you're bullish. We would not suggest new bullish positions at this time. Readers should double-check to see they are happy with their stop loss placement. Wait for a significant bounce before considering new positions.
Picked on March 03 at $ 68.11
PACCAR - PCAR - close: 76.23 chg: -0.91 stop: 71.9
PCAR has pulled back to its simple 10-dma but we suspect it could slip lower. Watch for a drop to the $75.00 level, which should be round-number, psychological support. Readers can use a bounce from $75.00 as a new bullish entry point.
Picked on February 28 at $ 75.25
Texas Industries - TXI - cls: 66.05 chg: -0.45 stop: 63.49
TXI has pulled back toward new support at the $66.00-65.00 level, which is normal since broken resistance tends to become support. We are not suggesting new bullish positions but readers could use a bounce from the $65.00 level as a new entry point.
Picked on January 09 at $ 60.18
Apollo Group - APOL - close: 75.91 chg: -0.53 stop: 78.01
We are surprised to see that our APOL put play is still open. A couple of days ago the stock looked poised to breakout and hit our stop loss. At this point we would not suggest new bearish positions unless the stock hit a new relative low and by that time shares would be near our target range.
Picked on January 23 at $ 77.61
Spectrasite Inc - SSI - close: 61.63 chg: -1.31 stop: 59.25
Heads up! SSI is pulling back with the market's decline but we're also running out of time before the company's earnings announcement next Monday. Instead of watching SSI pull back toward support at the $60.00 level and its rising 50-dma we're going to exit now to minimize our losses. We do not suggest holding over the earnings report but it might be worth speculating (a.k.a. gambling) on a straddle or strangle should there be a big investor reaction.
Picked on February 16 at $ 61.80
The S&P segment of the market remains, more or less, in a sideways trend as these indices retreated this week from just over the high end of its multi-month price range - suggesting that buyers and sellers remain pretty much in balance in their control or ability to take the market in a new direction.
The market may be continuing to mark time, ahead of when more influences get known and bring in new buyers or sellers. For example, the concern about the lack of a strong consistent earnings rebound in the tech market and for Nasdaq.
Selling premium as in short options is attractive during these sideways periods. Some would not call recent week's trading in the S&P 500 (SPX) seen below, a TREND at all, but rather the absence of trend. I am in the school that a broad trading range - a sideways move - is a definite trend.
Those of you who have read my recent Index Trader articles on the website - you can click here for the last one -will know that a sideways trend can make "moving average envelopes" a helpful indicator - this indicator is seen on the chart below.
The centered (magenta) line is the 21-day moving average; the red line above equal to 103% of the moving average; the dark green line below is equal to 97.5% of the moving average value for that day - another way of saying this is that the lower line is set to float 2.5% below the centered line. For the S&P 500 (SPX) and S&P 100 (OEX), the percent values, up and down, are usually around 3% and 90% of trading will tend to be at prices that are within 3% of SPX or OEX's 21-day closing average.
Two Technical Analysis Concepts
This action is also called a "bull trap" reversal - a move to new high followed by a quick and sharp reversal typically. This is often the result of a lot of exiting (buy) stops being hit first as short S&P stock index futures are liquidated. Then, stock prices settle down again.
Over the next couple of days (Thursday/Friday) we'll see if SPX closes under the average. If so, the SPX Index may be headed toward the low end of its trading range or toward the lower parallel level (dashed blue) line - this would also be back down toward the lower dark-green envelope line.
Corrections can be in "price" or "time" - or some of each. A PRICE correction is when a stock index, or a stock, retraces some portion of the prior move but less than two thirds
...OR prices mark time and go sideways (S&P) which is a TIME correction or a just plain "consolidation". A consolidation is most often a sideways trend followed by a resumption of the prior trend. However, the duration of the resulting sideways trend or trading range can be months long. IF the low end of the price range gives way, the consolidation, sideways trend and trading range was part of a lengthy top formation.
In this Trader's Corner, I'm suggesting to watch how Index price action plays out versus the 21-day moving average. A close below this average by week's end, suggests further downside or selling pressures ahead. Conversely, ability to hold hear the average, then rally some, is suggesting potential for a re-test of recent highs - right now that looks less likely to me.
Also, it appeared that this week's retreat from a brief journey to new highs in NYSE-related indexes (e.g., SPX, OEX and DJX) also was an outcome of the NYSE market being overbought. This is well demonstrated by the index leading the market, the Dow 30 Industrials (INDU). Also, by use of the stochastic indicator set at 21 (length = 21) and used on a daily chart -
INDU reached resistance implied by the upper trendline at the red down arrow AND the Stochastic model hit upper extremes for a second time recently. A second, more rarely, a THIRD time, that this indicator is up as high as the top most red zone, will tend to precede another decline of tradable dimensions and potential.
When you hear someone say the market is overbought or oversold, you should also assess what time frame they are talking about - assuming they KNOW what they are talking about and not just repeating something that they have heard.
Here I am talking about a case of the Dow 30 especially to have gotten overbought in terms of the potential for a fall over the next 2-3 weeks - the time horizon in fact that we option traders are often most concerned with.
In a strong bull market, which we no longer seem to be in, or in a powerful bear trend, overbought/oversold concepts are not so helpful as trading guides. In a strong up trend, such indicators will tend to go up and keep going up, staying at "overbought" levels for long periods.
The same is true in a bear market, and we can find plenty of examples prior to 2003 - 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!
In a TRADING RANGE market however, use of overbought/oversold readings can be quite helpful! Especially when an extreme in these indicators is accompanied by prices being at the high or low end of a trading range of some weeks; e.g., the recent Dow STOCHASTIC overbought extreme. This confluence could have alerted us to the high potential for a downside reversal - a wonderful help in formulating a strategy to exit calls (and possibly to buy puts) when the rally into new high ground started to fail.
Some Basics On Overbought/Oversold
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 INDEX that has closed higher for 10 days straight - if this price behavior is "over" or beyond what is usual for this index, 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. I tend to talk about the 2-3 trading horizon.
Good Trading Success!!
Today's Newsletter Notes: Market Wrap by Jane Fox, Trader's Corner by Leigh Stevens, and all other plays and content by the Option Investor staff.
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