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Daily Newsletter, Monday, 03/21/2005

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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

Fed Ahead

Fed Ahead

Policy words from Hong Kong and speculation about the abandonment of the Fed's "measured pace" language roiled the markets today. Volumes were lighter than average across the indices as the US Dollar Index rocketed higher and gold and the CRB dived.

Breadth was mixed, with declining volume outpacing advancing volume 1.8:1 on the NYSE while advancing volume beat declining volume on the Nasdaq by a factor of 1.5:1. Option volatility declined for both the OEX and QQQQ, but the option markets were no doubt distorted by the unwinding and resetting of positions following op-ex Friday. There was plenty of sound and fury, but it wound up signifying next to nothing for Nasdaq, which closed the day less than a point lower, while the Dow lost .6% and the SPX .49%.


Daily Dow Chart



The Dow declined straight out of the gait, falling to its session low of 10534 just after 11AM. The bounce that followed failed to clear 10600, and an uneasy range ensued for the remainder of the session. On the daily chart, the trendline break has yet to be revisited as the daily cycle works its way lower, today's session again printing a lower low and lower high. The 10640-10650 confluence is immediate resistance, above which 10725 is the number for daily cycle bulls to beat. A close above that upper should be sufficient to reverse the daily cycle downphase.


Daily S&P 500 Chart



The SPX also declined, but the post-11AM bounce from the 1179 session low produced a lower doji shadow that, had the SPX closed 6 points higher, would have qualified as a bullish hammer. The decline from last week is less steep than on the Dow, with the 1185-1189 confluence exerting its pull for the 4th consecutive session. A break above that level would need to clear 1195-97 to reverse the daily cycle downphase, while below today's low, next support is in the 1173 area.


Daily Nasdaq Chart



The Nasdaq missed a bullish doji hammer by less than a point, with today's gyrations trading both sides of unchanged both in the morning and afternoon. The bounce came from a low of 1994, though the drop below the round number lasted less than 2 hours this morning. On the daily chart, 1st resistance is at 2025, but the daily cycle downphase should persist failing a close above 2040. Today's low reached a new low for 2005 and tested levels not seen since early November. Support below these lows is at 1970-75.



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Aside from the usual upgrades and downgrades, much of today's corporate news was merger-related. Internet ASKJ rallied from its premarket open on news that e-commerce company IAC/Interactive (IACI) is seeking to acquire ASKJ in a $1.85 billion deal. IACI would issue 1.2668 shares for each ASKJ share, with Reuters reporting that IACI would buy back no less than 60% of the newly issued shares to help offset the dilutive effect of the issuance. The plot thickened later in the session as IACI announced another agreement to sell its 48.6% holding of Euvia Media ProSiebenSat.1 Media AG for $204M. IACI closed lower by 2.96% at 21.63, while ASKJ added 18.28% to close at 28.67.

Other internet merger news included YHOO's agreement to acquire Ludicorp Research & Development Ltd. and its Flickr photo website. YHOO rose 1.64% to close at 31.62.

Media tech developer AVID announced an agreement to acquire digital video firm PCLE for $426M in a deal that valued PCLE at a 30% premium to Friday's closing print. PCLE shareholders are to receive $1 in cash and .0869 AVID shares for each PCLE share. AVID estimates that the deal with add to earnings as soon as Q4 2005, and anticipates 2005's full year pro-forma EPS at $2.70. AVID got slammed for 10.07% to close at 56.61, while PCLE gained 15.49% to close at 5.74.

Financial services software provider SDS rocketed higher on news that it is a takeover target by an unnamed bidder, though a NY Post article reported that a group comprised of Silver Lake Partners, Texas Pacific Group and Thomas H. Lee Partners LP were willing to pay as much as $10 billion for the company. SDS gapped up above 30 and stayed there, closing the day +24.53% at 31.07.

Onyx Pharmaceuticals (ONXX) rose sharply on news that, along with Bayer, the company is planning a New Drug Application for possible accelerated approval. ONYX rallied in the premarket and spent the session edging lower to close +1.37% at 33.25.

Other premarket rallies occurred in DNA and IMCL on news that Novartis and Schering are delaying plans to seek regulatory approval to market their own experimental PTK/ZK cancer medication after a failure in late-stage trials. DNA gapped higher and closed +10.46% at 58, while IMCL finished +1.75% at 39.58.

Time-Warner announced that it will pay a $300M fine to the SEC in settlement of fraud charges, along with which it will restate its financial results from Q4 2002 to 2002 to reduce its reported online ad revenues by approximately $500M in addition to the $190M that it has already restated. TWX closed lower by 1.55% at 18.41.

On the heels of last week's slam for GM, the company announced today that it plans to cut white-collar jobs, with reductions of up to 28% of staff in some departments. Banc of America reiterated its "sell" rating on the company. GM dropped at the open but bounced 2 cents above its 52-week low of 27.98, finishing the day higher by 1.08 or 3.77% at 29.70.

After the bell, payroll and benefit provider PAYX reported Q3 earnings that rose from $80.5M or 21 cents in Q3 last year to $92.8M or 24 cents per share on revenue of $373.9M in the current quarter. These results met expectations on EPS and beat on revenue, with analysts expecting sales of $372.6M. PAYX closed the day -.19% at 31.10 and was trading 31.20 in the aftermarket as of this writing.

The bigger news today was in the treasury and currency markets, ahead of the FOMC announcement tomorrow, as the session opened with the US Dollar Index rallying, bond yields rising and gold and foreign currencies diving. Bloomberg reported that Hong Kong Monetary Authority Chief Executive Joseph Yam was suggesting that Asian central banks should be hesitant to shift to euro acquisitions at the expense of the U.S. Dollar. Addressing business executives in Hong Kong, Yam said "The euro may become so popular in this region, it may undermine the stability of international finance."

Euro futures had benefited recently from speculation that Asian central banks, which have been huge supporters of the US Dollar and treasury markets in recent years, would begin to shift their focus to favor euros over dollars. Today, this news was sufficient to take euro futures down over 1$ to a low of 1.3167, with the June contract finishing the session lower by 1.06% at 1.3197.

At the same time, reports were circulating this morning to the effect that the FOMC is taking the rallies in oil and other commodities very seriously- sufficiently so to consider the removal of the "measured pace" language that it has been using with respect to its projected interest rate hikes. Bloomberg reported that of the Fed's 22 primary dealers, 13 believe that the abandonment of the "measured" pace of rate increases could come as soon as the June 2005 FOMC meeting, with another 3 expecting that this could occur at tomorrow's announcement of the widely anticipated 25 bp increase.


Weekly TNX Chart



Predictably, the acknowledgment that interest rates must rise more quickly to keep pace with rallying commodities was bullish for the dollar and bearish for US treasury bonds. The 3 year weekly candle chart of crude oil (below) shows the effect of interest rates at sustained multidecade lows and the dollar's decline during that period. Despite this news, however, bonds were only fractionally weaker for most of the session, with ten year treasury yields (TNX) finishing higher by .8 bps at 4.519%.

In other news, the Treasury auctioned $38 billion worth of debt today, with $20 billion in 3 month t-bills auctioned at a high rate of 2.8% and generating a bid-to-cover ratio on the low-side at 1.8. Another $18 billion of 6 month t-bills was auctioned at a high rate of 3.035%, generating a stronger bid-to-cover ratio of 2.21.


Weekly chart of Crude oil



Oil was higher again as the media circulated morning reports about supply fears arising from another flare up of Nigerian labor disputes, with talk of a 3-day strike planned in April. This news overshadowed the promise of addition production hikes from Saudi Arabia, with Sheik Ahmad already discussing a second 500,000 increase and Saudi Oil Minister al-Naimi saying that there is spare capacity of up to 1.5M bpd that could be deployed immediately if necessary. Different sources quoted the amount he cited at 2M barrels per day. In any event and as Jim Brown discussed in the weekend Market Wrap, these amounts have so far failed to impress the markets, with last Wednesday's supply increases met with rising prices in the futures that day. Today, despite this news in the morning, futures traded both sides of unchanged with the May contract finishing higher by 20 cents at 57.45 after touching a high of 57.675. Marketwatch reported that the average retail price of gasoline reached a record $2.149 US per gallon, up 5.1 cents today.

The weekly chart of crude oil shows potential bearish divergences against the higher (record) high printed last week. These divergences will require downside bearish crosses for confirmation, and from the chart it appear that a weekly close below 52-53 support could be sufficient.

Tomorrow, the Commerce Department will release the PPI and Core PPI at 8:30AM, following which will be the FOMC announcement at 2:15 PM. Fear of the Fed had clearly set in, with volumes dropping toward the end of the session. On the one hand, the conventional wisdom would see rising treasury yields as being bearish for stocks, as the "risk-free" rate of return rises. On the other hand, a dollar seen to be rising could benefit equities as it attracts foreign capital seeking a positive return- the reverse of the 2002 combined dollar/stock decline.

These macro-economic trends are most difficult to predict, and I believe that the uncertainty in the markets today was the result of this dilemma. Added to the mix was post-opex week repositioning and the shortened trading week. The greatest clarity to be found today was the stronger dollar and weaker commodities and metals. My own guess is for lower equities against rising yields, but much will hinge on the Fed's words to accompany its rate decision tomorrow.
 

 
 




New Plays

New Option Plays

Call Options Plays
Put Options Plays
None None

New Calls

None today.

New Puts

None today.


Play Updates

In Play Updates and Reviews

Call Updates

Cleveland Cliffs - CLF - cls: 78.82 chg: +2.76 stop: 72.49*new*

Investors responded positively to the news that CLF had acquired 48.4 million shares of Portman Ltd, an Australian iron ore producer. CLF has been trying to buy the company and today's announcement brings CLF's ownership up to 27.6 percent of Portman's outstanding shares. Bulls can be happy with today's 3.6 percent rally in the face of a down day in the markets. We had a TRIGGER to go long at $77.05 so the play is now open. Actually CLF opened at $77.06 so our entry point has been adjusted to today's open. Our short-term target remains the $85.00-87.50 range. We are going to raise the stop loss to 72.49.

Picked on March 21 at $ 77.06
Change since picked: + 1.76
Earnings Date 02/16/05 (confirmed)
Average Daily Volume = 1.2 million

---

Parker-Hannifin - PH - close: 67.52 change: -0.60 stop: 63.99

No change from previous update.

Picked on March 03 at $ 68.11
Change since picked: - 0.59
Earnings Date 01/18/05 (confirmed)
Average Daily Volume = 1.0 million

---

Progressive - PGR - close: 89.13 change: -1.08 stop: 88.49 *new*

Another big down day for the IUX insurance sector is really starting to weigh on PGR's bullish trend. The lack of follow through on Friday's bounce makes us cautious. We are raising our stop loss to $88.49.

Picked on March 07 at $ 89.51
Change since picked: - 0.38
Earnings Date 04/21/05 (unconfirmed)
Average Daily Volume = 770 thousand

---

Red Robin Burger - RRGB - cls: 49.25 chg: +0.05 stop: 44.99

No change from previous update.

Picked on March 10 at $ 48.00
Change since picked: + 1.25
Earnings Date 02/14/05 (confirmed)
Average Daily Volume = 199 thousand
 

Put Updates

Allergan - AGN - close: 70.68 chg: -1.03 stop: 76.05

Good news! AGN has broken down below the February low. The stock did manage a bounce from today's low but we would look for any rebound to struggle under the $72 level.

Picked on March 13 at $ 73.09
Change since picked: - 2.41
Earnings Date 04/29/05 (unconfirmed)
Average Daily Volume = 777 thousand

---

Apollo Group - APOL - close: 75.07 chg: +0.48 stop: 76.75

No change from previous update. We will plan to exit before APOL's March 29th earnings report.

Picked on January 23 at $ 77.61
Change since picked: - 3.02
Earnings Date 03/29/05 (confirmed)
Average Daily Volume = 2.4 million

---

Beazer Homes - BZH - close: 155.39 chg: +0.48 stop: 162.01

No change from previous update. Don't forget that BZH splits 3-for-1 on Wednesday. Option symbols and values will change. Check with your broker for new symbols. Meanwhile a negative Barron's article suggesting the homebuilders are in a bubble that's about to burst certainly helps our bearish sentiment.

Picked on March 17 at $154.30
Change since picked: + 1.09
Earnings Date 01/27/05 (confirmed)
Average Daily Volume = 742 thousand

---

Google Inc - GOOG - close: 180.88 chg: +0.84 stop: 185.01

The IACI-ASKJ merger news today put a bid under Internet-related stocks today. GOOG managed to close over the $180.00 mark, which should put bears on the defensive. Some analysts are concerned that the IACI-ASKJ deal puts GOOG's relationship with ASKJ in jeopardy but the ASKJ-GOOG contract doesn't expire until 2007. Short-term some believe it could be a positive for GOOG since IACI will likely bring more traffic to ASKJ's search features and thus GOOG will share in the higher traffic and paid search results. GOOG remains very high risk for both bulls and bears here. We continue to watch the $185 level for resistance but would not suggest new shorts/puts until GOOG traded under $178.

Picked on March 10 at $179.49
Change since picked: + 1.39
Earnings Date 02/01/05 (confirmed)
Average Daily Volume = 10.9 million

---

Cheniere Energy - LNG - close: 70.70 chg: -0.05 stop: 75.01

No change from previous update.

Picked on March 11 at $ 69.49
Change since picked: + 1.21
Earnings Date 03/10/05 (confirmed)
Average Daily Volume = 517 thousand

---

Intl Bus. Mach. - IBM - close: 89.51 chg: +0.23 stop 92.15

Big Blue managed to slowly climb throughout most of the session only to collapse in the last half hour after testing the 200-dma. This looks like a new bearish entry point.

Picked on March 17 at $ 89.86
Change since picked: - 0.35
Earnings Date 04/14/05 (unconfirmed)
Average Daily Volume = 4.8 million

---

Mcgraw Hill Cos - MHP - close: 88.08 chg: -0.62 stop: 90.21

No change from previous update.

Picked on March 15 at $ 88.40
Change since picked: - 0.32
Earnings Date 04/26/05 (unconfirmed)
Average Daily Volume = 751 thousand

---

Millipore - MIL - close: 43.52 chg: -0.35 stop: 46.05

No change from previous update.

Picked on March 16 at $ 43.95
Change since picked: - 0.43
Earnings Date 04/19/05 (unconfirmed)
Average Daily Volume = 358 thousand

---

Pacificare Health - PHS - close: 59.16 chg: +0.12 stop: 62.01

No change from previous update.

Picked on March 20 at $ 59.04
Change since picked: + 0.12
Earnings Date 04/28/05 (unconfirmed)
Average Daily Volume = 1.1 million

---

Toll Brothers - TOL - close: 76.17 chg: -0.96 stop: 81.50

No change from previous update. A negative Barron's article suggesting the homebuilders are in a bubble that's about to burst certainly helps our bearish sentiment.

Picked on March 17 at $ 76.81
Change since picked: - 0.64
Earnings Date 02/23/05 (confirmed)
Average Daily Volume = 2.1 million


Dropped Calls

None today.
 

Dropped Puts

None today.


Trader's Corner

Point and Figure - Formations

First of all I would like to apologize for the P&F Support and Resistance article posted March 14th. Somehow all the tabs in the Word document were deleted when it was posted to the newsletter and the diagrams I constructed were useless as I'm sure you all noticed. Please go back and see that indeed it has been fixed and the article now makes sense. I think this article on support and resistance is one of the most important articles on P&F for you can use it to confirm your analysis that a stock is bullish, bearish or just about to turn.

With that out of the way, I hope you have been enjoying reading this series as much as I have enjoyed writing it. As I promised in my last article we will be discussing double and triple bottoms and tops, catapults and triangles.

The goal of technical analysis and P&F Charting is to reveal if the bulls or the bears are in control and where the most likely spot is for a reversal. But up until now we have not had a way of determining when to buy or when to sell. That would be helpful wouldn't it?


Double Top

Lets start with the most simple of P&F formations the Double top. It is just like the double top you see in the bar charts and the one you will see the most often.

Notice there are two columns of X's separated by one column of O's. Both columns of X's rise to the same spot, the $40 box. That's the Double Top and the absolute minimum required to identify this top.

But let's look at it a little closer. Starting with the first column of X's, we can see that buyers pushed the price from $35 to $40 or the buyers wanted more shares at $35 than sellers were willing to sell for $35. Buyers bid prices higher until sellers were willing to relinquish enough shares to satisfy the demand. There was no more demand for the stock above $40 or otherwise it would have gone higher. In fact, at $40, sellers offered more shares than buyers were willing to buy. The stock met resistance at $40 and retreated. The column of O's shows the retreat. Buyers were exhausted. The price fell until buyers could be found at $36 or just below $36 but not to $35. Here the buyers became interested again. You could say the stock found support at $36. You could also say the stock found a bottom at $36.

The next column of X's is where this situation becomes interesting. You can see that buyers bid the price back up to the $40 mark. We now have two tops at $40, a Double Top. Then what happens next is the key to understanding the supply and demand situation. If the stock meets resistance and reverses again, it means there are still too many shares for sale at $40 but if the buyers bid the price above the $40 mark, it means they had to bid the price higher to satisfy all of the demand for the stock. This would be interpreted as very bullish. In fact, it would be a buy signal and would look like this:


Double Top Buy Signal

Of course, you'd like more information before actually making a purchase decision. But in the absence of any other information, this single penetration of the Double Top is a bullish chart pattern and a buy signal.


Double Bottom

The Double Bottom looks like the opposite of a double top as you would expect. The bottom is formed when two columns of O's fall to the same spot. In the example above, that spot is the $36 box.

For a Double Bottom to form, the whole supply / demand situation is reversed from the Double Top example. Sellers offered too many shares for buyers to absorb. The excess supply drove the price down to find equilibrium with demand. The first instance of that in our example is at $36, where buyers again showed interest in the stock. The stock found support at $36 and formed a bottom then retraced shown by the column of Xs. So while buyers bid up the price from $36 to $39, there was no demand for the stock above $39. In fact, at $39, sellers offered more shares than buyers were willing to buy forcing the stock back down again. The stock met resistance at $39.

Finally, you can see that sellers drove the price down to $36 again to form a second bottom, a Double Bottom. The Double Bottom is another important P&F chart pattern. If sellers continue to offer more stock than buyers are willing to absorb, the price will fall further. If the price were to fall to $35, that would be a sell signal.

Double Bottom Sell Signal

This single penetration of the Double Bottom is a bearish chart pattern and a sell signal.


Triple Top

When a stock advances and is repelled three times as it reaches resistance at the same point, it will make three tops. That is an obvious Triple Top.

In this example, the Triple Top is at $40. When the stock moves to $41 and penetrates the Triple Top, this indicates that the number of shares available for sale is not meeting the demand. Buyers see the price rising and still want to buy additional shares. Demand outweighs supply.

Triple Top Buy Signal

This indicator, a penetration of a Triple Top, is a buy signal.


Triple Bottom

The same is true to the downside. If a stock encounters support at a certain point, reverses, and tests that support level two more times, the stock will form a Triple Bottom. If penetrated, the resulting sell signal is a good indicator that buyer's demand for this stock is being overwhelmed by the number of shares offered by sellers.


Triple Bottom Sell Signal

A Purdue University study performed by Professor Earl Davis constructed a table of 'probabilities' associated with various 'sell signals' and 'buy signals.' In a bear market a 'triple bottom sell signal' was profitable (in a bearish trade) 93.5% of the time, with an average gain of 23% over an average 3.4-month timeframe." I like those kinds of odds.

As you probably have noticed the tops are always made with the Xs and the bottoms with the Os since Xs denotes demand and Os supply.


Bullish Catapult

There are endless variations on these chart patterns. Here's an example where two chart patterns are combined to form a third pattern that reinforces the interpretation of the prevailing trend.

A Bullish Catapult is nothing more than a Triple Top followed by a Double Top.

The Double Top following a Triple Top is a confirmation that the number of shares available for sale is not keeping up with demand. Buyers want to buy more than sellers are offering to sell so the price increases to entice the sellers into parting with their supply.

Notice in this example the higher highs and the higher lows. Demand for this stock is increasing and supply cannot keep up with it. People who don't own it want to own it and are willing to buy at just about any price.


Bearish Catapult

On the downside, a Triple Bottom followed immediately by a Double Bottom is called the Bearish Catapult.

Notice in this example the lower highs and the lower lows. Demand for this stock is drying up. People who own it want to get out of it. They're now willing to sell at just about any price.


Bearish Triangle

I P&F formation I like the best is the Triangle because they are easy to identify visually. The only constraint on the triangle is that it must have 5 columns, although I don't usually hold a stock to this constraint and if I see a nicely formed triangle with only 4 columns I would still consider trading it.

Let's start with the Bearish formation, for a change. Notice the higher lows and lower highs in the example.

If you'd guessed that this pattern could go either way you would have been right so you have to wait for a resolution before entering a trade. But once the chart signals a direction, you have a good entry point. More importantly, you have a fairly close stop point if the trade doesn't work out.

In the Bearish Triangle example, you will usually have a Double Bottom sell signal as your trigger. Notice the double bottom at $34.

Here is a real life example of the bearish triangle.

I have marked the triangle with magenta arrows. Notice also that Stockcharts.com will tell you when this triangle breaks out, which is marked with a blue arrow. Did you notice the triangle breakout was at the double bottom breakout.

The only problem with this triangle is that it is above a bullish support line. I would be more inclined to trade this bearish triangle when the bullish support line breaks.


Bullish Triangle

Here's the same triangle example, except this time the chart resolved to the upside.

In the Bullish Triangle example, you will usually have a Double Top buy signal as your trigger. Notice the double Top at $38.

Here is a real life example of the Bullish Triangle.

I have marked the triangle with magenta arrows. Notice also that Stockcharts.com will tell you when this triangle breaks out and the double top.

If you are looking for charts with clearly defined buy and sell signals or charts that only display the most significant price movements, Point & Figure charts may be just the ticket. While the columns of Xs and Os on a P&F chart may seem unfamiliar at first, with a little practice you may begin to wonder how you ever lived without them.

Next week I hope to finish off the series with how to use P&F charts to determine price projections. However, I'm not sure I will be able to fulfill this goal however, because I am having a hard time finding the data I need.

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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