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Daily Newsletter, Wednesday, 03/30/2005

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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

Techs Rule

Techs Rule

Bulls were inspired today by falling oil prices, oversold conditions where price stopped on strong support, particularly for the Nasdaq, and they liked the encouraging economic data. The Dow (+1.3%) saw 29 of its 30 components in the green today and it recorded its first triple-digit gain in nearly a month while the Nasdaq (+1.6%) closed above the psychological 2000 mark for the first time in more than a week. In so doing it also broke its downtrend line from its March 7th high. Falling crude oil prices ($53.95/bbl, -$0.25, May contract), resulting from strong inventories data, eased some inflationary concerns ahead of tomorrow's February Personal Income and Spending report and Friday's March employment report. Crude oil inventories rose 5.4 mln barrels (consensus was +2.5 mln) and distillates fell only 1.1 mln barrels (consensus was for -1.5 mln), which offset a larger than expected decline in gasoline inventories (-2.9 mln barrels vs consensus of -1.8 mln). That drop in gasoline inventories is worrisomewe could see much higher prices in gasoline as the summer driving season approaches. Stand by for a Consumer Sentiment drop if gas prices keep heading higher. And the auto companies will not have an easy time selling their gas-guzzling SUVs and trucks. And with more money going to fill their vehicles, there will be less discretionary spending for all the other things in life. That will have an impact on the bottom line of a lot of non-oil related companies. But thats in the future (next month). Today was bullish.

With the increase in inventories, a lot of players who were long the oil market decided to take some profits but then at the end of the day they decided to buy their positions back. From yesterdays closing price of $54.20 (May contract), oil had dropped 3.3% to $52.40 at its lowest level today which was 9% off its most recent high of $58.20/bbl two weeks ago. It then spiked back up to close at $53.95 at the end of the day, down only $0.25 for the day. The GDP number, which came in at an unchanged 3.8% from last month, was below the higher expectations of 4.0%. But it suggested economic growth was at a pace that was not too strong to warrant more aggressive Fed tightening at the FOMC's next meeting (May 3). Traders were probably just relieved it wasnt worse since they probably planned on doing some buying today anyway. So with the market being oversold following three weeks of declines, which took the Dow and S&P to two-month lows and with the Nasdaq showing weakness not seen since last October, buyers couldnt stand it any longer and wanted to grab what they considered some good deals. The amount of selling in the past 3 weeks also had many shorts anxious to cover and protect profits and that fueled the rally as well today.


The bond market rallied today on lessening concerns about inflation. Yields are currently sitting near the flattest levels since 2001. The significance about this is that a flat yield curve and especially an inverted yield curve where 30-year yields are lower than 10-year, has always lead to past recessions. Add in a potentially aggressive Fed, which has also lead to past recessions and you can see were dancing on the edge of the cliff, potentially. Bond traders have started to talk of the Friday payrolls number, with expectations starting the inevitable creep higher in prices (drop in yields). There are some reports that temporary and recruiting agencies have seen improved hiring, or are expecting to see improved numbers. The question is whether or not their expectations will be met. The help wanted index, which had been falling steadily since late 2000, has seen some recent up-ticks (although this remains a difficult measurement due to the amount of job hunting now done over the Internet).

Tech stocks lead the way today, and in fact telegraphed that yesterday near the close when the Nasdaq got a strong bounce off its uptrend line from October 2002. One stock of particular interest today was Micron Technology (MU), up $0.36 to $10.48 or +3.6%, as strong sales to PC makers helped the chip maker offset weaker average DRAM pricing and beat analysts' Q2 forecasts by $0.03 last night. The better than expected earnings only fueled a pent up demand for tech stocks after the beating theyve been taking. The Philadelphia Semiconductor Index (SOX +2.3%) had been down roughly 5.5% in 2005 before today's surge. In other indices, the Russell 2000 (RUT) was up 1.7% today, erasing only a part of the drubbing small caps have taken this month (-6.9% since the March 7th high). The Nasdaq was up 1.6% getting above the all-important 2000 level. But it too has a ways to go to make up for the -6.4% shellacking it's taken since the March 7th high. The Dow and S&P 500 each lost -5.4% this month and got a 1.3% and 1.4% bounce today. Some of the leading sectors today were Airlines (+5.2%), Internet +3%, Networking +2.4%, Semi +2.3%, Healthcare +2.3%, Software +2.0%, Defense +1.8%, and Broker/Dealer +1.7%. Pulling up the rear, but still in the green, were Oil Service +1.0%, Biotechs +1.0% and the Oil index +1.2%. Not a bad day all around. Notice that the leaders to the upside today have been the ones most pounded recently and have underperformed in 2005--Internet Retail (+3.7%), IT Consulting & Services (+4.9%) and Airlines (+5.2%). These three have been in the Top Ten "worst" performing areas in 2005, falling 35.3%, 31.2% and 13.8%, respectively. Think maybe there were a few shorts in these sectors scrambling to cover today?

Taking a look at some charts for clues, starting with the DOW:

Dow Chart - Daily


The DOW found support between its 200-ema and 200-sma and just above its January low. It was not quite as weak as SPX which did drop to, and slightly below, its January low yesterday. This bounce now needs to hold--if it were to drop again through the 200-sma, the 200-ema and January low would be significantly threatened.

SPX Chart - Daily


The SPX chart shows how price bounced off the January low which also coincided with the uptrend line from March 2003 through the October 2004 low. Its 200-dma is slightly below at 1159 if there is to be one more push lower.

Nasdaq Chart - Daily



The Nasdaq also found support at a very important longer term uptrend line from October 2002, which coincided with the bounce high back in October 2004. This was after breaking below both the 200-ema and 200-sma. The 200-sma at 2013 could act as resistance now. If it does and the uptrend line gets retested I'm not sure it will hold this time. If it breaks, there's a downside Fibonacci projection for this leg down to 1913, or near the October 2004 low.

Oil Chart - May Contract - Daily


All eyes have been on oil for a while now. It could potentially have a serious impact on our economy if it continues to climb. It will rob people of their discretionary income which will have a negative impact on all other businesses. As depicted in the chart, it appears oil has more upside work to do before it's ready for a deeper correction. I expect oil to get a little above $60 before we see a pullback towards $50 after the summer, and then probably ramp back up even higher as we head into the winter.

OIX Chart - Daily


If oil heads higher I suspect the oil stocks will follow it. The oil index has been in a steep parallel up-channel and probably is not finished looking for new highs, just like oil. If price were to break below 450, there's a good chance it will head to the bottom of its longer term up-channel. If this were to happen sooner rather than later, it would likely be giving a heads up that oil price will also correct lower.

U.S. Home Construction Index Chart - DJUSHB - Daily


Looking similar to the oil charts with the steeper parallel up-channel out of the longer term up-channel, the difference here is that price has fallen out of the steeper channel and is back inside the longer up-channel. Even though a drop to the bottom of the longer term up-channel would still maintain the long term uptrend, that would be a steep correction and would likely prompt much hand-wringing about what's going on with the housing market and what it would mean for the broader market. It would likely be coincident with rising bond yields.

In addition to short-covering today there was some genuine buying interest as we head into month and quarter end. New money, or expected new money in April, prompted many fund managers to put some money to work and they've got their collective fingers crossed that they're buying some good deals and hoping they're not going to be disappointed with a continuing decline. Tomorrow and Friday are big days for economic reports and these always make it a little riskier positioning in front of them. Tomorrow we have initial claims (320K est), personal income (0.4% est), personal spending (0.5% est), Chicago PMI (60.5% est), help wanted index (41 est), and factory orders (0.5%). Needless to say we have some potential market movers in there. Highlighting the session will be the PCE Deflator (2.3%), a Greenspan favorite, and will have the markets on alert after the Fed's recent bullish-inflation tone and the recent PPI and CPI releases. After today's strong rally we could see a pullback tomorrow morning, especially if any economic reports are considered bearish. But if we get some positive numbers, that could ignite some additional short-covering. Be careful of the early whipsaws.
 

 
 




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

Amer. Intl Grp - AIG - cls: 57.16 chg: -1.04 stop: 55.95

Uh-oh! We feel like yelling, "ABORT, ABORT!" but we're not willing to give up on AIG just yet. AIG was the only Dow-component not to trade higher today. Instead shares dropped 1.78 percent after the company postponed their Q4 results for the second time. The lack of follow through on its reversal and on such a bullish bounce in the markets makes us very wary.

Picked on March 29 @ $ 58.01
Change since picked: - 0.85
Earnings Date 04/21/05 (unconfirmed)
Average Daily Volume = 9.2 million

---

PalmOne - PLMO - close: 25.08 chg: +0.22 stop: 23.25

We don't have much to report on for PLMO and this time that's a bad thing. The lack of participation in today's market bounce is a concern. Be on your guard.

Picked on March 23 at $ 25.71
Change since picked: - 0.63
Earnings Date 03/17/05 (confirmed)
Average Daily Volume = 3.2 million

---

Red Robin Burger - RRGB - cls: 50.56 chg: +0.14 stop: 44.99

No change from previous update.

Picked on March 10 at $ 48.00
Change since picked: + 2.56
Earnings Date 02/14/05 (confirmed)
Average Daily Volume = 199 thousand
 

Put Updates

Allergan - AGN - close: 70.09 chg: -0.32 stop: 75.01

The lack of participation in today's market bounce is good news for the bears.

Picked on March 13 at $ 73.09
Change since picked: - 3.00
Earnings Date 04/29/05 (unconfirmed)
Average Daily Volume = 777 thousand

---

Beazer Homes - BZH - close: 49.70 chg: -0.35 stop: 54.01

Ding! BZH slipped to $48.50 this morning, near the 100-dma, before bouncing. Yesterday we suggested that conservative traders consider exiting at $48.50. We're going to maintain our $48.00-46.50 target. Today's breakdown under the $50.00 mark is good news for housing bears in BZH and the lack of participation in the market's bounce by the home construction index is also good news. However, we do notice that BZH appeared to be bouncing higher by the close. Look for possible bounce back into the $51-52 range before BZH turns lower.

Picked on March 17 at $ 51.43
Change since picked: - 1.73
Earnings Date 04/21/05 (unconfirmed)
Average Daily Volume = 742 thousand

---

Google Inc - GOOG - close: 180.45 chg: +0.88 stop: 185.01

Good news! The market produced a big bounce and First Albany reiterated its "buy" rating on GOOG but shares of the search-engine giant failed to respond positively. This bodes well for our put play but we remain cautious especially if the market continues to bounce. Look for a drop under $177 before considering new bearish positions.

Picked on March 10 at $179.49
Change since picked: + 0.96
Earnings Date 02/01/05 (confirmed)
Average Daily Volume = 10.9 million

---

Intl Bus. Mach. - IBM - close: 90.68 chg: +0.08 stop 92.15

Today's 8-cent gain in IBM looks like good news to us. The Dow gains 135 points and IBM only adds 8 cents? That looks like relative weakness and bodes well for our put play. However, we remain cautious. The markets are still oversold and could continue to bounce for a few days yet. We would wait for IBM to trade back under the $90.00 level before considering new bearish positions.

Picked on March 17 at $ 89.86
Change since picked: + 0.82
Earnings Date 04/14/05 (unconfirmed)
Average Daily Volume = 4.8 million

---

MGM Mirage - MGG - close: 70.80 chg: +0.55 stop: 72.51

No change from previous update. MGG's lack of participation on the rally is good news for the bears. Our trigger to go short/buy puts is $68.75.

Picked on March xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 05/01/05 (unconfirmed)
Average Daily Volume = 997 thousand

---

Mcgraw Hill Cos - MHP - close: 87.89 chg: +1.83 stop: 90.21

MHP bounced with the market today and almost erased yesterday's losses. Be careful.

Picked on March 15 at $ 88.40
Change since picked: - 0.51
Earnings Date 04/26/05 (unconfirmed)
Average Daily Volume = 751 thousand

---

Millipore - MIL - close: 43.59 chg: -0.58 stop: 46.05

Good news! MIL did not participate in the market's oversold bounce today. Instead the stock lost 1.3 percent on heavy volume suggesting more weakness ahead.

Picked on March 16 at $ 43.95
Change since picked: - 0.37
Earnings Date 04/19/05 (unconfirmed)
Average Daily Volume = 358 thousand

---

Pacificare Health - PHS - close: 58.62 chg: +0.64 stop: 62.01

No change from previous update.

Picked on March 20 at $ 59.04
Change since picked: - 0.42
Earnings Date 04/28/05 (unconfirmed)
Average Daily Volume = 1.1 million

---

Toll Brothers - TOL - close: 77.10 chg: +0.09 stop: 80.51

We are encouraged that the home construction index and TOL did not truly participate in the market bounce today. However, we remain somewhat cautious as Merrill Lynch issued some positive comments on TOL today. If we don't see a continuation of the breakdown soon we may exit early.

Picked on March 17 at $ 76.81
Change since picked: + 0.45
Earnings Date 02/23/05 (confirmed)
Average Daily Volume = 2.1 million
 

Dropped Calls

None
 

Dropped Puts

Fedex Corp - FDX - close: 95.00 chg: +1.79 stop: 96.01

We are choosing an early exit in FDX. The bounce in the transports from its long-term support trendline and FDX's bounce from the $93.00 level have put our bearish play in serious jeopardy. We'd rather cut our losses here.

Picked on March 27 at $ 93.89
Change since picked: + 1.11
Earnings Date 03/17/05 (confirmed)
Average Daily Volume = 1.8 million

---

Cheniere Energy - LNG - close: 63.57 chg: -0.09 stop: 70.01

Target achieved! LNG continued to breakdown this morning and shares traded well into our target range of $62.00-60.00. Yesterday we mistakenly listed the target as $62.50-60.00. The low today was $60.60 before shares bounced back. We're closing the play at $62.00 per our published strategy. If you have not closed the play we urge caution. The market could continue to bounce for several days. LNG does have some resistance at the $65.00 mark but it would not surprise us to see LNG bounce even higher.

Picked on March 11 at $ 69.49
Change since picked: - 5.92
Earnings Date 03/10/05 (confirmed)
Average Daily Volume = 517 thousand
 


Trader's Corner

Who is this Fibonacci guy and his retracements?

Some of the best topics for articles often come from OIN Subscribers. If you don't think so, write me and tell me what YOU think would be a worthwhile topic to consider.

Recent Subscriber e-mail -

SUBSCRIBER QUESTION:
In reading your articles on bullish and bearish wedges, I find it interesting that I see a collation to the Fibonacci numbers in the reversal support/resistance points. Do you think one should consider such relatives when looking at support/resistance? Or would the support/resistance line be more relevant.

Like many, I have often tried and failed at interrupting such points, resulting in buying tops and selling bottoms. Think its, "The Fear Factor" working at its best?

RESPONSE:
What you referring (as the Fibonacci numbers) is probably a reference to the price trend retracement levels of .38, .50 and .62, used to judge possible support or resistance areas. This means of assessing it versus using say, the support/resistance levels implied by a chart trendline. First I need to give some explanation and background about the role of so-called "fibonacci retracements" in trading.

RETRACEMENTS
We owe some debt to Charles Dow for his observations that an intermediate trend often will retrace (give back) anywhere from around 1/3 to 2/3rds of the distance covered by the primary trend, before the primary trend resumes. There were further refinements on retracements made by W.D. Gann, a famous stock and commodities speculator of the first half of the 1900s.

But the origins of one of the most useful retracement theories for stocks and other markets came from someone who lived in the middle ages and was studying the population growth of rabbits.

Leonardo Fibonacci was an Italian mathematician who was doing such work in the early 1200s. The number sequence that is named after Fibonacci is where each successive number is the sum of the two previous numbers; i.e., 1, 2, 3, 5, 8, 13, 21, 34, 55, 144, etc. Any given number is 1.618 times the preceding number and .618 times the following number.

There are some technical indicators whose formulas rely on the Fibonacci number sequence, but the main application is to look at price moves in stocks or index and use the fibonacci retracements of .382 or 38 percent, .50 or 50 percent and .618 or 62%.

Looking at the number progression of 1, 2, 3, 5, 8, 13, 21, etc. where each succeeding number is the sum of the two before it, there are certain arithmetic relationships that exist: .618 is the percent that each number is OF the next higher number; .382 is the inverse of .618 (100 61.8 = 38.2). Well stick to a shorthand and round off .382 and .618 to an even 38 and 62 percent %.

Imagine a stock that in 12 months goes from 10 to 20, up $10 dollars. The stock has had a fantastic double but you think it could go yet substantially higher. You wished you had owned it at 10 and but still would like to buy it, but cheaper than 20. The stock starts to trade lower. At what level could you hope to buy the stock?

Considering what would constitute the 38, 50 and 62% retracements of the 10 to 20 dollar advance would suggest the following -

1. If the demand is really strong for the stock, you might not be able to buy it cheaper than 16.25 (.38 of the 10 gain subtracted from the 20 high point)
2. if the demand was average, you could hope to buy the stock at 15, which is a give-back of .5 or one-half of the 10 point run-up.
3. If demand turned out to be weak on the way back down from the high point of $20 (e.g., after some news stories about the company die down or change), you might anticipate or wait to see if you could buy the stock at 13.75 (.62 of 10, subtracted from the high point 20).

Also useful in trading index and, stock options, is to track what would constitute the 38, 50 and 62% retracements, after a minor or intermediate price swing.

There is a simple pragmatic reason for this popularity; buying or selling in these retracement areas often results in coming close to buying at the low and selling at the top. Maybe the saying of buy low, sell high, owes something to the common retracements.

You can set most charting applications to calculate retracements ranging from .33 to .38, .50, .62 to .66, In an correction (fall in price) within a larger uptrend, use of the retracement "tool" is by first pointing at the low, then the high. An example is provided below with the most recent (daily) chart shown below for the S&P 100 (OEX) and using my charting programs retracement drawing tool.

It is interesting to note that the OEX that as of the chart date below, the index has now come within 1 point of a 50% retracement of its October to early-March advance. Stay tuned on what follows! Many traders will assume support in this area because of the Index having retraced now fully half of its prior run up.

As, well, this one-half (.5) retracement coincides with current price as being at its prior low, at its 200-day moving average and near my lower (moving average) envelope line. All suggest a possible rally point, technically. Talk about convergence!

Considering just the Fibonacci aspects; if 554 is pierced then 546.50, at the 62% retracement, is where a final bottom might be (according to the common retracement concept). This view assumes that the OEX is still in an uptrend and won't retreat all the way back to the prior (late-Oct bottom) low.

By the way, you can always use a calculator and add or subtract the 3 percentage figures once it appears that a high and a low is in place for any minor or secondary trend in an index or a stock, and which allows a calculation of the retracement possibilities.

COMPUTING CORRECTIONS WITHIN AN UPTREND -
Once a minor downside correction begins, SUBTRACT the point figures that would represent a 38, 50 and 62 percent retracement of the high minus the rally starting point, from the recent high. Watch then for if and when these levels are reached. Worth doing, once it appears that a price swing has run its course and that a counter-trend opposite move is developing.

WITHIN A DOWNTREND -
In a downtrend, ADD what would be the 38, 50 and 62 percentage retracement of high to low, to the most recent low. These levels then become possible upside targets. Prices will often rally an amount equal to about half of the last decline or, another eighth (12%) more to 62% or an eighth less, to 38%.

In general in a countertrend rally within a dominant downtrend, once a minor downside correction begins, look to see if a rally gets to as high as a 38, 50, or 62% retracement of the prior move from high to low. If the rally begins faltering and buying interest dries up, it adds to the possibility that prices have rebounded as far back up as they are going to. And, to the more venturesome suggests a possible short or a play in puts.

SOME GENERAL GUIDELINES ON FIBONACCI RETRACEMENTS:
A strong trend will usually see only a "minimum" price retracement -- around 1/3 to 38%. If prices start to hold around this area, trade entry may be warranted.

In a normal trend (not powered by something extraordinary), a retracement will often be about half or 50% of the prior move. A common level to buy or sell by some will be at this point. After about this much of a return move has occurred; with an exit if it continues on much beyond 50%; e.g., 5% more.

Within the range of normal, but evidence of a weaker trend, will be a retracement of 62% or perhaps 2/3rds (66%). If prices hold this area, it can suggest initiating a trade, with an exit if the retracement exceeds 66%.

If a retracement exceeds one level, look for it to go to the next; e.g., if a retracement goes beyond 38%, look for it to go on and approach 50%. If it exceeds 50%, look for 62%. If a retracement exceeds 62% (or a maximum of 66%), then I look for what I call a "round trip" or a return all to the way to the area of the prior low or high this type action suggests a retest of the low or high and is the ultimate "retracement" so to speak, of 100%.

Retracements are most commonly done from the low to the high of the trading period being looked at (e.g., hourly, daily, weekly charts). If daily, intraDAY high to intraday low, and not based on the highest close to the lowest close, etc. However, you can experiment with retracements based on closing levels as they also are worth exploring; and can add to understanding of where the market is going. The common retracement levels work on all time frames or chart types; e.g., hourly (or less), daily, weekly and monthly charts.

NOTE -
To Option Investor Subscribers - Please send any technical and Index-related questions for possible use in my next Trader's Corner article to support@optioninvestor.com with 'Leigh Stevens' in the Subject line.

Good Trading Success!!
 

Today's Newsletter Notes: Market Wrap by Keene Little, Trader's Corner by Leigh Stevens, and all other plays and content by the Option Investor staff.

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