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Daily Newsletter, Wednesday, 04/13/2005

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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

Two Strikes

Two Strikes

"Two Strikes against US Q1 GDP" reads the title on an article discussing Wednesday's March retail sales figures. March's advance retail sales disappointed, with the ex-autos figure rising 0.1 percent against expectations of a 0.6 percent rise. If both auto and gas sales are backed out of the headline number, retail sales fell 0.1 percent.

That's the first decline in a year in that number, one source notes. Many had expected auto and gas sales to produce a gain, plumping up the headline number, and they did gain, rising 0.7 and 2.1 percent, respectively. That wasn't enough to keep the headline number from disappointing. February's figures were revised slightly higher, however.

The fear, of course, is that rising energy costs will cut into consumer spending, and that a reduction in spending in the U.S. will have global implications. An ECB member spoke discouragingly of Europe's recovery today, for example. Some speculate that energy costs could reduce U.S. consumer spending by a full percentage point during the first half of the year. Although perhaps not a bellwether of consumer spending, Harley Davidson (HDI) beat earnings, but warned for 2005, sending that stock sharply lower and echoing the concern among retailers. HDI also said it would cut production.


Digging into the retail sales figure revealed that clothing store sales dropped 1.9 percent, general merchandise store sales fell 0.7 percent, and department store sales declined 2 percent. Durable goods sales were broken down to show furniture store sales declining 0.6 percent and electronic and appliance stores sales slipping 0.3 percent, but building supply and gardening store sales climbing 1.5 percent. Some forecasters had already trimmed their Q1 GDP estimates yesterday, based on the U.S. trade data, and some feel that the weak retail sales figures could lead to a further trimming of estimates.

The RLX, the retail sector, has spent several weeks consolidating beneath the resistance of the 30- and 50-sma's and above the support of the 200-ema and -sma's, and the RLX headed down immediately to retest those supporting averages. This occurred despite a Prudential Equity Group upgrade of WMT based on valuation. The RLX has proven to be an important index to watch to gauge market performance over recent months.

Annotated Daily Chart of the RLX:


Annotated Daily Chart of the SPX:


The SPX's erasing of Tuesday's gains makes Tuesday's break of the likely bear flag look real, although the SPX did find support at a last-ditch rising trendline off the March low. The possibility exists that it could just be broadening that bear flag. On a breakdown below Tuesday's low, the flag breakdown should be confirmed. Support approaches at the 38.2% retracement of last year's rally, a historical horizontal support level, and the 200-ema and -sma's. On a test of that support, protect bearish profits if in bearish positions, deciding ahead of time whether you'll keep a partial position to follow the SPX lower, if it does go lower, or exit and watch as the 200-sma and -ema are tested. That second choice might be the wisest choice, as some consolidation might be expected at those averages, even if the SPX eventually heads lower. Consolidation means leaking options premium. Head-and-shoulder formations can also be rejected, forcefully, at the neckline. Until that support is tested, selling rallies may be the best tactic.

If the SPX should instead bounce from the last-ditch support reached Wednesday, an upside breakout would not occur until a break above the 30- and 50-sma's, confirmed by a move above the 19.1 percent Fib level on this chart. On that break the SPX might run up into a higher right-shoulder level for its possible H&S, but such a climb could be short lived before another period of consolidation. Expect a flattening from 1213-1220 before final decision is decided. Protect bullish profits there as that's another area where consolidation might be expected.

Annotated Daily Chart of the Dow:


The Dow's 60-minute 100/130-ema's have been capping upside movements, so they might be used to determine an upside breakout level, confirmed by a move above the 4/07 high. The 50 percent Fib level is an easy marker for a downside breakdown.

Annotated Daily Chart of the Nasdaq:


The Nasdaq verged on a breakdown below its 50 percent retracement level as trading closed, perhaps lending the Apple and AMD results special significance. As this report was prepared soon after the close, those results were not available, but Thursday morning, pay special attention to how NQ futures have reacted to overnight developments. This will help assess whether the Nasdaq might be likely to open lower and head down toward next support or bounce from this support that has been holding for a month. The Nasdaq will not have stopped its trend of lower highs and lower lows, though, until a new high is formed, so bullish plays should be considered countertrend and not good risks until there's an upside breakout. If entering a bearish play on a possible breakdown, be ready to jump back out of any apparent breakdown if there's a drop-and-pop type open.

Annotated Daily Chart of the RUT:


The day started out with a negative bias, with futures down despite seeing gains in many Asian and European bourses, excluding the Nikkei which lost again. Other morning developments impacting sentiment and the financials included a wee-hours-of-the-morning announcement that Morgan Stanley investment bankers Joseph Perella and Terry Meguid would leave the company as of Wednesday. Discussion on CNBC noted the popularity of these two bankers and speculated about the effect on Morgan Stanley. After the upheaval a couple of weeks ago when CEO Philip Purcell named Zoe Cruz and Stephen Crawford co-presidents and the resultant resignations of several top executives, rumors had swirled that Perella and Meguid would also leave. That speculation was squashed, by Perella and Meguid, if CNBC correspondents were to be believed, so that Wednesday's announcement came as a surprise. MWD plummeted 2.48 percent.

Other developments included the Mortgage Bankers Association mortgage applications numbers for the week ending April 8 at 7:00 EST, with those figures showing a 6.1 percent increase from the previous week on a seasonally adjusted basis. The purchase index increased by a similar 6.4 percent and the refinance index rose 5.6 percent. Refinancing activity took a smaller share of total activity, however, slipping to 38.1 percent of total applications from the previous 38.3 percent. The conventional index climbed 6.3 percent, and the government index rose a smaller 2.9 percent. The average interest rate for a 30-year, fixed-rate mortgage climbed to 59.95 percent from the previous week's 5.91 percent. Points also increased. For more than a month, the DJUSHB, the Dow Jones U.S. Home Construction Index, has been doing battle with its 30- and 50-sma's, and the index declined from them again Wednesday, falling 2.18 percent.

At 10:30, both the API and Department of Energy reported crude and gasoline inventories climbing and distillate inventories falling, but they differed in their accounting of those inventories. The API said crude supplies rose 4.0 million barrels, and the DOE, 3.6 million barrels. The API said gasoline supplies, of primary interest after the refinery fire in Texas and with the prime season for gasoline usage approaching, rose 2.9 million barrels, and the DOE, 800,000 barrels. The API said distillate supplies fell 1.5 million barrels, and the DOE, 100,000 barrels.

The results on crude and gasoline supplies were better than expected, and led some to speculate that crude prices might drop below the $50/barrel level. Equities popped higher, but reversed within minutes and headed down to a morning low. Crude prices had already gapped below some key trendlines just before the announcement, and then consolidated at a key Fib level after dropping, giving mixed evidence that was weighted toward the bearish side.

Annotated 60-Minute Chart for Crude:


Early in the afternoon, Merck (MRK) and Eli Lilly (LLY) tried to perk up the markets, with MRK saying that Q1 EPS would likely come in above previous estimates. Traders hoped that LLY would prevail in the patent trial in a U.S. District Court, with the decision expected Thursday. Drug stocks rose, but by mid-afternoon, traders were focusing on the U.S. five-year bond auction and the after-the-close earnings reports due by Apple and AMD. The five-year auction did not go well, with foreign buyers failing to show up at the hoped-for levels, representing only 28.2 percent of the bids. Equities tumbled, breaking through expected support.

Overnight, ASML, supplier to semiconductor giant Taiwan Semiconductor, a SOX component, dampened hopes for a sharp recovery in the industry this year, saying that semiconductor fab capacity utilization was showing a slow improvement, but not a sharp recovery. The company expected to see lower order intake in the current quarter than it had in the just-ended-in-March quarter. The SOX ended the day above 400, but the day was a bearish one. AMD is a SOX component, of course, as is Taiwan Semiconductor. Again, watching NQ reactions to overnight developments might provide a clue as to how the SOX might trade Thursday. Although neither Compuware (CPWR) or Foundry Networks (FDRY) is a component of the SOX, downside guidance from those companies also dampened enthusiasm for tech stocks Wednesday.

Thursday's economic releases begin with the usual 8:30 release of jobless claims, but also include February's business inventories. Most notable ahead of Friday's economic numbers, however, will be the slew of earnings expected tomorrow, with DJ, FDC, NYC, PEP, LUV, SUNW, UIS and UNH all reporting Thursday.

Markets perch on breakdown levels, and the day was a bearish one for most sectors. This reporter believes that many of the consolidation patterns seen on the indices could be bear flags or "b" distribution patterns, but even a casual examination of the month-long consolidation patterns discovers a lot of zooming around. Wildly bullish days often follow discouragingly bearish ones, and vice versa. Although indices verge on breakdowns, those breakdowns haven't quite occurred, and indices have been here before during the last month. Until traders see decided breakouts one direction or the other, anything is possible despite those possible bearish formations. Trade with care, especially during this opex week.
 

 
 




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

Carpenter Tech - CRS - close: 60.62 chg: -0.96 stop: 59.95

No change from previous update on 04/10/05. Our trigger to go long is $64.05.

Picked on April xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/25/05 (confirmed)
Average Daily Volume = 334 thousand

---

KB Home - KBH - cls: 121.10 chg: -1.81 stop: 117.00

No change from previous update on 04/12/05.

Picked on April 12 at $122.91
Change since picked: - 1.81
Earnings Date 03/21/05 (confirmed)
Average Daily Volume = 1.4 million

---

Red Robin Burger - RRGBE - cls: 51.19 chg: -1.34 stop: 49.49

RRGB began trading today under its old symbol again. The stock dipped toward the $50.00 level before bouncing this afternoon. Readers can use the bounce as a new bullish entry point but we would confirm that market direction is positive before initiating new longs.

Picked on March 10 at $ 48.00
Change since picked: + 3.29
Earnings Date 02/14/05 (confirmed)
Average Daily Volume = 199 thousand

---

Research In Motion - RIMM - cls: 74.55 chg: -0.85 stop: 72.49

No change from previous update on 04/10/05. Our trigger to go long is $78.25.

Picked on April xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/05/05 (confirmed)
Average Daily Volume = 10.1 million

---

Whole Foods - WFMI - close: 100.12 chg: -0.61 stop: 98.99

No change from previous update on 04/10/05. Look for signs of a bounce and move back over $102 or $103 before initiating new long positions.

Picked on April 06 at $104.16
Change since picked: - 3.64
Earnings Date 05/03/05 (unconfirmed)
Average Daily Volume = 956 thousand
 

Put Updates

Allergan - AGN - close: 70.55 chg: -0.28 stop: 72.51

No change from previous update on 04/10/05.

Picked on March 13 at $ 73.09
Change since picked: - 2.54
Earnings Date 04/27/05 (confirmed)
Average Daily Volume = 777 thousand

---

Beazer Homes - BZH - close: 48.10 chg: -1.58 stop: 51.01

No change from previous update on 04/12/05 and 04/10/05.

Picked on March 17 at $ 51.43
Change since picked: - 3.33
Earnings Date 04/28/05 (confirmed)
Average Daily Volume = 742 thousand

---

Pacificare Health - PHS - cls: 56.05 chg: -1.27 stop: 60.05

No change from previous update on 04/10/05. PHS is nearing our profit target in the $55.00-54.00 range.

Picked on March 20 at $ 59.04
Change since picked: - 2.99
Earnings Date 04/28/05 (confirmed)
Average Daily Volume = 1.1 million

---

Starbucks - SBUX - close: 47.11 chg: -0.84 stop: 51.75

No change from previous update on 04/11/05.

Picked on April 10 at $ 48.62
Change since picked: - 1.51
Earnings Date 04/27/05 (confirmed)
Average Daily Volume = 4.3 million

---

Wynn Resorts - WYNN - cls: 64.77 chg: +0.28 stop: 68.05

No change from our previous update on 04/12/05 and 04/10 but it is worth noting that WYNN traded toward its 100-dma overhead and failed. This is the second failed rally at the 100-dma in a week.

Picked on April 03 at $ 66.04
Change since picked: - 1.27
Earnings Date 04/29/05 (unconfirmed)
Average Daily Volume = 1.1 million
 

Dropped Calls

Anadarko Petroleum - APC - cls: 74.25 chg: -1.45 stop: 72.49

We were very tempted to hold on to APC. The stock is holding up better than many of its peers in the oil sector. Unfortunately, with the OIX and OSX sector indices breaking down it seems foolish to hold on to APC even through crude oil prices have fallen back toward what could be strong, psychological support at the $50.00 a barrel level. We would not be surprised to see an oversold bounce in crude and APC soon but we're going to exit here anyway to minimize our losses.

Picked on March 31 at $ 76.10
Change since picked: - 1.85
Earnings Date 04/29/05 (confirmed)
Average Daily Volume = 2.3 million

---

Occidental Petrol. - OXY - cls: 68.58 chg: -3.09 stop: 67.99

Uh-oh! This looks like bad news for OXY bulls. The stock is under performing the OIX and OSX oil indices. We were expecting the $70.00 level to act as round-number, psychological support. Barring that the simple 50-dma should have acted as support and OXY has broken through both of these levels on big volume. We're not stopped out yet but it looks like OXY will continue lower tomorrow.

Picked on April 03 at $ 73.64
Change since picked: - 5.06
Earnings Date 04/26/05 (confirmed)
Average Daily Volume = 2.4 million

---

Oil Service Holdrs - OIH - cls: 92.56 chg: -2.34 stop: 92.49

The OIH holders also gave up ground with the OSX index losing 2.4 percent. The breakdown in the OIH under the $94 level and its simple 50-dma suggests a deeper correction in the works. We would expect the OIH to trade toward the $90.00 mark and its rising 100-dma.

Picked on April 03 at $ 98.70
Change since picked: - 6.14
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 3.9 million
 

Dropped Puts

None
 


Trader's Corner

Use of Trendlines for Price Channels

First, brief answers to a couple of Subscriber questions, one also relating to trendlines -

OIN SUBSCRIBER QUESTION:
What are your preferred settings for MACD, slow Stochastics and RSI for Weekly, Daily and 60 minute time frames? I'm doing some backtesting on TS and would like your inputs as a starting point.

RESPONSE:
I try to label every chart with my "length" settings (i.e., number of trading periods to use for its calculation) but I don't always show more than Daily and Hourly charts with such indicators. And I don't use MACD (Moving Average Convergence Divergence) all are measures of market momentum, but RSI and (slow) Stochastics are 'normalized' so that these indicators always show a 0 100 scale.

For those who don't know, the MACD indicator is calculated by taking the difference between two exponentially smoothed moving averages of closing prices of 12 and 26-day duration usually these are the only values ever used, although I would just note that Gerald Appel, the trader who formulated the MACD indicator, suggested that a slightly different set of values ought to be used as a sell "signal".

I use the default MACD settings in my charting/technical analysis (TradeStation - TS) application, which are Appel's 12 and 26; TS uses 9 for a MACD moving average and I use that too.

For RSI and Slow stochastics on DAILY charts, I may use 14 for number of days (length), as this is a common default setting. Lately, I've been using 13, part of the Fibonacci number series instead. I also use the next higher Fibonacci number of 21 for slow stochastics and sometimes, for RSI.

For WEEKLY charts, I use 8, which comes before 13 of course, in the 1,3.5, 8, 13, 21, etc Fibonacci number progression. To measure 2 months or 8 weeks is my ideal time frame to look at on a weekly chart.

OIN SUBSCRIBER QUESTION:
You mentioned in your last article that you use both trendlines and moving averages sometimes to determine levels for support or resistance. Is one better or more reliable for this purpose?

RESPONSE:
TRENDLINES are more definitive. Sometimes when there is no nearby trendline, a key moving average like 21, or 50, and 200-day averages, may be the area where trends find support or resistance. This can be shown with the charts of recent market action in a couple of indices

The first chart, of the S&P 100 (OEX) below, shows recent rallies stopping exactly at its minor down trendline. Two highs tentatively establish such a line, but with a third point making a better definition. We now have 5 points establishing the down trendline shown below. Meanwhile, the 21 and 50-day moving averages showed the broad area of resistance, but lacked the greater precision useful for trading.

The lower UP trendline, is where I think good support could develop; assuming there's a move down to this trendline, which I think likely. You can't see where the lower points are in the OEX trendline below. There are only 2 lows "defining" this trendline, so this trendline needs a third point to have more confidence in the intersecting point on the line being SUPPORT.

MOVING AVERAGES as SUPPORT/RESISTANCE -
It's apparent in the COMP chart below that the 21-day average often coincided with support and resistance, as does the 50 and 200-day averages at key times

USE OF (TRENDLINE) PRICE CHANNELS
I You may have noticed in my Index Trader commentaries that I often work with trendline channels, both on hourly and daily charts. Often I use the hourly charts, but my particular charting application also allows me to save a lot of hourly data.

This is not possible on many applications as you take what is given unfortunately. What you can see on the daily chart is what you can also see on the hourly charts, only in better detail

In the S&P 500 (SPX) hourly chart below a series of down, then up trend channels are highlighted. The inability for recent lows to hold the lower end of an hourly uptrend price channel suggests that there could be another down leg here per the down arrow

But then I was also struck by THIS possible uptrend channel on the S&P 100 (OEX) chart, suggesting that support could be found only slightly lower

CONSTRUCTING TREND CHANNELS -
The technique is simple but you need to also take care of following some rules for it.

A price channel is constructed by drawing a line parallel to
either an up or down trendline that slopes in the same direction.
A trendline is the first requirement, which can be constructed
after 2-3 lows or highs form.

The second, parallel, line can then initially be constructed with only ONE high or low point, which is a concept quite different than the rule for drawing the underlying trendline. Most charting software will place a line parallel to another, as long as you have a starting point or any one point above or below a trendline.

In an uptrend there are minor price swings that go with and
against the direction of the trend. The downswings are used to
define an uptrend line. The top of the first upswing can be used
to define the upper boundary of the price "channel" within which
a trend tends to proceed as seen below, with the construction coming from a chart used in my book (Essential Technical Analysis)

The chart above shows how an uptrend channel is constructed.
The upper channel line in an uptrend tends to define resistance,
or a rising area of selling interest, as prices trend higher.

Note here that after the first 2 downswing lows allowed the
initial drawing of an up trendline, the first rally high AFTER
these two lows, then defined a "line" of resistance not only
going forward, but going back in time as well by extending the
line "backward" from that point. This is an interesting aside
only, as the useful aspect of the upper channel line here is to
see where the next rally highs might come in.

There tends to be 3 results after selling pressure, at the upper
end of the channel, acts in such a "deflecting" manner: prices
continue higher but stay just under or around the upper channel
line, there is a pullback to around the middle of the channel, OR
prices drop back to the low end of the channel back to the
support trendline.

If there is a subsequent high that forms that is above the first
top that has been used to construct the upper channel line, it is
typically redrawn with a parallel line that goes through this
higher high as is seen in the chart below (the chart also comes from my book)

The widest point is used to construct the opposing channel line,
relative to the trendline. This, because we want to see the
widest possible parameters for our channel - in keeping with its
intended use to define potential extremes within the price
boundaries traversed by a trend in its "trajectory".

NOTE -
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 Linda Piazza, Trader's Corner by Leigh Stevens and all other plays and content by the Option Investor staff.

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