Bulls STEEL Today's Bullish Showing
Bolstered by a merger in the steel sector with Metals USA (NASDAQ:MUSA) $21.12 +52% agreeing to be bought by private investment firm Apollo Management for $22 per share in cash, the Dow Jones Steel Index (DJUSST) 143.16 +5.23% was among today's top percentage sector gainers, where speculation of consolidation in the group found its way to Olympic Steel (NASDAQ:ZUES) $16.99 +24.5% and Insteel Industries (NASDAQ:IIIN) $11.08 +12.6% in the form of speculative buying and short covering.
We are very encouraged by the bullish breakout in the major stock averages (DJIA, S&P 500, and the NASDAQ Composite). However, with the Dow up three hundred points in three days the market is looking a little short-term overbought. We would like to add new bullish candidates to the play list but we will wait until tomorrow to see if there is any profit taking and thus a better entry point.
Amerada Hess - AHC - close: 89.08 chg: -0.33 stop: 86.25
Readers may want to take a step back and give AHC a wait and see approach before moving in. The stock traded higher this morning and hit the $91.00 level before succumbing to weakness in crude oil prices. Crude oil traded lower after the Wednesday inventory numbers came in above expectations. More importantly crude oil prices have now broken down below their 200-dma. This could put a serious crimp on any rebound in shares of AHC. If AHC trades under the $88.00 level we would seriously consider exiting this play early.
Picked on May 17 at $ 89.41
Caterpillar - CAT - close: 93.52 chg: +1.56 stop: 89.00
Another triple-digit gain for the Dow Industrials helped lead a broad-market rally higher and CAT followed. Shares of CAT broke through its 100-dma and traded at our entry point of $92.35 to open the play. This confirms the breakout from its inverse H&S pattern that points to a $100 target. Our target is the $99.25-100.00 range. Don't be surprise to see a little profit taking after the three-day rally. Readers could use a dip back toward $92.00 as a new entry point if they missed today's breakout.
Picked on May 18 at $ 92.35
Federated Dept Stores - FD - cls: 67.94 chg: +1.34 stop: 62.49
FD has closed at another new high boosted by the market's rally. Readers may want to wait for a potential dip back toward the $65 or $66 levels before initiating new bullish positions. Our short-term target is the $70.00 level.
Picked on May 17 at $ 66.60
Hovnanian - HOV - close: 56.45 chg: +2.27 stop: 52.49 *new*
Housing stocks soared on Wednesday out performing all other sectors save the airlines. The DJUSHB home construction index added 4.5 percent. Shares of HOV followed with a 4.18 percent gain to breakout over the $54.50-55.00 level. Our target is the $59-60 range. We are raising our stop loss to $52.49.
Picked on May 06 at $ 54.26
Invitrogen - IVGN - close: 78.60 change: +0.61 stop: 74.85 *new*
Thus far there has been no post-ASCO conference sell-off in the biotech sector and that bodes well for the group and IVGN. The stock traded to $79.30 during today's market rally. Our short-term target is the $80.00 level and more conservative traders may want to exit early. We are raising our stop loss to $74.85.
Picked on May 03 at $ 75.51
Eli Lilly - LLY - close: 60.36 change: +0.80 stop: 57.99 *new*
This morning before the open an analyst firm upgraded LLY to a "buy" with a $65 target. This pushed LLY to gap up at the open. The stock added 1.3 percent on above average volume. The move over $60.00 looks like a new bullish entry point to us. Yet some traders may want to wait and see LLY fill the gap from this morning near $59.60. Our target is the $65 level. We are raising our stop loss to $57.99.
Picked on May 04 at $ 60.15
Reynolds American - RAI - cls: 82.61 chg: +1.07 stop: 77.95
RAI outpaced the rally in the S&P 500 index on Wednesday. The move helped confirm the recent breakout over resistance near $81.25 and volume was above average. Our target is the $85-86 range.
Picked on May 16 at $ 81.31
L-3 Comm. - LLL - close: 68.59 chg: +0.99 stop: 69.55
Now that the stock market is breaking out to the upside this is not a safe environment for bearish plays. Readers may want to seriously consider exiting their bearish positions to minimize losses. With that in mind we're encouraged that LLL's rally today stalled under the $69.00 level, which we expected to act as resistance. The stock traded in a narrow 35-cent range for the latter half of the session. We are not suggesting new bearish positions at this time.
Picked on May 10 at $ 68.01
MGIC Invest. - MTG - close: 60.07 change: +0.52 stop: 61.11
It's time to go to red-alert for MTG. The market's bullish breakout has made this a dangerous environment for bearish positions. More conservative traders may want to exit MTG early to avoid further losses. We're keeping the play open for now. Today's rally stalled under the simple 50-dma and the top of its descending channel. Yet the close over the $60 level makes this a precarious position for the bears. We are not suggesting new positions at this time.
Picked on May 15 at $ 58.91
Precision Castparts - PCP - cls: 75.16 chg: +1.31 stop: 75.05
No change from our previous update on 05/15/05. We are waiting for PCP to breakdown below support near $72.00 and hit our entry point at $71.95.
Picked on May xx at $ xx.xx <-- see TRIGGER
Parker Hannifin - PH - close: 60.48 change: +1.04 stop: 62.01
The market's rally has fueled an oversold bounce in shares of PH. The stock managed to close over its 40-dma and the $60.00 level. Fortunately, the rally failed under resistance near $62.00. Considering the current bullish market environment we are not suggesting new bearish positions and conservative traders may want to exit here to avoid further losses.
Picked on April 28 at $ 59.08
Research In Motion - RIMM - cls: 75.49 chg: +3.04 stop: 66.85
Target achieved. RIMM surged today out performing all the major indices and adding 4.19 percent. The stock also broke out over its simple 200-dma on volume about 40 percent above the average. Our target was the $76.00-77.00 range and RIMM hit $76.25 late this afternoon. It would be tempting to keep the play open considering the breakout in the NASDAQ and RIMM's move over the 200-dma but each individual trader will have to make that decision on their own.
Picked on May 10 at $ 70.51
Marriot - MAR - close: 64.45 chg: +1.93 stop: 63.37
We have been cautious on MAR for the last few days and today's market rally was the last straw. MAR rebounded with a three-percent gain on above average volume today. The big move was also fueled by news that room rates rose again and summer rates for the industry are expected to hit record highs. We have been stopped out at $63.37.
Picked on April 28 at $ 63.37
OIN SUBSCRIBER QUESTION:
I do keep raising my exit point on remaining positions; a so-called "trailing" stop, as I try never to give back all of my profit. I will use trendlines most often to find these points and exit calls if the index breaks down below its up trendline; or, with puts, if the index breaks out above a significant down trendline.
I was inclined myself to exit today on all Nasdaq 100 (NDX) calls (recommended on the recent dip to the 1438 area) when the NDX climbed above 1500 today; but, the market looks strong still and I could have as well held some calls and bumped my remaining exit point as noted below.
My last stated target or objective (Obj.) on S&P 100 (OEX) calls is 565-568, which has not quite been reached. It would be warranted to raise the suggested stop (to protect partial profits) to 558.
If my objective is reached, and it looks like OEX can get into my target zone here shortly, keep the same protective stop on remaining calls for those who want to hold some calls yet. But raise the stop as the days progress per the below hourly trendline.
I am inclined to exit on all in the OEX, given what I thing will be possible strong resistance at 568. A stop or exit strategy is noted on the hourly OEX chart below...
MORE ON TRADING SYSTEMS -
Today's TradeStation software and I think others are similar, uses something that the TradeStation people call a "Strategy Builder". This allows you to build a rule-based trading system not from scratch but by taking you through what you want to accomplish; where component rules are already set up for you to use, including what "stop-loss" rules, if any. For example, you want an exit signal if, after entering a trade, the index goes X number of points against you.
As far as exit-if-wrong stops, an example of how they work is that you get home and after turning on your software trading application, a message pops up that you need exit the last calls or puts you bought because the price closed against you by more than your risk point. When you "back-test" the profit/loss of your trading system it assumes you got out at those points. When you build your strategy you put in a dollar amount each point loss or gain represents. It will even figure some "slippage" as we rarely get out just exactly with the loss we pre-figured.
Let me back up slightly. I said that most trading systems can be generally broken down into ones that use technical indicators or ones that use chart patterns; or, a combination of both of course, but I am trying to be basic here.
I described having the idea that I wanted to buy an Index (e.g., the S&P 100, OEX) when the OEX Relative Strength Indicator (RSI) goes ABOVE 30 on a daily chart after being under that level; or, whatever level I thing is "oversold", and I can test different levels. I also wanted to exit if I was wrong by 5 points in the OEX. Part of my idea was also that I wanted to be in puts (a "sell short" rule) if the RSI fell BELOW 70, but to exit if the index instead ran up 5 points against me. By the way, setting up the rule this way, is so as to NOT get you into puts when the RSI FIRST goes above 70; RSI may be on its way to 80, back down to 75, then up to 85, before falling! Hey, markets get extreme!!
This kind of strategy is all relatively easy to set up in these new kinds of software. I say "relatively", because nothing worthwhile is gotten with little to no effort and it takes some hours to learn how to use these kinds of software; more at the beginning. It seems like that only in trading is there the idea that you can put a minimum amount of work for maximum results!
An important concept of strategy testing and development is the TESTING part. You can test your ideas BEFORE you trade by "applying" your strategy or system (like the RSI-related one described), on prior years price data. Just apply the trading system you built and named (e.g., "Leigh's hot-shot RSI strategy") on a chart and it marks every trade that strategy would have gotten you in and out of. After you read the report of how many winners, how many losers, this strategy produced and the dollar profit or loss, you can then decide if it has promise.
In the foregoing example of an RSI Indicator-type system, you can test the best (e.g., most profitable) RSI "length", the best oversold and overbought levels to use as "triggers", etc.; even, an optimum exit-if-wrong or stop level to use; for example, is it best to risk 5 points from entry or should you give a trade entry a bit more leeway.
To complete this sort of basic primer on the use of rule-based trading systems I should also describe:
PATTERN RECOGNITION SYSTEMS -
You find, for example, that its quite meaningful in terms of predicting a good-sized advance in the indexes or stocks you follow, when there are at least three days of higher highs. The trading system rule that defines this "condition" can be quite simple. The trading rules might look like the following.
The condition we are looking for: a high greater than the high of one  bar ago (e.g., an hour or day on a BAR or Candlestick chart) and that the high of 1 bar ago is also greater than the high of two  bars ago and the high of 2 bars ago is greater than all the high of three  bars ago all conditions must be true. The reverse situation applies to a series of lows less than the 1-3 bars preceding it.
If either of these conditions are met, our trading system goes long (e.g., buys calls) or "sells short" (e.g., buys puts).
Entire trading systems, and very profitable ones at that, are sometimes constructed this simply. The software application usually then triggers an audible and visual alert when a trading system, applied to any index or individual stocks, is triggered for example, when you download your end of day data or are trading in real time with a live (real-time) data feed.
BASICS OF TRADING SYSTEM DEVELOPMENT
Creating the systems "rules" is only part of the process of creating profitable trading systems.
The above three components often involve three different rules and corresponding "signals" when the conditions (the system rule or rules) are met. For example, if you create a signal that enters the market based on a momentum indicator, you add a trailing stop signal that will capture profits and a stop-loss exit signal that will limit losses.
A trailing stop is one where the "rule" is that a stop is in place that "trails" the current price by some amount; e.g., 5 points in OEX. An initial stop might be 3 points, then once the Index has moved in your favor, a trailing stop condition kicks in. Again, these are common elements of trading systems but, there are no RULES to say what rules have to be in your trading system.
Once you have a well-defined set of rules to enter and exit positions and perhaps a system of risk protection or stops (exits), it is then necessary to see how well the ideas comprising the systems performed in the past. This is basically WHY you have to have defined rules only by defined rules, can the software "apply" the system to a market; e.g., show the results of the system to the last 5-7 years of OEX price history.
Testing involves applying the system to as much price history as can find this could be 5 or 10 years or more. "Optimization" of a rule-based system is often applied here optimization is a computerized test to determine WHICH variables (e.g., which specific moving average or averages) resulted in the most profitable or the most consistent profits for the back period being examined.
Or, to use our above example, which "length" setting of RSI works best along with which specific overbought or oversold extreme is the most profitable as the "trigger" point for trade entry. What the software does is test all possible combination of lengths and overbought/oversold extremes or, the ones that had the greatest profits. For example, the outcome may be to use a 17 period RSI, and sell after the RSI retreats from a reading above 75 and buy when the indicator rebounds from an extreme below 25.
MORE ADVANCED -
Regardless of the rules and markets, one of the things that has to be on your checklist when studying results is why did the losing trades lose money? How are they different from the winning trades? It is important to scrutinize the losing trades and investigate what happened on each occasion. The software applications that have well-developed systems testing and development capabilities, have templates and tools that allow the study of all these aspects of trading system results.
Analysis of the biggest losing trade is a starting point to see how a system doesnt work, so there are no holes in the system rules though which a trade could slip and cause significant losses or more that the maximum you are willing to take.
A system should be studied on two levels:
Since we are working in the financial world, this means that we should see all our results in terms of dollars (or monetary units). For example, its not correct to compare the return on investment of buying 100 shares of a 10-dollar stock with buying 100 shares of a 100-dollar stock. The comparison would only make sense if buying or selling some set dollar amount of each; e.g., $10,000.
SUMMARY OF THE TRADING SYSTEM APPROACH
Moving from the stage of ideas that "may be" profitable to back-testing these rules is a fascinating and worthwhile process that serves as a "reality check". Often, through the results of back testing, it becomes apparent that even with a promising system, slight changes will result in an investing or trading method that has even greater profit potential.
Systems testing and development might be something you are not immediately attracted to, but is something that is may be useful after a lengthily experience in using technical analysis. This was the case with me and I thought I would never warm to the approach of a "mechanical system".
I became enthusiastic about this type of application when I saw that it could validate or, invalidate, long held personal beliefs about what kinds of technical analysis techniques worked best as a basis for market action.
Moreover, I found that the more I knew about technical analysis and the more months and years that I had observed the unfolding of many different chart patterns, the more I got out of the ability to create trading systems with the new software seen in the 1990s and later especially this was quite the opposite result of what I expected.
Systems testing and development is a natural continuation of learning technical analysis, especially for those who are more computer savvy or at least comfortable.
Good Trading Success!
Today's Newsletter Notes: Market Wrap by Jeff Bailey, Trader's Corner by Leigh Stevens, and all other plays and content by the Option Investor staff.
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