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Daily Newsletter, Wednesday, 05/25/2005

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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

Winning Streak Ends At Eight For NASDAQ

Winning Streak Ends At Eight For NASDAQ

Stocks gave back some of their recent gains with the NASDAQ Composite (COMPX) 2,050.12 -0.55% ending an 8-session winning streak with an 11.5-point loss as investors moved some cash to the sidelines on profit taking.

Breadth at both the NYSE and NASDAQ ran decidedly negative for the bulk of the session, where a late-afternoon rally attempt never gained much traction with decliners outnumbering advancers by a 2-to-1 margin.

Volumes were light, especially at the NASDAQ which turned just over 1.49 billion shares, with average daily volume running 1.68 billion so far this month. NYSE volumes were nothing to write home about with 1.72 billion changing hands. Average daily volume in May has been running 1.91 billion on the big board. 


Topping today's slate of economic data, durable goods orders jumped 1.9% in April, marking the first increase this year. Economists had forecast a 1.5% increase. March's durable goods data was revised up from the previously reported -2.3% decline to -1.6%.

Digging deeper into the report, orders for electronics (excluding semiconductors) fell 5.8%, as orders for communications equipment fell a sharp 18.8%. Computer orders surged 15.8% and shipments of electronics rose 0.2%. Machinery order edged up 2.2% while shipments rose 1.5%. Orders for electrical equipment increased 3.4% while orders for fabricated metals increased 1.7%. 

Shipments of durable goods rose 1.6% in April, helped largely by an 8.2% spike in orders for transportation goods. Excluding this volatile sector/component, durable goods shipments would have fallen 0.2% in April.

Meanwhile, inventories of durable goods showed a fractional build, rising 0.1%, the 17th consecutive monthly gain.

In the housing sector, new home sales inched up 0.2% in April to an annualized rate of 1.316 million. However, March's estimate was revised sharply lower to 1.313 million from 1.431 million. 

Economists had expected April's number to drop to 1.333 million from March's original estimate. The median price of new homes sold rose 3.8% on a year-over-year basis to $230,800. The number of unsold new homes rose 0.2% to 440,000, or a 4.1-month supply. 

Overall, sales of new homes surged 37.2% in the tiny Northeast market and rose 2.8% in the West. Sales declines showed the South falling 5.3%, while Midwest sales fell 0.5%.

Crude oil for July delivery surged back above the $50 mark following the latest release of oil supply data. The Department of Energy announced an unexpected decline in weekly inventories, with crude levels dropping by 1.6 million barrels versus expectations for another increase. Unleaded gasoline supplies rose by 0.6 million barrels and distillate supplies were up 1.9 million barrels in the latest week. The American Petroleum Institute (API) released some conflicting data, stating that crude inventory levels actually rose by 2.3 million barrels during the previous week. Distillate stocks climbed 2.5 million barrels while gasoline inventories fell by 416,000 barrels. July Crude Oil futures (cl05n) rose $1.31, or 2.64% to $50.98 and helped keep bullish sentiment for broader equities at bay.

In stock specific news, shares of Calpine (NYSE:CPN) $2.64 +33.33% surged higher in heavy trading as investors applauded the company's reorganization plan to cut about $200 million in annual costs and reduce debt by $3 billion by year's end. The utility said it hopes to cut costs and reduce debt by selling up to 8 more power plants.

Auto parts retailer AutoZone (NYSE:AZO) $86.80 -0.47% slipped lower to test correlative 200-day SMA ($85.12), 50-day SMA ($85.02) and 21-day SMA ($85.29) intra-day after posting Q3 earnings of $147.8 million, or $1.86 per share, compared to year-ago earnings of $1.68 per share. Sales dropped 1.6% to $1.34 billion in what CEO Bill Rhodes called a "considerably weaker" performance. Wall Street had forecast earnings of $1.80 per share on revenue of nearly $1.38 billion. The company said it has repurchased 3.2 million common shares at an average price of $87 during the latest quarter, amounting to $278.6 million. 

Computer Sciences (NYSE:CSC) $46.55 +1.68% gained 77-cents after announcing its Q4 profit more than doubled as the firm logged a big, one-time gain from the divestiture of some units and as revenue from continuing operations rose 7.9% due to strength in commercial activities. The company reported earnings of $411.8 million, or $2.13 per share, versus its year-ago profit of $1.01 per share. Sales from continuing operations increased to $3.88 billion from $3.59 billion a year ago. 

This morning, Boston Scientific (NYSE:BSX) $29.46 -3.72% released its 2005 earnings forecast, with expectations coming in at $1.85 and $2.00 per share (before items) on total worldwide sales of $6.35 billion to $6.57 billion. Furthermore, BSX said it sees worldwide sales of its drug-coated stent products coming in at $2.62 billion to $2.76 billion for the year. BSX's guidance was below Wall Street's estimated earnings of $2.06 per share on revenue of $6.51 billion for the year. In other news, BSX said data from its nine-month Taxus V clinical trial further supports the efficacy of the Taxus Express2 paclitaxel-eluting coronary stent system for the treatment of coronary artery disease in diabetic patients. 

Closing U.S. Market Watch - 05/25/05


Treasuries found a choppy intra-day trade with prices falling and yield higher. The benchmark 10-year yield ($TNX.X) rose 3.5 basis points to 4.072% after challenging the 4.0% yield level earlier in the morning.

Treasuries reversed early morning gains when Federal Reserve Bank of Atlanta President Jach Guynn said the improved employment situation will likely offset some of the troubles created by higher energy prices. His comments were included in a speech made before the Certified Professional Home Builder luncheon in Atlanta. Mr. Guynn said he expects GDP growth will remain on a very positive path and thinks the forecast he made earlier this year of growth for all of 2005 in the range of 3.5%-4% still seems reasonable. Speaking to reporters after the luncheon, Mr. Guynn argued for more interest rate hikes from the FOMC.

Mr. Guynn's comments combined with today's stronger-than-expected durable goods data and robust housing figures likely sparked some profit taking.

I make a quick note that the Pacholder High Yield (AMEX:PHF) $8.95 -3.13% fell sharply right at the close of today's trade on 12,200 shares traded at $8.95. This closed-end "junk bond" fund traded between $9.18 and $9.29 all day. On May 13th, PHF announced it would pay a monthly dividend of $0.075 per share for the Month ending May 31. The dividend is payable on June 10, 2005 to shareholders of record on May 31, with ex-date for the dividend tomorrow. Given a "consistent" monthly dividend of $0.075 per share, tonight's SEC yield would equate to 10.05% given a closing price of $8.95. 

The Oil Service Index (OSX.X) 132.47 +1.71% was today's sector winner, and on a Wednesday-to-Wednesday close is just outpacing the homebuilders as Depicted by the Dow Jones Home Construction Index (DJUSHB) 878.12 -1.23%, which gave back 11 points in today's trade.

With June Crude Oil futures (cl05m) expiring last week, I've rolled to July energy futures in the U.S. Market Watch. 

Still, I like to keep track of a crude oil futures chart with my various fitted 38.2% retracement. Not unlike the "old" June contract, I've shown this chart of the September Crude oil futures (cl05u), where the same technique used in the June contract is carried over. Still a bearish bias below $52.73-$52.95 zone.

September Crude Oil (cl05u) - Daily Intervals


Last week's trade around the $50.00 level in the September contract would be darned close to an EXACT 50% retracement from the contract high of $60.00 to the inflection low of $40.58 found in late December. Last week's low on the above contract would also come right were the powerful bullish gap higher low came. My thoughts tonight are that EVEN IF the EIA and API data both showed BUILDS in crude inventory, we would have probably seen SHORT COVERING in crude oil futures today. I (Jeff Bailey) still think crude works lower with resistance in the above contract holding from $52.72-$52.95 on a daily settlement basis, with eventual fill of February gap to the $48.22-$48.73 area.

Last Wednesday we didn't review the sector bell curve data from Dorsey/Wright and Associates, but after a little vacation and missing a few days of trade, I wanted to look where the sector bell curve was sitting since last TUESDAY's close. I showed the following table comparison in this morning's Market Monitor, where on a TUESDAY-to-TUESDAY basis, we find net gains in the average level from 43.51 to 46.29.

Sector Bell Curve - (courtesy Dorsey/Wright & Assoc.)


STEEl would show a week-to-week improvement from very "oversold" bullish % levels of 0-14% to 16-20%. Now, last Wednesday I lead off the Market Wrap with the mentioning of the Dow Jones Steel Index (DJUSST) 137.45 -2.40% as some merger news in the sector sparked a price bounce for several stocks in the sector. While very "oversold," this sector bullish % (STEE) remains very weak. Broker UBS helped fuel some selling in the sector today after the firm lowered its outlook for steel prices. The firm said it sees hot-rolled steel for 2005 falling 8% to $560 a ton, and cut its 2006 estimate 10% to $465 a ton citing a building of inventories and weakening demand. My thoughts here is that last week's bounce was likely some shorts taking profits, but weakness persists and sector bulls that thought they might have "caught a bottom" have been quick to move back to the sidelines.

I would encourage traders to go back and review the 05/11/05 Market Wrap and the sector bullish %. 

How are the TRANsports doing? From a sector bullish % standpoint, we can see the TRAN has moved up from 34-36% to 38-42% range, but Dorsey/Wright has changed its colors from "favored" to "average" now. You should know why as key resistance for PRICE as depicted by the Dow Transportation Average ($TRAN) 3,599.49 -0.91% was tested on Monday.

Dow Transports ($TRAN) - Daily Intervals


The collision between bulls and bears took place on Monday at the 3,650 level in the TRAN. Field position as depicted by the sector bullish % looks favorable for the bulls, and I (Jeff Bailey) do see the TRAN working through the 3,650 level in sessions to come, but I do think bulls want to see any near-term consolidation take place ABOVE the 3,555 level. I placed some recent sector bullish % inflection points on the above TRAN chart so we can get a feel for "field position." What I draw from the above is that while the TRAN bullish % is not nearly as strong, or as high of a bullish % as found during the January-March rise, the TRAN's current rise come from a lower level of bullish % and can give more upside in a price move. Still, we "knew" that 3,650 was going to be a major near-term level of resistance and I would plan on some consolidation near-term (next week or so). Bullish implications can be observed on a break much above that key level of resistance.

S&P 500 Index (SPX.X) - Daily Intervals


On Tuesday, the SPX printed a "doji" and today's action below Tuesday's low is a near-term negative for bulls. I have "eyeballed" future 50-day (blue dots) and 200-day SMA (red dots) action that might just provide some correlative "right shoulder" reverse head/shoulder pattern identification. Are bulls overly eager to push the issue here? Or would they rather get the reverse head/shoulder pattern setup and a pullback near 1,170 going, then ramp the SPX to "bull confirmed" status above 1,211 and break the head/shoulder top pattern? 

You know what a bear is thinking right now after Monday's high of 1,197.44. If that gives way over the next couple of sessions, the next level of risk is assessed back at the "right shoulder" and 80.9% retracement of 1,211.35. I think the TRAN still a key sector/index with 3,650 the trigger point for massive short covering.

While the broader S&P 500 Bullish % ($BPSPX) remains in "bear alert" status, the narrower NASDAQ-100 Bullish % ($BPNDX) reversed back up to "bull confirmed" status last Wednesday at 44% and has risen to 46% bullish since.

NASDAQ-100 Tracker (QQQQ) - Daily Intervals


It wasn't until after writing last Wednesday's Market Wrap that I noticed the narrower NASDAQ-100 Bullish % had reversed back up to "bull confirmed" status at 42%. Earlier this month I had back tested trade action in the MONTHLY Pivot levels (shown in PINK) where history had shown that after a trade of MONTHLY S2s (like we saw in April, the major indices should NOT have trade much above their MONTHLY R1s. Action so far this month would indicate institutional computers have a BIG buy bias and May's "Max Pain" theory of $36.00 ($1 increments) had bears experiencing the "max pain." 

A 3% pullback in the QQQQ would NOT be uncommon from these levels, but BEARS won't be complacent. Here's a point and figure chart of the QQQQ, where the PRICE scale shown represents increments of 1%, or a 1% change in PRICE. 

In September the NASDAQ-100 Bullish % ($BPNDX) reversed up from 26% to 32% and "bull alert" status, and by late October, early November had achieved "bull confirmed" status at 52% and then rose way up to 80% before finally reversing back lower from such "overbought" bullish % readings.

Last week I received a question on how a "longer-term" trader/investor could begin building a bullish position in the QQQQ and leg into (build the position over time). Here's one way we can use the point and figure charts to determine how to build a position with this market now "bull confirmed" status.

Change your measure to 1% box size, but still use the conventional 3-box reversal method. Look at your retracement bracket above, then look at the following point and figure chart of the QQQQ.

NASDAQ-100 Tracker (QQQQ) - 1% box size


If looking to establish a partial bullish position in the QQQQ, one could do it right now, but might plan for a 3% pullback. See how in September (red 9) this chart would have given a "buy signal" at $35.31, then pulled back 3% to $34.27, then reversed back up 5% in October (red A) to $36.02? Then pulled back 3% to $34.96? See all those 3% pullbacks?

A 3% pullback from recent "X" at $37.85 would be to about $36.74. Note where the 38.2% retracement of the conventional retracement is on the bar chart! That's the "pullback entry" point with a rather tight 1% stop loss.

The conventional $1 box chart of the QQQQ currently has a $55 bullish vertical count association with it.

 
 




New Plays

New Option Plays

Call Options Plays
Put Options Plays
None STRA

New Calls

None today.

New Puts

Strayer Education - STRA - cls: 86.17 chg: -0.82 stop: 87.75

Company Description:
Strayer Education, Inc. is an education services holding company that owns Strayer University and certain other assets. Strayer's mission is to make higher education achievable and convenient for working adults in today's economy. Strayer University is a proprietary institution of higher learning that offers undergraduate and graduate degree programs in business administration, accounting, information technology, education, and public administration to more than 23,000 working adult students at 34 campuses in 8 states and Washington, D.C. in the eastern United States and worldwide via the Internet through Strayer University Online. Strayer University is committed to providing an education that prepares working adult students for advancement in their careers and professional lives. Founded in 1892, Strayer University is accredited by the Middle States Commission on Higher Education. (source: company press release)

Why We Like It:
Shares of STRA were hammered in early May after the company issued an earnings warning for the second quarter. The oversold bounce stalled at the $90.00 level, which is now overhead resistance. With momentum oscillators turning bearish we see new short-term overhead resistance near $87.50 where the stock has been unable to pierce for the last five sessions. The P&F chart for STRA looks very bearish with a long-term $40.00 target. We're going to suggest traders target a short-term drop toward the $80.00 level. We'll officially target a drop into the $81.00-80.00 range. We're setting our stop loss at $87.75 just above the new resistance.

Suggested Options:
We're going to suggest the July puts.

BUY PUT JUL 90.00 SDQ-SR OI= 26 current ask $6.60
BUY PUT JUL 85.00 SDQ-SQ OI= 86 current ask $3.70
BUY PUT JUL 80.00 SDQ-SP OI= 57 current ask $1.95

Picked on May 25 at $ 86.17
Change since picked: - 0.00
Earnings Date 01/26/05 (unconfirmed)
Average Daily Volume = 258 thousand


Play Updates

In Play Updates and Reviews

Call Updates

Amerada Hess - AHC - close: 93.13 chg: +1.33 stop: 89.95*new*

The Energy Dept. reported a surprising decline in oil inventory numbers this morning and this sent crude oil prices spiking higher adding more than 2.3 percent to more than $50 a barrel. As is usually the case the API inventory numbers showed a discrepancy with the Energy Dept's report but the market ignored the API figures. Oil stocks out performed the market today with oil service-related issues leading the way. Shares of AHC added 1.44 percent and its MACD indicator produced a new buy signal. We are suggesting that traders prepare to exit as AHC is nearing our target in the $93.50-94.00 range, which is near technical resistance at the top of its descending channel. We're also going to raise our stop loss to $89.95.

Picked on May 17 at $ 89.41
Change since picked: + 3.72
Earnings Date 07/27/05 (unconfirmed)
Average Daily Volume = 1.6 million 

---

Amer. Intl Group - AIG - close: 54.08 chg: +0.28 stop: 52.49

NY Attorney General Spitzer's office released news about its complaint against AIG but this was digested as old news. The report did not impact shares of AIG and we suspect that the worse is behind it for the stock price. Today's small gain actually put AIG above its simple 50-dma. We are still waiting for the stock to breakout over the $55 level and hit our entry point at $55.05.

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/09/05 (confirmed)
Average Daily Volume = 15.5 million 

---

Caterpillar - CAT - close: 92.47 chg: -1.36 stop: 89.00

No surprises here. We've been warning readers that we expect CAT to dip with the market and shares pulled back toward support at the $92.00 level today. We'd like to see the $92 level hold but in reality we're expecting CAT to dip closer toward the $90 level. 

Picked on May 18 at $ 92.35
Change since picked: + 0.12
Earnings Date 04/20/05 (confirmed)
Average Daily Volume = 2.8 million 

---

Career Education - CECO - close: 34.39 chg: -0.60 stop: 32.45

As expected we're seeing CECO dip with the market. We're expecting a pull back toward the $33 level or at least its 50-dma near $33.35. Wait for the pull back before considering new bullish positions. 

Picked on May 23 at $ 35.24
Change since picked: - 0.85
Earnings Date 05/02/05 (confirmed)
Average Daily Volume = 2.5 million 

---

Rockwell Collins - COL - close: 48.74 chg: -0.36 stop: 44.95

No change from our previous update on 05/24/05. We're looking for a pull back toward the simple 100-dma in the $46.25-45.50 range as our entry point.

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/27/05 (confirmed)
Average Daily Volume = 800 thousand 

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Federated Dept Stores - FD - cls: 67.33 chg: -1.69 stop: 64.45 

As we suggested earlier shares of FD are pulling back with the market and its first stop was minor support near the 10-dma. The question now is will the 10-dma hold or will FD pull back further toward the $66.00 or even the $65.00 level, which should act as stronger support.

Picked on May 17 at $ 66.60
Change since picked: + 0.73
Earnings Date 05/11/05 (confirmed)
Average Daily Volume = 2.9 million 

---

Reynolds American - RAI - cls: 81.92 chg: -0.77 stop: 77.95

No surprises here either. We've been expecting RAI to pull back. We're watching for a dip into the $80-81 range. Wait for a bounce before considering new positions. 

Picked on May 16 at $ 81.31
Change since picked: + 0.61
Earnings Date 04/27/05 (confirmed)
Average Daily Volume = 866 thousand 

---

United Technologies - UTX - cls: 106.83 chg: -0.17 stop: 102.45

We're encouraged to see the $106 level holding as support but if the Dow keeps drifting lower we'd watch for a dip toward the $105 level. 

Picked on May 23 at $106.25
Change since picked: + 0.58
Earnings Date 04/20/05 (confirmed)
Average Daily Volume = 2.0 million 

Put Updates

Precision Castparts - PCP - cls: 76.30 chg: +0.46 stop: 75.05

No change from our previous update. We are still waiting for PCP to breakdown under support and hit our entry point at $71.95. However, if the stock keeps climbing and breaks out above its three-month trend of lower highs we might consider switching directions.

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: - 0.00
Earnings Date 05/03/05 (confirmed)
Average Daily Volume = 492 thousand 

---

United Thera. - UTHR - close: 51.63 chg: -1.75 stop: 56.05

UTHR lost another 3.2 percent on even stronger volume than yesterday's decline. This produces a nice confirmation of the new sell signal although we do see that some traders bought the dip at the $50.00 mark suspect that level would act as round-number support. We would not be surprised to see an oversold bounce back toward the $53 region and traders can actively watch for the bounce to fail and use it as a new bearish entry point. Our target is the $48.25-47.50 level. 

Picked on May 24 at $ 53.38
Change since picked: - 1.75
Earnings Date 05/03/05 (confirmed)
Average Daily Volume = 452 thousand 

Dropped Calls

None

Dropped Puts

None


Trader's Corner

BELLWETHERS; also, On Balance Volume (OBV)

OIN SUBSCRIBER QUESTION: 
I have your 5-18-05 (Trader's Corner) article "Achieving More Winning Traders: Systems Trading, Part 2", but I can't remember reading Part I. Can you tell me what date this Trader's Corner article was written so I can read it?

RESPONSE: 
Part 1 actually was not titled 'Systems Trading' at the top of the column. It is within my 5/11/05 Trader's Corner article, titled "Getting more winning trades". The lion's share of that column is the section sub-titled "TRADING SYSTEMS; Part 1". I began the discussion of this topic there. 

I'm afraid my effort was only an introduction to this area as well as some of the rationale for devising and testing your own trading ideas in a systematized trading strategy; e.g., a 'system' generating buy/sell 'signals', plus commonly, an exit strategy for losing trades, etc. 

Software that does this, such as the one I know TradeStation, the premier player in this field, can be quite worthwhile to use. Even if you only use it to test winning and losing percentages from using various indicator settings, as well as which indicator variables (e.g., 'length' or optimal levels for 'overbought' or 'oversold') make for the most winning trades. 

System Trading Part 1, as part of my 5/11 Trader's Corner, is found in the online OI Newsletter by clicking here 

System Trading Part 2, which comprises my 5/18 Trader's Corner article is found in the online OI Newsletter by clicking here


BELLWETHERS  

I have a number of recurring themes that I write about ('a broken record'?!) and one is the idea of stocks or indices that are bellwethers for the major market indices; e.g., the S&P 500 (SPX) and the Nasdaq Composite (COMPWh

When we think of a bell ringing as signaling danger or as something to stop and pay attention, this idea is also meaningful in relation to trading the market. There is the concept of a bellwether stock or a bellwether sector, that by ITS price action, can tip us off ahead of or AS a top or bottom is forming in the major indexes. 

In the Nasdaq, there are certain companies and market sector (e.g., semiconductor stock sector SOX index) indexes that by virtue of their size or relative importance will be virtual "stand-ins" for, or will be closely linked to, a market index or average. 

I use the example in my book (Essential Technical Analysis) of the earliest bellwether index I know of - the role the Dow Transportation average (TRAN) plays as a related or linked average, to the Dow Industrials (INDU) -- if one average or the other fails to accompany the other to a new high or low, this is a bullish or bearish divergence. Note here that the action of the bellwether can be a bullish omen; e.g., if TRAN resists falling to a major new low along with INDU. 

I've often written about the idea of where an Indicator, such as the Relative Strength Index (RSI) fails to also make a new high, or low, relative to what is happening with the price of the Index itself; such divergences are often tip offs to an impending top or bottom. Having a good idea that a top, or bottom, is forming is one of the most helpful things that can occur in terms of buying index puts or calls before the market breaks sharply from the existing trend. 

An example of a bearish Price/RSI Divergence is seen to the left in the S&P 100 (OEX) chart below ...

OEX fell to a new relative low around the middle of April, but at the time, the RSI was at higher low. This made for a bullish tip off to a possible (price) bottom and upside reversal.

In this situation seen above, the RSI acted in a manner similar to a "bellwether", but the main use of the term is to refer to a stock or an index that may be indicative for a possible similar turning point or reversal in the main averages. 

The idea for a key stock or index that acts as a bellwether is that a bellwether goes, "so goes the market". 

For example, Cisco Systems (CSCO) has been for a number of years, and I think still is, a bellwether stock in the Nasdaq. Intel Corp (INTC) tends to be another one, as is the Philadelphia Semiconductor Index (SOX).

CSCO, along with Microsoft Inc. (MSFT) and Intel, accounted at one time for nearly 25% of the entire value of the Composite Index. I'm not sure what the percentage is today, but its significant. 

Size is not the only criteria for assuming a "bellwether" status. As important, it should be a company that represents the leading edge business that exemplifies that exchange in the case of Nasdaq, the need for internet and communications hardware has kept Cisco still in a forefront position in necessary tech equipment. 

Besides a key individual stock like Cisco, a related stock index that is also a bellwether for Nasdaq especially, is the Russell 2000 (RUT). 

I like to look at bellwether stocks also for the something added they give namely that I can study volume for it. Volume is a good secondary indicator for example, a drive to a new high is accompanied by a decline volume trend LOOK OUT. 

NEXT CHART: Cisco (CSCO) versus the Nasdaq 100 (NDX)  

There were ways that Cisco's price action, even though the stock has been languishing for some time, that tipped off key turning points in the Nasdaq 100. The two are compared below ...

While the Nasdaq 100 (NDX) was in a strong up move over August of '04 to December/early-January, Cisco (CSCO)was in a lackluster sideways trend or trading range. At the point where CSCO made an approximate double top (circled, left), NDX still could have been considered to be going strong. Well, after CSCO topped out or hit the top of its range, NDX made a final top and began a long slide down. 

During the rally that developed in from the April ('05) lows, CSCO actually broke out or pierced its down trendline first, as can be seen lower right in the chart above, providing a clue that the NDX pullback to under 1450 was likely to be minor, before a strong rally continued. 

Intel (INTC) + Volume, versus the Nasdaq 100 (NDX)

The bellwether tech stock Intel (INTC) made a "V" bottom low in April and rallied strongly before the broader Nas 100 got into gear. Accompanied the rally was a strong move higher in On Balance Volume (OBV). I'll have more to say about what OBV measures shortly. 

Needless to say, here at least, price and volume patterns in INTC were providing an indication to get positioned in NDX calls while the Index was still 'basing'; such so-called basing action could have been interpreted as a consolidation before another down swing. This was a much less likely interpretation due to the price and volume action of bellwether INTC.

A bellwether stock and related index will sometimes have the same technical pattern. Sometimes it will not follow the index higher or lower, which does not mean in and off itself that you would exit index options because of what the stock is doing. It's those occasion where the bellwether stock makes a top or bottom ahead of the index that tend to be the most valuable. The points where the bellwether is a leading "indicator" can occur at a key turn or shift in the trend. 

About the OBV Indicator - 
On Balance Volume is a cumulative running volume figure that adds LL the volume on an up date and subtracts ALL the trading volume n down day. If there is more trading volume on up days then here s on down days, OBV rises. What we are concerned with is the direction of line, up or down, not the actual number. 

This indicator uses daily stock trading volume for its construction. The insight it makes furthered Charles Dows concept that volume should INCREASE in the direction of the dominant trend. On-Balance Volume provides some further assessment of this idea. 

Semiconductor Index (SOX) as a bellwether for the NASDAQ  

One of the best sector bellwethers for the Nasdaq is the Semiconductor Index (SOX). It made a clear cut top in late-November, well ahead of the final top in the Nasdaq 100 (NDX). If you werent accumulating NDX puts, don't blame it on the lack of warning (for a top) provided by the bellwether SOX index. 

An outstanding bellwether 'signal' provided by the SOX for the broader NDX, was its double bottom. While you could have had some doubt that Nasdaq was making a bottom around 1400 (even though NDX seemed to be 'basing' and had completed a 2/3rds retracement), this pattern was not as "strong" technically as a double bottom, which is what had formed in SOX. A good "bellwether" in this instance! 

BLUE CHIP BELLWETHERS 

For the NYSE Composite Index (NYA), the Dow 30 Average (INDU) and the S&P Indices, a key bellwether stock is General Electric (GE). This company is a major player in major areas of activity in the mainstream economy (e.g., power, appliances, etc.) that is represented by these averages. 

Bellwether stocks, just like bellwether indexes, will tend to "confirm" new highs or lows; i.e., both will go to new high or new low for the price move underway. If instead, the bellwether "diverges" from the index, it's not a good sign for the continuation of the index trend for much longer. 

There are some noteworthy comparisons to be made between GE and the OEX in the next chart...

GE made a top ahead of the OEX in December, suggesting some trouble ahead for the Index, but both the stock and the index of which its part did make new highs; that's the key point. The real DIVERGENCE (a bearish one) was that GE by far failed to confirm the new high that the OEX made in March. This was a clue to the steep multiweek OEX decline that was to follow. 

During the March-April decline of the S&P 100, GE has gone sideways as seen in the chart above, as stock has had a lengthily period of a relatively narrow trading range (defined by the two parallel dashed level lines). The recent breakout above the top end of that 'rectangle' pattern in GE was a confirming bullish pattern relative to the rebound in the OEX. 

BACK IN 2004  
While the S&P 100 (OEX) was making a double, then triple top in 
February March 2004, GE was in a definite downtrend, suggesting that OEX would reverse to the downside at some point and probably 
reverse significantly lower at that. 

If traders were wondering if OEX was going to break out to the 
upside at the blue arrow within the circle, as the Index popped 
up above the down trendline on two days running NOT! at least 
based on what GE was doing as it never got close to doing the 
same. 

Last but not least, is a note about the break below the 200-day moving average seen twice in the stock in the above chart, but not in the Index. The first break (see circled price action in GE) was showing such weakness that it was doubtful that the OEX was going to get far in its rally after that. 

The apparent breakout move in OEX above its down trendline seen in the chart above, had no similar breakout pattern that occurred in GE, suggesting that that particular OEX rally was not going to gain traction.

With such a key bellwether (GE), widely held in fund portfolios, to not be able to get back above the most widely watched moving average (200-day), is suggestive of what institutional money is doing, which is a major factor in moving the overall market.

The action in bellwether GE stock provided some useful clues to what the OEX was going to do ahead in the instances discussed. 

Dow Transportation average (TRAN) as a sometimes bellwether for the Dow 30 (INDU)  

The Dow Transportation Average (TRAN) will sometimes make a very key bullish or bearish divergence from the Dow 30 (INDU), as happened back in the fall (Oct. '04) when TRAN did NOT confirm the new INDU low (at the yellow circle). In fact the Transports were in a very strong steady uptrend, which continued after the INDU low, foretelling the very strong rebound in the Dow that followed.

While bellwether action is not the be all/end all of chart analysis, comparison of bellwether price and volume action to the major indices, ALONG with other factors (patterns and indicators), will sometimes provide a key clue to an upcoming trend reversal. And, that's when they prove their use as ONE of our trading tools. 

Good Trading Success! 

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. 

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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