Daily Newsletter, Wednesday, 06/29/2005
HAVING TROUBLE PRINTING?
Revised GDP, Oil and Oracle of little help
It was one of those days when the MARKET seemed to have a mind of its own. It felt like a Triple-Witch expiration as the major indices traded either side of unchanged as the second quarter draws to a close tomorrow afternoon.
Advancers edged out decliners at both major exchanges, and volumes were on the light side. With one day left in the month's trade, NYSE volume has been running 1.8 billion shares per day, while NASDAQ has been turning 1.71 billion. That's a 3% decline in volume for the NYSE compared to May, while NASDAQ shows a 3% increase in average daily volume since May's 1.66 billion (lowest since October 2004).
Still, compared to last year at this time when NYSE volume averaged just 1.30 billion per day and NASDAQ was averaging 1.58 billion per day, volumes seem brisk.
The major indices bid at the open after the U.S. Government said Q1 Gross Domestic Product increased 3.8% to $11.1 trillion on an annual basis. The 3.8% revision was up from last month's 3.5% estimate.
Brisk spending on housing projects, more investment by business in equipment and software, and a trade deficit that was less of a drag on economic growth all played a role in the higher first-quarter GDP reading.
August Crude Oil futures (cl05q) fell 94 cents, or -1.62% to settle at $57.26 after the EIA said weekly crude oil inventories rose by 1.1 million barrels. The build reversed a three-week trend of draws. At the bottom of today's Option's Market Monitor I put together a consolidated table of the EIA's recent weekly inventory reports for crude oil, gasoline and distillate inventories, as well as a link to the EIA's web page where more complete data can be found.
At 12:01:19 PM EDT I showed an updated table of these data. What I found informative when looking at this data overtime is just how responsive the market is to what is going on NEAR TERM with crude oil inventories. Then, when we hear that traders are already concerned with what is going on with heating oil inventories (part of distillates) you and I can look back at inventory levels found for distillates, and see how refiners are really starting to ramp up supplies to meet the pending winter demand. Since May 6, distillate inventories are up 10.5% to 113 million barrels.
Stocks making headlines included Oracle (ORCL) $13.57 +5.76%, DuPont (DD) $44.63 -0.68%, American Intl. Group (AIG) $58.48 +5.99%, Monsanto (MON) $63.00 -7.13%, General Mills (GIS) $47.21 -6.71% and Motorola (MOT) $18.53 +0.98%.
Oracle rose almost 6% after reporting upbeat quarterly earnings with gains in its applications segment due to its acquisition of PeopleSoft in early 2005 (18-month hostile pursuit).
DuPont, on the other hand, saw its share price fall only slightly after the Environmental Protection Agency (EPA) reported that a controversial chemical used by DuPont to make the nonstick substance Teflon poses more of a cancer risk than indicated. DD, a Dow component, is currently near its lowest levels of the year and there is an ominous bearish H&S formation on a daily chart with a neckline at $47 (currently at 44.63).
Shares of AIG rose 6% and closed at a three-month high after the company said Q1 net income rose 44% year over year. Shares of AIG are still about 20% below trading levels when accounting investigations began in February.
As far as the downside is concerned, General Mills Inc. posted fourth-quarter earnings that actually rose 65%, however, analyst expectations were not met as consumers might be finding breakfast substitutes. Shares of GIS fell 6.7%.
Monsanto fell over 7% after the seed and agricultural products supplier posted sharply lower earnings for the fiscal third quarter and issued a fourth-quarter forecast that remained below analysts' forecasts. A change in accounting would narrow its expected free cash flow to a negative $400 million in 2005, compared with a previous estimate of negative $900 million.
Initial Public Offerings found a bullish reception today. Neustar (NSR) rose $4 from its IPO price of $22, and this telecom services firm wasn't the best IPO of the day. DSW Inc. (DSW) closed at 24.10, up from its $19 IPO price as traders marked up this retailer and stomped out thoughts of a weak IPO market.
Note: Retail Ventures (RVI) $13.59 +5.59% is DSW's parent company and has doubled from its November low. Today we know why.
U.S. Market Watch - 06/29/05 Close
The AMEX Gold Bugs ($HUI.X) were today's percentage gainer among sectors. Jim Brown mentioned some end of quarter "window dressing" and wouldn't you know it.... today's HUI.X gains get this index back in the green for the quarter!
Check this out. Of the asset classes represented in the "Beetle's Balanced Benchmark," only the Dow Diamonds (DIA) now show a loss.
Balanced Benchmark - 06/29/05 Close
Markets are going to be closed on Monday in observance of Independence Day, and for those that need to feed their "fix" for some type of market action, you should review your retirement account and look at rebalancing your portfolio.
I established the "Beetles Balanced Benchmark" a couple of years ago, to not only demonstrate how an investment portfolio could seek out enhanced returns, while reducing risk, but to also give us a view of just where money has been moving.
Cash flowed into the greenback this quarter with the U.S. Dollar Index (dx00y) currently up 6.02% since 03/31/05 (P/L % from 03/31/05 benchmarking). It had been thought that dollar strength was "doom" for equities, but history has shown that that's not always the case. The latest quarter is a pretty good example. Yes, dollar strength can make U.S. exports less price competitive overseas, but dollar strength can also have foreign capital moving to the U.S. when market participants find U.S. assets more attractive than others around the globe! This can be driven my monetary policy, economics, etc. etc.
Still, we may have seen some negative impact of the stronger dollar on the Dow Diamonds (DIA), which contains some of the "who is who" of multinationals!
Longer-dated Treasury maturities as depicted by the TLT vastly outperformed the "safer" shorter-dated maturities (SHY) and intermediate-term IEF. While the P/L % column does NOT account for the impact of dividends, those "junk bonds" as represented by the PHF (has generated $0.075 per month, per share) have also faired well.
Mid-caps as depicted by the IJH have been the top performer in our equity class, and the mighty small-caps (IWM) made a valiant comeback after a 5.66% decline in the first quarter.
By rebalancing your longer-term holding, it will FORCE YOU to "take some profits" in those areas that have seen "outperformance," and place those assets into areas that have "underperformed" and may hold some newly created "value."
Now... August Crude Oil futures (cl05q) is not an asset class that is actually represented as being "held" in the BBB, but had we bought this contract on March 31, we'd be break-even on that contract. I should clarify here that on March 31, the Continuous Contract ($WTIC) closed at $55.40 and it closed today at $57.26, which was down 94 cents. So, oil has probably had a negative impact as a "tax" on the economy, and risen 3.3% since March 31.
Wow! A quarter's time seems like "long-term investing" doesn't it?
Since our visit last Wednesday, what do you think the supply/demand situation looks like as it relates to buy/sell signals on the PnF charts and bullish % readings for the major indices?
For the NASDAQ-100 (NDX / QQQQ) there has been no net change and is still reading "bull confirmed" at 56% for its bullish % ($BPNDX). We've been stuck at this percentage since June 16.
What surprises me a bit is that the much broader NASDAQ Composite Bullish % ($BPCOMPQ) has risen further to 46.60%, its highest reading since reversing up on June 15 at 44.23%. This is a "bullish sign" in my opinion and would represent "bullish divergence" at this point. We're still seeing some newly generated point and figure buy signals being generated, despite some price pullback.
Think about this for a minute. What was one of the MAJOR critiques that analysts had about the "euphoria" of technology stock gains in the late 1990s, early 2000s?
I remember, and rightfully so, the critique was that the gains were represented by just a FEW of the tech heavyweights. What technicians were talking about was the PRICE gains were not BROAD, but were NARROW, as investors focused on just a FEW stocks for gains. When the bubble went "pop" in the FEW favorites, that's when all heck broke loose to the downside.
I think it still "healthy" that were seeing the building, or net gain of PnF chart buy signals on a BROADER scale as depicted by the NASDAQ Composite Bullish % ($BPCOMPQ), while the narrower NASDAQ-100 Bullish % (%BPNDX) just sits here.
I don't, have time to look at all 100 stocks of the NDX/QQQQ each and every day. You don't either, but we can envision that there's some backfilling having taken place the past couple of weeks for the NDX/QQQQ.
Hey... about 1% more than perhaps a bull would have liked. Right? Strengthening internals are great, but you can't buy fireworks for the 4th if you're long the QQQQ and PRICE is falling.
NASDAQ-100 Tracker (QQQQ) - 1% box chart
I don't want traders to get in the habit of lowering stops on a long position and in recent Market Wraps, I thought we should expect a 4% pullback in the QQQQ/NDX.X. Well, late last week, on what I (Jeff Bailey) feel was some "fear of tariffs against China" we did see the QQQQ fall to $36.74 on our somewhat unconventional technique of measuring supply (0) and demand (X) on a 1% box chart. If you're stopped on a long, then you're stopped on a long, but I'd still be aware of what the INTERNALS are saying. Especially if your BEARISH the QQQQ.
Yes, I'm bullish the QQQQ right now (see Market Monitor profiles) and while it may be a "Jeff's just trying to convince himself the QQQQ is bullish" one thing I did not mention in the past was the possibility of a 5% pullback to the Feb/March (3/4) relative lows, if market participants were to compensate for a recent 11% gain from the bottom, compared to a "then" gain of 9% from the August (8) rebound lows.
NASDAQ-100 Tracker (QQQQ) - Daily Intervals
Here's the QQQQ on a daily interval bar chart, with a conventional use of retracement. The BEST WAY to get Stochastics and MACD to kick higher is PRICE action. Oils recent decline should improve bullish psychology, and there may be some hesitancy among bulls ahead of tomorrow's FOMC decision on interest rates. Everyone "expects" a 25 basis point hike. For me, I think a BULLISH response will be signaled if the QQQQ can get a close above $37.26.
Late last week I made some observations in the Market Monitor on "why" I thought the QQQQ was then having trouble above the $38.00 level. It's showing up again, but now lower at an e-mini NASDAQ futures comparitive to QQQQ $37.26.
Here.... look at this.
e-mini NASDAQ futures (nq05u) - Daily Intervals
FUTURES traders tend to trade LEVELS more than anything (oscillators, moving averages, etc) and often times a DAILY settlement will provide the trigger for the building of a bias (bullish or bearish). After writing last Wednesday's Market Wrap, it was really eating at me as to "why" the QQQQ couldn't get a break back above $38.25 going, as it kept getting PUSHED back below $38.00. After doing some work with retracement on the e-mini futures contract, it became apparent that there was determined selling, where each futures settlement AFTER 06/07 kept finding selling, despite some strong looking intra-day gains. That determination means something!
Now look at what has been taking place. Yes, buyers where we might expect it. Are they getting ready for another run at the highs? Has this been just a rest and needed digesting of gains from the May lows? This contract hasn't been able to settle above 1,521.75 since settling below on June 24 (Friday).
Do BUYERS need to wait for a settlement before going long? No! Somebody's buying in order to keep it from going to 0.00 right? There's nothing wrong with buying 1/4, or 1/2 of a position and then LOOKING for a CONFIRMATION of strength with a settlement above the recent couple of session's highs.
Watch your NH/NL indications! They can give you a feel for any resumption of BULLISH leadership, which has also been taking a "rest" on the NASDAQ.
I say we're going higher and haven't seen this year's highs at this point. I'll back it up with a bullish stop just below the recent lows.
On a Wednesday-to-Wednesday basis, the S&P 500 Bullish % ($BPSPX) has slipped to 64.40% bullish from 66.20% bullish. Not a major concern that sellers (supply) is getting the upper-hand over buyers, but here we've got some NYSE and NASDAQ blend of stocks. Perhaps my more bullish "NASDAQ" thought right now.
I tell you what though. An "unhealthy market" isn't often found when you've got the brokers hitting all-time highs.
New Option Plays
by OI Staff
Call Options Plays
Put Options Plays
Coventry Hlth Care - CVH - cls: 71.74 chg: +0.97 stop: 68.49
Coventry is a national managed health care company based in Bethesda, Maryland operating health plans, insurance companies, network rental services companies, and workers' compensation services companies. Coventry provides a full range of risk and fee-based managed care products and services, including HMO, PPO, POS, Medicare Advantage, Medicaid, Workers' Compensation and Network Rental to a broad cross section of employer and government-funded groups, government agencies, and other insurance carriers and administrators in all 50 states as well as the District of Columbia and Puerto Rico. (source: company press release or website)
Why We Like It:
The healthcare stocks continue to be a pillar of strength in this market. We have had our eye on CVH for a while as it consolidates under resistance in the $72.50 level. Watching the recent action we believe the stock could be on the verge of a breakout to a new all-time high soon. If the markets do react positively to the FOMC announcement tomorrow then we want to position ourselves to catch the next leg higher in CVH. Therefore we are suggesting a trigger above its highs. Our entry point will be $72.75. The Point & Figure chart is currently bullish and points to an $89.00 target. We will target a move into the $77.50-80.00 range. We do not plan on holding over CVH's late July earnings report.
We are suggesting the August calls even through we plan to exit ahead of the late July earnings report.
BUY CALL AUG 70.00 CVH-HN OI= 53 current ask $4.00
BUY CALL AUG 75.00 CVH-HO OI=451 current ask $1.30
Picked on June xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/26/05 (unconfirmed)
Average Daily Volume = 1.0 million
Molson Coors - TAP - close: 61.38 chg: +0.44 stop: 59.49
Molson Coors Brewing Company is the fifth largest brewer in the world. It sells its products in North America, Europe, Latin America and Asia. Molson Coors is the leading brewer in Canada, the second largest in the U.K, and the third largest brewer in the U.S. The company's brands include Coors Light, Molson Canadian, Molson Dry, Carling, Kaiser, Coors, and Zima XXX. (source: company press release or website)
Why We Like It:
We like TAP as a bullish candidate for a couple of reasons. First, the stock has been pretty resilient and unaffected by the market's volatility over the last few weeks. Second, the stock appears to have built a new bottom over the last six weeks. Granted the play is not without risk. The P&F chart looks pretty bearish. There is recent news of an SEC inquiry into its merger documents but the stock barely moved on the news. Longer-term TAP is facing heavy competition from BUD but short-term we see potential upside. There is potential resistance at the 50-dma near $62.50 and readers can keep this in mind as they plan their trades. We would not be surprised to see TAP test the 50-dma, pull back for a bit and then rebound higher. We like today's relative strength and breakout over minor resistance at the $61.00 level. We suggest bullish positions here or on a dip back to the $60.50 level, which should be the front line of support. Our target is the $64.00-65.00 range but we'll plan to exit before the company's late July earnings report.
We are suggesting the August calls but plan to exit before the late July earnings report.
BUY CALL AUG 60.00 TAP-HL OI= 50 current ask $3.20
BUY CALL AUG 65.00 TAP-HM OI= 23 current ask $1.05
Picked on June 29 at $ 61.38
Change since picked: + 0.00
Earnings Date 07/28/05 (unconfirmed)
Average Daily Volume = 909 thousand
KLA-Tencor - KLAC - close: 43.88 chg: -1.39 stop: 45.76
KLA-Tencor is the world leader in yield management and process control solutions for semiconductor manufacturing and related industries. Headquartered in San Jose, Calif., the company has sales and service offices around the world. (source: company press release or website)
Why We Like It:
We are adding KLAC as a bearish candidate based on its technical breakdown today. This is purely a technical play as we can't quantify how much of today's decline may have been caused by investor reaction to the merger news surrounding KLAC. The headlines we're referring to involve August Technology, which just announced it is merging with Rudolph Technologies for $10.50 a share. KLAC already had a bid out for August at $11.50 a share. Looking more closely at KLAC we see a technical breakdown under its simple 200-dma and support at the $44.00 level. The P&F chart for KLAC is already bearish and points to a $24.00 target. We do see potential support for KLAC near the $42.00 level but we're going to target a decline toward the $40.00 region. Some traders may want to pause before considering put positions in KLAC and wait for the SOX semiconductor index to breakdown from its six-week consolidation under support near the 420 level, which it is close to doing. We plan to exit this play before KLAC's late July earnings report.
We are suggesting the August puts.
BUY PUT AUG 45.00 KCQ-TI OI=1799 current ask $2.65
BUY PUT AUG 42.50 KCQ-TV OI= 151 current ask $1.45
BUY PUT AUG 40.00 KCQ-TH OI= 360 current ask $0.75
Picked on June 29 at $ 43.88
Change since picked: - 0.00
Earnings Date 07/28/05 (unconfirmed)
Average Daily Volume = 5.4 million
In Play Updates and Reviews
by OI Staff
AmerisourceBergen - ABC - close: 68.60 change: +0.58 stop: 64.95
ABC almost made it to our target today. The stock rallied to a new high of $69.15 before a small afternoon pull back. Our target is the $69.50-70.00 range. We are not suggesting new plays here and more conservative traders may want to take profits now.
Picked on June 13 at $ 65.57
Change since picked: + 3.03
Earnings Date 07/21/05 (unconfirmed)
Average Daily Volume = 1.3 million
Ashland Inc - ASH - close: 71.31 chg: +0.82 stop: 67.95 *new*
After two days of consolidating above what should be round-number support at the $70.00 level shares of ASH rallied higher to close near all-time highs. Positive comments from an analyst firm didn't hurt the stock either. Meanwhile at the company's shareholder meeting investors voted to approve the company's sale of its minority stake in Marathon Ashland Petroleum LLC to partner Marathon Oil for $3.7 billion in cash and stock (source: AP). This marks the end of ASH's participation in any oil refining business. We remain bullish on the stock and we're raising the stop loss to $67.95.
Picked on June 16 at $ 70.05
Change since picked: + 1.26
Earnings Date 07/25/05 (unconfirmed)
Average Daily Volume = 1.1 million
Chubb Corp - CB - close: 85.69 change: -0.59 stop: 82.49
No change from our previous update. In the news CB confirmed that it would report earnings on July 26th. We do not plan on holding over the event.
Picked on June 10 at $ 85.05
Change since picked: + 0.64
Earnings Date 07/26/05 (confirmed)
Average Daily Volume = 1.2 million
Rockwell Collins - COL - close: 47.77 chg: -0.56 stop: 46.49
No change from our previous update. The MACD is nearing a new buy signal on the daily chart.
Picked on June 27 at $ 46.75
Change since picked: + 1.02
Earnings Date 07/26/05 (unconfirmed)
Average Daily Volume = 800 thousand
Cummins Inc - CMI - close: 75.19 change: -0.34 stop: 70.95
CMI looks pretty good here with only a minor decline following yesterday's surge higher. No change from our previous update. Our target is the $77.50-80.00 range.
Picked on June 19 at $ 74.03
Change since picked: + 1.16
Earnings Date 07/21/05 (unconfirmed)
Average Daily Volume = 970 thousand
Fording Candn Coal - FDG - cls: 91.80 chg: +0.77 stop: 88.49
Looks like traders bought the dip near the $91.00 level above its simple 100-dma. We remain bullish on the stock here.
Picked on June 19 at $ 90.30
Change since picked: + 1.50
Earnings Date 07/25/05 (unconfirmed)
Average Daily Volume = 384 thousand
Goldman Sachs - GS - close: 102.79 chg: -1.17 stop: 101.89
The action in GS today was disappointing. The stock has slipped back under its 200-dma and the technical oscillators are deteriorating. We have our stop loss under the bottom of the recent trading range. If GS doesn't bounce soon we'll be stopped out. Currently shares are just above their exponential 200-dma. More aggressive traders may want to buy a bounce from here. The rest of us can probably wait for another move over the $104.00 level.
Picked on June 28 at $104.35
Change since picked: - 1.56
Earnings Date 06/16/05 (confirmed)
Average Daily Volume = 4.8 million
Rio Tinto - RTP - close: 123.81 chg: -0.49 stop: 119.99
No change from our previous update.
Picked on June 27 at $123.33
Change since picked: + 0.48
Earnings Date 08/03/05 (unconfirmed)
Average Daily Volume = 160 thousand
SLM Corp - SLM - close: 50.24 change: -0.53 stop: 48.95
Lack of follow through on yesterday's rebound is discouraging but we would remain bullish on SLM with the stock above $50.00.
Picked on June 20 at $ 50.92
Change since picked: - 0.68
Earnings Date 07/14/05 (unconfirmed)
Average Daily Volume = 1.8 million
Wellpoint Inc - WLP - close: 69.66 chg: +1.17 stop: 65.90
Healthcare stocks were higher today and WLP added 1.7 percent. We suspect that today's rally might be window-dressing related. Our target is the $74.00-75.00 range.
Picked on June 05 at $ 68.40
Change since picked: + 1.26
Earnings Date 07/27/05 (unconfirmed)
Average Daily Volume = 3.5 million
BodyAmbac Fincl. - ABK - close: 70.66 chg: +0.01 stop: 71.51
Wednesday morning saw some follow through on ABK's Tuesday rebound but the buying powered stalled near the $71.00 region and its trend of lower highs. This might be consider a new bearish entry point but we would suggest readers wait for a move back under $70.00 or even $69.50 before considering new positions.
Picked on June 26 at $ 69.62
Change since picked: + 1.04
Earnings Date 07/20/05 (unconfirmed)
Average Daily Volume = 992 thousand
ESCO Tech. - ESE - close: 101.00 chg: -0.49 stop: 102.51
We remain very guarded here with ESE. The stock found support at the $100.00 level today and that does not bode well for any bearish positions. We're not suggesting any new plays until ESE trades back under $99 or $98.
Picked on June 26 at $ 97.80
Change since picked: + 3.20
Earnings Date 08/10/05 (unconfirmed)
Average Daily Volume = 102 thousand
Netease.com - NTES - close: 57.39 chg: -0.58 stop: 55.95
The action in NTES doesn't bode well for the future and while the stock is still above technical support at its 21-dma we are choosing to exit early. More aggressive traders may want to consider keeping the play open. There is a possibility for some last minute window dressing tomorrow before the quarter ends.
Picked on June 13 at $ 57.29
Change since picked: + 0.10
Earnings Date 07/26/05 (unconfirmed)
Average Daily Volume = 752 thousand
Dow Theory + Moving Averages: which to use
by OI Staff
I am writing the first part of my sort of 'annual' column on Dow Theory and how it relates to the basics of technical analysis, which is a large enough topic to require more than one column.
It seemed timely to me since I noted in my last Index Trader column ('Always Different, Always the Same') that last week's sharp sell off could be a top or cap to the most recent advance, which was a retracement of part (2/3rds) of the last decline in the Dow; at a minimum, this last downswing was a tradable trend using Index puts with an exit probably by Monday; old trader's saying: "take quick profits" (when they come).
The Market of course came back some yesterday (TUES), but it remains to be seen where this goes. By the way, ever notice how Monday, Wednesday and Fridays are often continuations of the existing trend and Tuesday and Thursdays are often 'reversal' days? But that's another story.
Getting back to a second point I made in my last Index Trader column about a possible top: one noticeable feature of the recent advance in the Dow Industrials (INDU) was the fact that the Dow Transportation Average (TRAN) didn't follow suit with a similar strong rebound.
According to Charles Dow and his so-called 'Dow Theory' (he never called his body of writings a 'theory'), the recent advance in the Dow 30 (Industrials), with the Transports following suit, makes the Dow 30 rally suspect about carrying on to a NEW high above 11,000. If INDU did go to such a new high and TRAN did NOT, this would be a definite 'non-confirmation' and possible sell Dow theory 'sell signal'.
This market juncture seems like a good time to lay out the main tenets of Charles Dow's observations of market behavior and how 'technical analysis' useful in options trading, developed from and after Dow's work. At least in the west; Japan was another story.
Before going further on Dow, this response is to an e-mailed question on moving averages from an Option Investor (OI) Subscriber:
OIN SUBSCRIBER QUESTION
I enjoy your Index Trader column but I am confused because different analysts talk about using the 10, 20, 30, 50, 100, and 200 day SMAs (Simple Moving Averages) and/or the 10, 20, 30, 50, 100, and 200 day EMAs (Exponential Moving Averages) That makes 12 different moving averages.
For picking entry and exit points to "swing trade" index options (QQQQ, SPY etc.), which moving averages do you recommend using?
Well thanks for your note and indication that you find value in my Index Trader column (found ONLINE on the Option Investor home page by clicking on "Index Trader").
This subject of which moving average to use and why, is likely worth an Trader's Corner column of its own and I'll get to that in one of my future Wednesday columns (and perhaps say more about why I use particular moving averages in my Index Trader weekend articles from time to time).
I myself use simple moving averages almost exclusively. I am not just not looking for the quicker 'trigger' that can be supplied by the Exponential Moving Average (EMA)
For those that don't know, a 'simple' moving average adds together a certain number of time periods (e.g., for 10-days of the closing price of an index, stock, etc.), whether the period (or, 'bar') is days, hours, weeks, etc. Each period in a simple average like this is EQUALLY weighted; e.g., in a 10-day simple moving average, each of the last 10 days' closes is simply 1/10th of the sum total that is divided by 10. Simple.
The 'exponential' calculation for an average allows recent price activity to generate a more rapid change in an average price. A type of "smoothing" is applied; one that assigns a percent value (for example, .15), to the last close and this value will be added to a percentage of the previous period's close.
The higher the percentage weighting (e.g., 15, 25 or 50%) given to the most recent close, the more sensitive will be the resulting moving average to the most recent price change(s). All data previously used is always part of the new result, although with diminished significance over time.
The answer to your question also very much depends on what time frame you are trading: what it means that you are a 'swing trader'? Day to day, trading every, or most minor price swings or moves that develop? If so, an EMA (Exponential Moving Average) may be a quicker 'trigger' so to speak and alert you a change in trend quicker. This is a consideration of the TYPE of moving average. The next topic is 'LENGTH' considerations.
Use the 5 and 10-day moving averages on daily charts if you are a short-term (swing) trader of options to buy calls/puts, or buy/sell short the QQQQ Nas 100 tracking stock. For example, by taking a position if QQQQ crosses above/below its 5, then, 10-day moving average. However, I attempt to figure out or 'time' intermediate trends and trend changes, in order to profit from larger price moves. Therefore, I use moving averages of at least 13 or 21 days.
Another part of my response is that I use 13 and 21 day 'length' setting because these numbers are part of the 'Fibonacci' number series (1,3,5,8,13,21, etc, where each number is the sum of the prior TWO numbers). Why?
This would be a long answer, not fully covered here. You can go to a prior Trader's Corner (3/30) on the use of Fibonacci numbers in "Fibonacci retracements" by clicking here.
But figure I owe you a longer article on moving averages, including use of the fibonacci numbers for the 'length' setting for moving averages and why that could be advantageous.
For example, as long as the indices are trading above the 21-day SMA, I assume the up trend will continue. (The fibonacci number '21' is where the 20 comes from actually.) Pullbacks TO or around the 21-day moving average will often tend find support or buying interest in this area. If not, and the 21-day SMA is pierced, I look for the near-term trend to be down in the period ahead (over days); if so, I look for rallies up TO the 21-day SMA to get deflected and for selling to come in as this average acts as 'resistance'; if so, this becomes a put-buying opportunity.
As hard as it is completely generalize on this subject, I would say to forget about the longer numbers for you as a shorter-term trader EXCEPT perhaps to take note of the 50 and 200-day moving averages. When a closing price first (after some weeks) crosses above or below the 50-day moving average, it's an ALERT that the intermediate trend direction may be reversing.
Crossing above/below the 200-day moving average (some prefer the 100-day, but the 200-day SMA is in more widely used and watched) often acts as CONFIRMATION that the trend has changed. However, closes above/below the 200-day SMA should then continue. Further, if the 50-day SMA goes on to cross above/below the 200-day SMA, that crossover can be confirmation that the long-term trend has shifted from up to down, or down to up.
If you have some indication that the intermediate to long-term trend has changed, you may or probably will want to trade more heavily in the SAME direction as the longer-term trend; e.g., in a dominant or overall up trend, buy calls more actively on pullbacks to support.
BACK TO DOW THEORY
Where the Dow Transportation average (TRAN) has not been following the path of the Dow 30 (INDU), is illustrated by this recent chart, one I used recently in the (Index Trader) column I mentioned and of interest here and topical. This chart will illustrate several things, not only later in terms of Dow Theory, but what came before, on moving averages:
The upper index in the chart below is the Dow 30 (INDU) of course. The moving average is the 21-day period and is the simple moving average (SMA) discussed already. The moving average envelope study simply applies lines that are 2 to 2.5% above and below, respectively, the day's SMA. The Stochastic also uses a 'length' setting of 21. (It's often the SECOND time the (Slow) Stochastic goes to the upper or lower extreme that marks the best trade in index calls or puts.) These aspects of the chart are not the point of the comparison of INDU and the Transportation average (TRAN), below, but I mention them in passing as relevant to the moving average discussion.
RELEVANT TO DOW THEORY
The most noteworthy point on the INDU versus TRAN charts above is illustrated by the (light blue) trendlines that slope in OPPOSITE directions. The trend in the Dow 30 was up during its last upswing, versus the down trend seen in the Transportation Average (TRAN). Charles Dow, and o talked about his two averages needing to 'confirm' each other; if they don't, the push down or up in either average may not last. This was certainly the case above, at least on a short-term basis and so far in the unfolding of the market trend.
Strictly speaking, Dow in his articles was speaking about a new HIGH or a new LOW being made, and whether a similar new high/low was achieved in the other average.
The most recent peak in INDU was about 3 percent under its 12-month high. The recent peak in TRAN was 6 percent under its yearly high. This situation suggests that, assuming the Industrial average does push up to a new peak at some point in the weeks ahead, to watch what happens to the Transportation average.
We can say definitely that this average (TRAN) would have significantly further to go to catch up the Dow at that point, especially in the face of rising fuel costs. More on the interplay of the two averages and what this business of the interplay of the two relates to later.
Charles Dow didn't consider his ideas on the market as a "theory", rather his observations on how the market behaved or would behave in terms of the averages he invented.
What came to be known as "Dow Theory" is not a system of market timing really but more of a forecaster of the major or 'primary' trend (over many months, sometimes years)and a predictor of
Back in the 1880s and 1890s, Charles Dow (who, along with Edward Jones formed Dow Jones & Co.) came up with the first stock market averages, which became, over time, the Dow Jones Industrials (now 30 stocks) and the Transportation average (Symbol: TRAN and now 20 stocks) as well as a Utility stock average (now 15 stocks).
As I noted before, the Dow Industrials might be better called the "Dow 30" as these stocks have become more technological, communication, manufacturing and service oriented and less "industrial", unlike the case of the heavy industry stocks like U.S. Steel that were part of the early Dow.
BY THE WAY
This average of 30 stocks is not capitalization weighted, as is the case of the Standard and Poor 500 or Nasdaq Composite index. Dow stocks of companies that have become price laggards, even if theyre much smaller companies than say General Electric or Microsoft, can have more of a dragging effect in the PRICE weighted Dow 30 average than indexes that give more weight to the biggest companies with far more shares outstanding as in the S&P 500(SPX).
Only the Dow Industrials and Dow Transportation (then a group of railroad stocks) averages are used in what became known as 'Dow theory'.
In a second part to this next week I can cover the main tenets of Dows observations on market behavior, which is a lot more than just how these two averages behave.
One of Dow's most important contributions was the idea that "confirmation" of the primary trend occurs by the actions of BOTH the Industrial and Transportation averages. A related aspect to this, really the flip side of it - is the concept of "divergence". Dow spoke mostly about confirmation divergences between averages and between prices and volume or between price action and indicators is mostly what came in this century by various technical analysts.
Dow said that if the Industrials moved to a new closing high or low, without the Transportation average following suit at some point (within a few months usually) and fail to "confirm" the new high or low or, if the Transportation Average (TRAN) goes to a new peak or new low, without the same action in the Industrials we should be on alert for a possible change or reversal of the primary trend.
The reasons for this are simple, but it was at the time a quite unique and original observation on Dows part. Take the example where industrial/manufacturing activity is strong and the Dow 30 average continues to move higher because of it. But, at the same time, orders for those goods are slowing. This situation results in a build up of inventories.
Where such a slowdown would show up however, is in transportation activity as there is less shipping business for these companies. Slowing orders in the transportation sector will tend to result in a fall off of company earnings. Astute followers of these stocks would notice this and selling would start to show up in these stocks, either keeping a lid on stock prices or actually driving them lower.
Conversely, manufacturing could start picking up but might not be at first reflected in a pick up in those stocks as earnings tend to lag orders however, an increase in shipping might be noticed more readily and cause transportation stocks to begin rising. During this period the Dow Industrials might fall to a new low, but not the Dow Transportation average.
Therefore, a new high or low in the Industrial average, not confirmed by the Transportation average is suspect. In the case of a new high not confirmed by the Transportation stocks it may indicate that the same slowing of earnings and hence stock prices, will show up later on in the Dow Industrials.
In my book (Essential Technical Analysis) I used the following chart example of a major blockbuster type Dow signal that could have put anyone on the right track in terms of getting into stocks big time as a new low in the Transports was not confirmed by a new low in the Industrials -
We can assume that manufacturing was holding relatively steady perhaps there was not a big build up of inventories - but transportation stocks were suffering more relative to the heavy volume and good earnings that they were experiencing in the prior year(s).
MORE, next time -
Good Trading Success!
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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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