Option Investor

Daily Newsletter, Wednesday, 01/04/2006

Printer friendly version

Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews
  4. Trader's Corner

Market Wrap

Out of Breath, Job Done, Santa Flies Home

On the last day of the official Santa Claus rally period, Santa appeared slightly out of breath. He wrapped up pretty packages, but left off the labels indicating whether they were for bulls or bears. He flew home leaving some questioning where indices might go next.

After a volatile session Tuesday sent some indices into their biggest one-day gains in months, this second day of trading in the new year and last day of the typical Santa Claus rally was primed to produce a choppy consolidation session. The choppy action was dutifully delivered.

Annotated Daily Chart of the SPX:

Annotated Daily Chart of the Dow:

Annotated Daily Chart of the Nasdaq:

Annotated Daily Chart of the SOX:

Santa tied all his packages with the same ribbons and bows. Indices moved up to key resistance and MACD hooked up, but the indices shown here did not cleanly break through that resistance nor did MACD's produce a bullish cross. Similarly, MACD on the Russell 2000's daily chart hooked up, but did not produce a daily cross. The Russell 2000 broke above a descending trendline off the December high, but did not close above a flag that began forming in late November.

There are no labels on those similarly wrapped packages, so that market participants are going to have difficulty deciding whether Santa intended those packages for the bulls or the bears. This proves particularly troubling given the import of Friday's jobs report ahead of January's FOMC meeting. Charts usually give some idea of next most likely direction, but these give few clues.

Action across various sectors contributes to the confusion. The financials, as represented by the BIX and BKX, produced doji at the top of climbs, essentially capping gains today. Homebuilders and other stocks in their food chain couldn't help Santa wrap those presents in cheerier papers, either.


Earn $2,000 Each Month with a Conservative Options Strategy

We will show you how you can make $2,000 in cash each month using your existing portfolio equity as collateral. This low-risk strategy works no matter which direction the market goes. Best of all, it is easy to implement and no previous experience with options is necessary.

Take a complimentary 30 day test drive. Click Here:


The Mortgage Bankers Association released mortgage applications for the week ending at 7:00 EST. Once again this week, the composite measuring mortgage loan application volume fell, this time by 1.5 percent on a seasonally adjusted basis. On an unadjusted basis, volume dropped 20.8 percent from the previous week's volume and 9.9 percent from the year-ago level. The purchase, refinance, conventional and government indices all dropped. Four-week moving averages fell 4.2 percent in the seasonally adjusted market index, 3.3 percent in the purchase index and 5.9 percent in the refinance index. Refinances did increase as a percent of total applications, to 42.7 percent from the previous 40.2 percent.

The average contract interest rate for a 30-year fixed-rate mortgage fell to 6.15 percent from its previous 6.21 percent, but points increased. The volume of adjustable-rate mortgage (ARM) applications fell to 28.8 percent of all applications, down from the previous week's 32.5 percent. None of that was good news for homebuilders, and the DJUSHB, the Dow Jones U.S. Homebuilders Index, dropped 0.75 percent.

Another economic release may not have been a cheerful as it appeared on the surface. At 10:00, November's factory orders followed the mortgage information. The forecast was for a gain of 2.4-2.6 percent, depending on the source, and the actual number came right in line with expectations, higher by 2.5 percent. Inventories rose 0.2 percent, with the inventory-to-sales ratio remaining steady at 1.18. Motor vehicle orders dropped 7.8 percent. Another component, transportation orders, rose 15.8 percent, driven higher by new orders for airplanes. Boeing (BA) garnered 148 new orders in November, up significantly from October's 36 and contributing to a record 806 aircraft orders for the company through December 12.

However, Bloomberg posited that if orders for transportation equipment had been backed out of the factory orders number, that number would have been flat. Without aircraft orders, orders for capital goods fell 2.1 percent. Unfilled orders rose three percent to a record $621.4 billion, and preliminary data from early December indicated a possible leveling off of manufacturing growth.

The TRAN had risen into the 10:00 release, and was waiting just below a descending trendline off its December 27 high. With Frontier Airlines (FRNT), Jetblue Airways (JBLU), Pinnacle Airlines (PNCL) and Skywest Inc. (SKYW) among its components, a further climb was fueled by gains in airlines. Many non-airline components gained more than 1.5 percent in early trading, some more than two percent, with some of the trucking companies perhaps benefiting from an early pullback in crude prices. After the factory orders number was released, the TRAN broke above a descending trendline off its December 27 high, but had pulled back below that trendline by the close, coiling just beneath it.

The usual crude inventories release was delayed for a day due to Monday's holiday, but crude slipped lower before cash markets opened due to developments overseas relating to natural gas. European gas supplies had been disrupted by a dispute that arose Sunday between Russia and the Ukraine, with Russia stopping most of its shipments to the Ukraine. Since Europe receives about a fourth of its supplies through Ukrainian pipelines, that hit Europe's supply, too. Before the market opened, Russia's Gazprom and the Ukraine reached a five-year agreement in which it will pay more than previously for the gas it receives from Gazprom.

Crude costs weren't to stay down, however, and crude's daily chart shows the battle going on between crude bulls and bears.

Annotated Daily Chart for Crude for February Delivery:

While Santa was working his last day before winging off on vacation, analysts busied themselves unveiling upgrades and downgrades. Bear Stearns upgraded Google Inc. (GOOG) to an outperform rating, up from its previous peer perform. The analyst raising the rating coined a new term, the "Google ecosystem," when praising the company's increasingly interactive business community, but he also referenced the company's long-term fundamentals when upgrading the company and raising its price target to $550 from its previous $360 target. This analyst could be termed conservative, it seems, when compared to the Piper Jaffray analyst who upped the target to $600 yesterday. In addition, two newspapers this week, the Los Angeles Times on Sunday and the New York Post today, reported that Google might sell an inexpensive computer through Wal-Mart with this computer reportedly not using the Microsoft operating system. GOOG was to gain 2.27 percent, closing up 9.90 points at $445.13.

Banc of America Securities upgraded Exxon Mobil (XOM) to a buy rating from its former neutral rating, but the firm downgraded Citigroup (C) and General Motors (GM). Citigroup's 1.84 percent drop was to contribute to the weakness in financials. Office Depot (ODP) also collected a downgrade, this one from Goldman Sachs. The firm cited valuation concerns when downgrading ODP to an inline rating from its former outperform one. ODP peer Lowe's (LOW) collected its own downgrade from J.P. Morgan, with that firm citing a slowdown in home sales. ODP dropped 1.90 percent and LOW, 1.23 percent.

Pharmaceuticals and biotechs grabbed the spotlight. Pfizer (PFE), Schering-Plough (SGP) and Merck & Co. (MRK) presented at a Morgan Stanley conference today. All three headed higher in early trading, with PFE closing higher by 3.23 percent; SGP, 0.23 percent; and MRK, 1.16 percent. Biotech Boston Scientific (BSX) gained 3.47 percent after speculation that Guidant's (GDT) board may favor BSX's bid over JNJ's when the board meets next week.

December auto sales were released, with stocks of auto makers displaying some volatility before and after their release. Sales figures were expected to be down and they were. DaimlerChrysler was one of the first to release figures. Its total sales dropped 5 percent, and U.S. sales of Chrysler and Mercedes-Benz vehicles dropped 2 percent in December, with a promotion of free gas not helping sales. Total sales had been expected to drop 5.3 percent. Sales for 2005 rose 5 percent. DCX was to close lower by 0.44 percent.

Ford and General Motors released their results later during the day. Ford's sales dropped 9 percent, with some sources having expected a deeper drop of 10.5 percent, and with U.S. sales of cars falling 5.8 percent and trucks, 10.2 percent. For 2005, Ford's U.S. sales dropped 4.9 percent. Ford's stock closed higher by 2.29 percent.

GM's December U.S. sales dropped 10.3 percent when compared to the year-ago level, with 2005's U.S. sales dropping 4 percent. GM's results were deemed slightly worse than expected, while at least one source deemed DCX's and F's slightly better than expected. GM closed higher by 2.69 percent. All three major U.S. car manufacturers' stocks rose into the sales figures, dropped afterwards and then rose again. F dropped heavily in the last minutes of trading, however.

Tomorrow will include several economic releases, with initial claims at 8:30, December's ISM services at 10:00 and crude inventories at 10:30. Earnings remain light, but attention tomorrow will probably be on the crude inventories and resultant action in crude and on Friday's jobs numbers.

It's as easy to imagine rollovers on all these indices as it is to imagine breakouts, and that's a problem. Many indices attempted breakouts today, with more and less success on various indices. None of the breakouts proved particularly convincing, and playing such breakouts can be an iffy matter over the last year. It's far better to have already been long from those tests of the 50-sma's and 72-ema's and to be making decisions about protecting profits than to be looking for new bullish entries, but do make those decisions about protecting bullish profits.

For guidance, keep a watch on the SPX. If it should break convincingly above today's high, watch for next resistance at about 1284. If long, continue to tighten stops and plan your tactic for dealing with the current retest of December's high and then of the 1284 level, if that should be approached. If planning new bearish trades, make sure that you're seeing a rollover at the resistance levels depicted above, and watch for potential support at the midlines of the regression channels shown above, many of those midlines now roughly congruent with converging 10- and 30-sma's. If prices should plummet through those levels, watch 50-sma's for next support.

New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
None None None

New Calls

None today.

New Puts

None today.

New Strangles

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Biogen Idec - BIIB - close: 47.27 change: +0.53 stop: 43.95

Biotech stocks posted another gain with the BTK index up 1.3% and closing near five-year highs. BIIB followed higher with its own 1.1% gain but closed off its best levels of the session. A bounce from the $47 level could be used as a new bullish entry point. Our target is the $49.85-50.00 range.

Picked on December 27 at $ 46.11
Change since picked: + 1.16
Earnings Date 01/25/06 (unconfirmed)
Average Daily Volume = 3.2 million


Cytec Ind. - CYT - close: 48.65 chg: +0.25 stop: 45.95

CYT continues inching higher and is poised to breakout past its August highs near $49 soon. We do not see any change from our previous updates. Keep in mind that our target is only the $49.85-50.00 range. More aggressive traders may want to aim higher. The P&F chart points to a $65 target. The biggest challenge to initiating new positions now is the time frame. We do not want to hold positions over the Jan. 19th earnings report (which is currently an unconfirmed date).

Picked on December 22 at $ 47.01
Change since picked: + 1.64
Earnings Date 01/19/06 (unconfirmed)
Average Daily Volume = 333 thousand


Foster Wheeler - FWLT - close: 37.10 chg: +0.83 stop: 35.49

FWLT rebounded from the bottom edge of its trading range with volume coming in well above the daily average, which is bullish. We remain on the sidelines. Our trigger to buy calls is at $38.05. If triggered we'll target a run into the $42.00-42.50 range. Currently the P&F chart is very bullish with a $73 target.

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 03/15/06 (unconfirmed)
Average Daily Volume = 598 thousand


Gilead Sciences - GILD - close: 55.45 chg: +0.75 stop: 49.99

The two-day bounce in GILD has improved the technical picture for GILD. The stock now looks poised to breakout over resistance near $56. Volume today came in decent again for the second day in a row. The P&F chart points to a $66 target. Our target is the $59.00-60.00 range. We do not want to hold over GILD's mid January earnings report.

Picked on December 22 at $ 54.51
Change since picked: + 0.94
Earnings Date 01/17/06 (unconfirmed)
Average Daily Volume = 4.3 million


Ipsco Inc. - IPS - close: 86.35 change: +0.65 stop: 79.99

IPS set another new all-time high today. We do not see any change from our previous update. If you don't want to chase it look for a potential dip back toward the $85 level. Our target is the $89.00-90.00 range. We do not want to hold over the January earnings report.

Picked on December 30 at $ 83.55
Change since picked: + 2.80
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 396 thousand


Mohawk Ind. - MHK - close: 90.14 change: +0.54 stop: 85.90

We have been triggered in MHK. The stock spiked higher near the opening bell to $90.50. Our trigger to buy calls was at $90.25, over round-number resistance at $90.00. Today's move confirms yesterday's breakout and marks a move above the $86-90 trading range. Now that the play is open we are targeting a rally into the $94.85-95.00 range. by its early February earnings report.

Picked on January 04 at $ 90.25
Change since picked: - 0.11
Earnings Date 02/02/06 (unconfirmed)
Average Daily Volume = 355 thousand


Petrochina Co - PTR - close: 85.05 change: +1.55 stop: 79.99

PTR confirmed yesterday's trading-range breakout with another strong gain today, up 1.85%. Today's gain also puts PTR above its late September peak and potential round-number resistance at $85.00. If you don't want to chase it here there is a chance shares will pull back and retest the $83.00-84.00 range before moving higher. Our end of February target is the $89.50-90.00 range.

Picked on January 03 at $ 83.50
Change since picked: + 1.55
Earnings Date 03/00/06 (unconfirmed)
Average Daily Volume = 488 thousand


United States Steel - X - close: 49.84 chg: +0.40 stop: 44.99

Shares of X continue to climb even though the current bounce is getting a little long in the tooth. It may be time for a pull back. The 10-dma near 47.75 should offer some support. On the positive side the MACD indicator is nearing a new buy signal. Our late January target is the $52.00-52.50 range. The Point & Figure chart for X points to an $86 target. We do not want to hold over the January earnings report.

Picked on December 23 at $ 47.05
Change since picked: + 2.79
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 3.8 million

Put Updates

Netease.com - NTES - close: 58.10 chg: +1.52 stop: 58.01

NTES continued to bounce today and shares remain inside its $56-59 trading range. We are still on the sidelines. Our trigger to buy puts is at $54.95. If triggered we'll target a decline into the $50.25-50.00 range. We do not want to hold positions over the February earnings report.

Picked on January xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/21/06 (unconfirmed)
Average Daily Volume = 4.2 million


Progressive Corp - PGR - cls: 116.03 chg: +0.51 stop: 120.05

The bullish market action today has put the brakes on PGR's decline. Volume came in pretty strong for the range-bound session today. Watch for a bounce back to the 10-dma near $119, which is short-term overhead resistance. We do not see any change from our weekend update. Our target is the $110.50-110.00 range but we only have 16 days if the current earnings date is correct. We do not want to hold over the earnings report.

Picked on December 30 at $117.45
Change since picked: - 1.42
Earnings Date 01/19/06 (unconfirmed)
Average Daily Volume = 836 thousand


Scotts Miracle grow - SMG - cls: 46.61 change: -0.02 stop: 47.55

Wow! We are really surprised that SMG did not show more strength today. The stock failed to breakout over the $47 level and it just might turn lower. We are not suggesting new plays at this time. A failed rally here or under $47.00 would be welcome news. We would wait for a decline back under $46.00 and maybe lower (if you're more conservative) before considering new bearish positions.

Picked on January 01 at $ 45.24
Change since picked: + 1.37
Earnings Date 01/26/06 (unconfirmed)
Average Daily Volume = 354 thousand


Stryker Corp. - SYK - close: 45.37 chg: +0.77 stop: 46.51

We expected a bounce today and that's what SYK delivered with a 1.7% rebound that stopped under its simple 10-dma. There is still a chance that SYK will rebound toward the $46 level. We would not suggest new bearish positions here. Wait for a failed rally to occur before considering new entries. The Point & Figure chart points to a $23.00 target. Our target is the $40.25-40.00 range, near its October lows. We do not want to hold over the January earnings report. That gives us about three weeks, maybe less.

Picked on December 30 at $ 44.29
Change since picked: + 1.08
Earnings Date 01/17/06 (unconfirmed)
Average Daily Volume = 2.1 million

Strangle Updates

(What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.)


Amer. Eagle Out. - AEOS - cls: 22.80 chg: -0.51 stop: n/a

AEOS reported same-store sales growth of +9.8% for December. The news elicited a small rally that eventually failed but the sell-off saw a late day rebound. Volume came in very high at almost three times the daily average. Shares of AEOS remain under their trendline of resistance. We see no change from our weekend update on AEOS. We only have three weeks left before January options expire. We're not suggesting new plays. The current strangle has an estimated cost of $2.35 with the January $27.50 calls (AQU-AY) and the January $22.50 puts (AQU-MX). We are targeting a rise to $4.70.

Picked on November 13 at $ 25.47
Change since picked: - 2.67
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 3.6 million


Abercrombie&Fitch - ANF - close: 65.00 chg: -0.72 stop: n/a

ANF was weak most of the session with a decline to its simple 21-dma near the $64 level. Volume came in above average. We see no change from our weekend update. We are adjusting our target to breakeven at $5.15. We are not suggesting new strangle positions at this time. The options in our strangle are the January $65 calls (ANF-AM) and the January $55 puts (ANF-MK). Our estimated cost was $5.15.

Picked on November 13 at $ 59.67
Change since picked: + 5.33
Earnings Date 11/15/05 (confirmed)
Average Daily Volume = 2.7 million


Blue Coat Sys. - BCSI - cls: 39.99 chg: -0.14 stop: n/a

A failure to produce any sort of oversold bounce today does not bode well for the bulls. Contributing to the lackluster session was an analyst reiterating their "hold" rating (a.k.a. "don't buy" rating). We do not see any change from yesterday's update. More conservative traders may want to exit early right here to reduce their losses. We only have three weeks left before January options expire. We're adjusting our target to breakeven at $3.25. Our current play involves the January $50 call and the January $40 put. Our estimated cost is $3.25.

Picked on December 04 at $ 45.43
Change since picked: - 5.44
Earnings Date 02/14/06 (unconfirmed)
Average Daily Volume = 416 thousand


Building Materials - BMHC - cls: 73.44 chg: +0.65 stop: n/a

BMHC is still trying to bounce but it's struggling with the $75 level. We are not suggesting new strangle positions at this time. The options in our strangle play are the March $90 calls (BGU-CR) and the March $70 puts (BGU-ON). Our estimated cost is $8.20. Our target is $12.50 by March expiration.

Picked on December 18 at $ 80.95
Change since picked: - 7.51
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 527 thousand


Chicago Merc. Exchg. - CME - cls: 357.80 chg: -5.23 stop: n/a

There is little change from yesterday. CME continues to show relative weakness. There are only three weeks left before January options expire. We are adjusting our target to breakeven at $26.70. That means CME needs to trade well above $400 or under $350 if we're going to hit our new target. We are not suggesting new positions. Our current play involves the January $400 calls (CMJ-AK) and the January $350 puts (CMJ-MA). Our estimated cost was $26.70.

Picked on November 20 at $375.90
Change since picked: -18.10
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 879 thousand


Four Seasons - FS - close: 52.34 chg: +0.57 stop: n/a

FS is still bouncing. Today's gain would confirm yesterday's breakout over the 50-dma. We have less than three full weeks before January options expire. FS needs to trade under $47.50 if we have a chance of recouping our expenses here. The options in our strangle were the January $60 calls (FS-AL) and the January $50 puts (FS-MJ). Our estimated cost was about $2.60. We are adjusting our target to breakeven at $2.60.

Picked on November 08 at $ 55.37
Change since picked: - 2.98
Earnings Date 11/10/05 (confirmed)
Average Daily Volume = 319 thousand


Lear Corp - LEA - close: 29.73 chg: +1.42 stop: n/a

Today's bullish breakout in LEA is probably the last nail in the coffin for our strangle play. The automakers and the parts suppliers all rallied after the December vehicle sales figures came in bad but not worse than expected. There are only three weeks left before January options expire. For this play to succeed or even breakeven we need to see LEA trade over $35 (not likely) or under $25 (a dwindling prospect). We might be able to recoup the cost of this play by buying calls on LEA if the stock can breakout over the $29.00 level. We are no longer suggesting new strangle positions. The options in our strangle are the January $35 calls (LEA-AG) and the January $25 puts (LEA-ME). Our estimated cost was $1.60. We are lowering our target to $1.60.

Picked on November 06 at $ 30.24
Change since picked: - 0.51
Earnings Date 01/25/06 (confirmed)
Average Daily Volume = 1.8 million


Verifone Holdings - PAY - cls: 25.90 chg: +0.32 stop: n/a

We see no change from our weekend update on PAY. Our cost for the January strangle was about $2.60. Currently the PAY-AX Jan. $22.50 calls are trading at $3.30bid/$3.70 ask. Our target is for a rise to $4.50. We only have three weeks left before January options expire.

Picked on October 12 at $ 19.98
Change since picked: + 5.92
Earnings Date 12/01/05 (confirmed)
Average Daily Volume = 259 thousand


Questar Corp. - STR - close: 79.46 chg: +0.83 stop: n/a

STR continued to rally with the energy sector even though natural gas futures took a 4% loss today. Shares of STR are now poised to breakout over the $80 level. We only have three weeks left before January options expire and to see this play even breakeven we'd need to see a rally towards $85 or a decline towards $65. We are adjusting our target to breakeven. Our strangle involves the January $80 calls (STR-AP) and the January $70 puts (STR-MN). Our estimated cost was $5.10.

Picked on November 20 at $ 76.25
Change since picked: + 3.21
Earnings Date 01/26/05 (unconfirmed)
Average Daily Volume = 716 thousand


Texas Ind. - TXI - close: 51.03 chg: +1.37 stop: n/a

We are still in a wait and see mode with TXI. The company is due to report earnings on Thursday, January 5th. The earnings report is pretty much our only chance to try and score (and/or breakeven) with this strangle play. If the news fails to jolt TXI out of its three-month trading range then our strangle is in deep trouble. We are not suggesting new plays but aggressive traders might consider a new position using February strikes. The options in our strangle are the January $55 calls (TXI-AK) and the January $45 puts (TXI-MI). Our estimated cost is $2.70.

Picked on November 27 at $ 49.57
Change since picked: + 1.46
Earnings Date 01/05/06 (confirmed)
Average Daily Volume = 354 thousand


Valero Energy - VLO - close: 54.91 chg: +0.55 stop: n/a

VLO is still rebounding and looks poised to breakout over resistance near $55.75. January options are set to expire in three weeks. If this play is going to score we need to see VLO trade well over $55 or under $45 before expiration. Our target is set to breakeven at $2.93.

Picked on November 21 at $ 50.50
Change since picked: + 4.41
Earnings Date 01/30/06 (unconfirmed)
Average Daily Volume = 10.7 million

Dropped Calls


Dropped Puts

PACCAR Inc. - PCAR - close: 71.55 change: +1.20 stop: 72.51

Danger! PCAR is on the verge of a bullish breakout. The U.S. carmakers released their December sales figures today. While the numbers were terrible the markets seemed to breathe a sigh of relief that they figures weren't worse than expected. This powered a bounce in Ford, General Motors and many of the parts manufacturers. Shares of PCAR added 1.7% and on above average volume. The technical picture is turning more bullish for PCAR. The rally did stall at the $72 level but odds look strong for some follow through tomorrow. We want to exit early and cut our losses here.

Picked on December 20 at $ 69.49
Change since picked: + 2.06
Earnings Date 01/24/06 (unconfirmed)
Average Daily Volume = 838 thousand

Dropped Strangles


Trader's Corner

'Post Mortems' and Other New Year's Resolutions

My New Year's resolution as far as this weekly (Trader's Corner) Wednesday column is to write about market analysis principles that are reflected in some way only in CURRENT chart and technical patterns. Based on the e-mails I've gotten over the months, OIN readers are mostly interested in the way things are unfolding NOW, relating to options trades their in, were in, or are thinking about making; my interest also. As I note often in my book (Essential Technical Analysis), if technical patterns and indicators arent useful for predicting the trend, which is how profits are made, they aren't of practical use to us.

What makes us better traders doesn't tend to stem just from the winning traders, but also from the losing ones or from where we predicted the trend based on an incomplete or inaccurate analysis and outlook. We don't tend to do post mortems on trades that we were right on; but probably should, at least to a degree, by confirming that what instincts and analysis were most accurate. For sure we should review losing trades, or just where a trend reversal surprised us, so that we reinforce what factors WERE predicting the outcome that developed.

If you believe that the market is moved by random events and news that can't be predicted ahead of time, my discussion here may seem strange. But, 30 years of trading experience continue to convince me that there is very little that happens that the market was not somehow 'setting up' for. The market as a mechanism of price prediction is nothing short of incredible. But, reading the 'tea leaves' can be a lot of work and requires a substantial focus and continued evaluation and reevaluation as the trend unfolds. Not for nothing that only a very few make fortunes by trading. The one I knew well, and this was typical of the other 'Trading Wizards' that my old UBS colleague Jack Schwager wrote about, who learned the MOST from mistakes and misperceptions.

As far as the experts, the talking heads you see on CNBC and the other market media ... well, a Psychologist named Philip Tetlock recently wrote a book called "Expert Political Judgment: How Good Is It?" He studied in detail not only political 'experts', but those doing all kinds of forecasting, including economic. I wish he had included all the market prognosticators, but the findings are likely similar for all; namely, that the 'experts' arent much better than you and I in predicting the outcome of events and trends.

Actually it's worse than that, as there is a tendency for predictions to have less than a chance outcome. For example, if the market can go up, down or sideways, each has a 33.3% chance of being the outcome ahead. Tetlock's research suggested in some cases that experts' predictions were right less than a third of the time, or less than a 'chance' outcome.

This is the old 'dartboard' theory of picking stocks for example; i.e., the studies where stock selection was done by throwing darts at a stock page; and which will sometimes outperform the average mutual fund gain that year.

Now there were some experts that did better than others, but the KEY difference was what a writer said in his Tolstoy essay called "The Hedgehog and the Fox", where the KEY was what kind of thought process is used to predict future outcomes.

So called hedgehogs professed to "know one big thing"; e.g., market trends are determined by what the Fed does; Elliott Wave tells all, etc. "Foxes" on the other hand, don't see a SINGLE determining explanation about why things happen the way they do. They tend to see a shifting mix of factors that suggest the way things will go THIS time. On balance the 'foxes' do better than 'chance' in predicting. Not that the 'hedgehogs' don't also have some BIG wins. When they're right, they're very right.

I had not been heavily bearish about this recent trend-less market for a couple of reasons which I'll go into, but then saw last week's downside action was now suggesting deeper retracements than the shallow ones we had been seeing in the month from late-November to late-December. The major upside reversal of the past two days made this view obviously WRONG!

What did I miss? By doing the same thing that 'hedgehogs' do that makes predictions sour: getting too convinced by the apparent obvious.

There were 3 BEARISH technical patterns/aspects that developed:
1. The failure of rallies to penetrate the 'line' of repeated highs in the major indexes. This is still the case.
2. Last week's fall below prior (down) swing lows in the major indexes; which I suggested pierced the low end of 'rectangles', or lengthily sideways trading range patterns. More on #2 later.
3. The downside price 'gaps' of last week in the Nasdaq that suggested the possibility of that the indexes could have substantially more downside ahead, perhaps even half-way in a move lower.

Instead, the indexes reversed after the S&P 100 (OEX) and the Nasdaq 100 (NDX) only retraced around a 'minimal' 38% retracement of the Oct-Nov advance; suggesting a still strong UPtrend.

Besides the perception that the Fed was perhaps done raising rates, my post mortem is on what technically was suggesting that the market had substantial rebound potential; once it was done 'coiling', ahead of its spring back move?

The 2 BULLISH factors I wrote about last week in this column:
1. The contraction of 10-day Nasdaq total UP volume to 'baseline levels where major intermediate-term rallies are highly likely.
2. The lengthily sideways move had the earmarks of a 'time correction' that was 'throwing off' the prior overbought condition; and is often suggestive of a shallow correction only, before a resumption of the major trend; i.e., up.

These factors argued AGAINST a steep further drop. What did continue to be highly predictive for the rebounds from Tuesdays' lows, was the pullback to and rebound from the S&P and Nasdaq UP trendlines, shown in the charts coming up. Not for nothing that I rely on trendlines so: they 'work'.

I also wrote last week about the possible formation of 'rectangle' patterns, which when pierced on the downside, suggested deeper downside targets than was the case (ahead of yesterday's strong upside reversal). This (12/28) article can be viewed/re-viewed by clicking here.

Before going into the TWO bullish factors, was I right (a fox) or wrong (a hedgehog) on seeing the last (lower) low as a breakdown below a RECTANGLE? Not that prices won't do the unexpected, REGARDLESS of any technical pattern.

The question is was I too 'loose' in my interpretation of possible rectangle top patterns because it supported a too-lazy analysis and a feeling that the market should go down in early-January like it did LAST year??? You have to identify the pattern correctly BEFORE expecting that price action will conform to the common outcome for breaks of this pattern.

Getting this pattern right is important because 'rectangle tops' and 'rectangle bottoms' are one of the 5 patterns that were shown to have a good predictive value in Dr. Andrew Lo's MIT study; the others were the 3.) Head & Shoulder's, 4.) double top and 5.) the broadening bottom.

The S&P 500 (SPX) chart below as outlined had the most likely RECTANGLE top pattern but, and I should review my own book, this interpretation would have been more likely had there been another low or two in the same area as in early-December. It was a bit of a stretch to say that the lows this week penetrated the low end of a well-defined rectangle. By the way, a 'bear trap' reversal is always a new low for a move, followed by an immediate (and, frequently strong) upside reversal.

Yet to come is a break out above the prior highs at SPX 1275, but this looks possible given how fast the Index came back here.

The reliability of the UP TRENDLINE shown above dating back to the October lows) as offering technical support was great. The low was also near the 50-day moving average, adding some bullish credence to the low seen yesterday.

The reason that you want to check one Index against other related indexes is illustrated by the fact that in the S&P 100 (OEX) chart shown below, there is NO, zero, nada rectangle top pattern; only a move to a lower low, down to the trendline followed by a strong reversal and upside rebound. As with SPX, yet to come is a breakout move, In the case of the OEX, above the possible Double Top. Stay tuned on that!

By the way, yesterday's OEX low makes the THIRD point in the up trendline, putting it beyond the 'minimal' TWO lows necessary to form a valid trendline.

As I discussed about 'TIME' corrections earlier on, OEX's strong rebound after the RSI was getting close to an oversold area (after a lengthily sideways move) is suggesting that its correction has run its course; the retracement (not shown) did not even reach 38%, which tends to be a 'minimal' retracement.

As far as my speculation about a possible rectangle top in the Nasdaq, we were not even close to it in the Nasdaq 100 (NDX), shown below. EXACT however, was the rally from the up trendline shown, after the completion of a 'Fibonacci' 38% retracement.

The same oversold reading in the NDX's Relative Strength Index, RSI (above), similar to the OEX, was close to being realized before NDX took off like a shot.

My Up Volume 'indicator', which is simply that major tradable S&P bottoms tend to occur around the time of, or just AFTER, similar reoccurring 'baseline' levels are seen in the 10-day moving average of total daily NYSE UP (Advancing) volume. This fits the old adage that 'volume (tends to) precedes price'.

This way of looking at Up volume, which was an historical stable in key market stats shown in the S&P 'Trendline' charts, continues to amaze as to how simply and reliably it 'works' in marking bottoms; not so in tops, which are not easily defined by this indicator.

The Nasdaq 10-day Up Volume indictor shown below under the price chart for the Nasdaq Composite (COMP), was the most reliable indication that the market was coming down to another 'bottom', ahead of yet another up 'leg'.

I've seen this pattern over the years 'signal' numerous bottoms just ahead (over decades even), yet I still sometimes get overly taken in by a bearish point of view when an apparent top is forming, as occurred from late-Nov to late-Dec. Stay tuned of course, as to a breakout to new highs!

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.


Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.

Readers are urged to consult with their own independent financial advisors with respect to any investment. All information contained in this report and website should be independently verified.

To ensure you continue to receive email from Option Investor please add "support@optioninvestor.com"

Option Investor Inc
PO Box 630350
Littleton, CO 80163

E-Mail Format Newsletter Archives