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Newsletter

Daily Newsletter, Wednesday, 03/01/2006

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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

You Can Bank on a Rally

Or can you? Through much of February, financials lent strength to the indices. The BKX, the KBW Bank Index, and the BIX, the S&P Banks Index, charged higher over the last three weeks and showed particular strength last week. Some market watchers questioned that leadership, given the recent uncertainty about the current rate-hike cycle and the continued yield-curve inversion. Some of those uncertainties played out in yesterday's strong profit taking among the financials. Today, the BIX and BKX appeared to lag other indices' gains, but the SOX and TRAN ran forward, assuming leadership roles. Most tech-related indices gained.

Annotated Weekly Chart of the BKX:

Despite today's SPX gains and hopes that by this time this week, we'd see more conclusive evidence of next direction on the SPX, this Wednesday sees that index just about where it was last Wednesday, both in price and in relationship to its rising wedge.

Annotated Weekly Chart of the SPX:

Despite today's strong gain, the Dow could not press above the 10-sma. Unlike the SPX, it remains below last Wednesday's 11,137.17 close. Like the SPX, it also has not clearly revealed next direction, despite hopes that it might have done so by today.

Annotated Weekly Chart of the Dow:

Those already long the Dow or Dow stocks should protect longs with hopes that the Dow will move back to the top of that broadening formation or even break through the top, but this in-between spot, in a broadening formation, does not appear a good spot for new positions.

During the pre-market period today, some market watchers pointed to former favorite CSCO's behavior as indicating renewed Nasdaq strength. Ahead of a Merrill Lynch conference this afternoon, this former tech darling closed yesterday at $20.24, its highest close since September, 2004. By mid-afternoon, the stock's price had shot above $21.00 and article titles gave CSCO credit as leading tech shares higher. Market watchers want to hear good news out of CSCO at that conference, and especially want to hear that the company is increasing its spending. Watch your stops if you're long this stock as some volume patterns indicate that some are selling into the rallies. If that supply dries up or is absorbed, CSCO could shoot higher, but if CSCO or Merrill Lynch says something disappointing and supply overwhelms demand, it could go down as fast as it rose. CSCO closed at $21.06, up $0.82 or 4.05 percent.

Annotated Daily Chart of the Nasdaq:

If the SOX has managed to break out of its bull flag and back above its last gap, then Nasdaq dips to and bounces from the 10-sma might be considered tentative buying opportunities, but with smaller positions than usual and with full awareness of the resistance soon to be faced. Many reasons exist to peg the recent climbs as suspicious, and the SOX's gappy climb remains one of those reasons.

CSCO wasn't alone in creating enthusiasm for tech-related stocks. Many SOX components played their part. ALTR gapped higher this morning and then ran up above $21.00, after closing yesterday at $20.04, but it wasn't the only SOX component to bounce. NSM also gapped higher, NVLS shoved past a gap on its daily chart, TXN saw an early and strong gain, and many other components bounced from their recent drubbings. INTC was more of a follower than a leader among the chip stocks, however, showing tepid gains as it also touched $21.00, but not able to hold onto its highs into the close. INTC closed at $20.80, up $0.20 or 0.97 percent. During the pre-market period, J.P. Morgan downgraded the company's 2006 earnings estimates and Stifel Nicolaus cut its price target for the company.

Annotated Daily Chart of the SOX:

The day's economic release calendar was full. The Mortgage Bankers Association released mortgage applications for the week ending February 24 at 7:00 EST. That report might have gained more interest after this week's disappointing numbers for new and existing home sales if market watchers hadn't been so focused on later data. The MBAA figures showed that the Market Composite Index decreased 1.2 percent from the previous week's figure on a seasonally adjusted basis and was 18.9 percent lower than the year-ago level. The Purchase Index decreased 1.9 percent, the Refinance Index climbed 0.1 percent, the Conventional Index decreased 1.4 percent, and the Government Index increased 1.5 percent. Four-week moving averages were down more than two percent for the Market, Purchase and Refinance Indices. Refinancings decreased as a percentage of total applications. The average interest rate for a 30-year fixed-rate mortgage fell to 6.18 percent and points decreased, too. A spot on CNBC later in the afternoon used the narrowing of the gap between rates for one-year ARMS and 30-year fixed-rate mortgages as an example of how real-life decision-making processes are affected by the inversion we're seeing lately.

Other early morning reports included January's Personal Income figures. Personal incomes rose 0.7 percent, but headlines warned that inflation cut into those gains in incomes. With consumer inflation increasing 0.5 percent and core inflation gaining 0.2 percent, real disposable incomes gained only 0.1 percent. Real consumer spending gained only 0.4 percent. Both gains proved the weakest in many months, although the headline number for consumer spending, a 0.9 percent gain, was the strongest since last summer. That resulted in a decline in savings.

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Print and television commentators were soon pondering the quandary facing the FOMC with this divergence in headline and core numbers and personal incomes and consumer spending. The FOMC typically relies on core numbers as representing the true state of inflationary pressures, but committee members can not forever ignore the probable eventual effect of continued high non-core trends. Those of us in the real world know that higher energy costs already factor into our day-to-day experiences. Jim touched on this subject in his Wrap last night, so I won't belabor the subject.

These reports and concerns about the performance of individual stocks such as Google (GOOG) and Pfizer Inc. (PFE) merely provided the background against which the ISM was to appear at 10:00. A study claiming that PFE's Celebrex painkiller almost doubles the risk of heart attacks pressured that stock in pre-market trading. It dropped in early trading, but bounced from the day's low and managed a close near the flat-line level, up $0.07 or 0.27 percent. GOOG printed a small-bodied candle, with a close only a few points above yesterday's, up $2.18 or 0.60 percent.

The ISM number came in higher than expected. The number had been forecast to rise to 55.6-55.8 percent from January's 54.8 percent. However, ISM was reported at 56.7 percent for February. New orders jumped to 61.9 percent, up from 58.0 percent the previous month, and employment climbed to 55.0 percent, up from 51.3 percent. The price index fell to 62.5 percent, down from 65 percent.

Construction spending was also reported at 10:00, and that number disappointed. Spending had been expected to increase 1.0-1.3 percent gain but instead showed an increase of only 0.2 percent. That was the smallest increase since June, the Commerce Department reported.

Equities had risen into the ISM and construction spending numbers, but dropped afterwards, climbing again into and beyond the release of crude inventories. American Petroleum Institute (API) figures showed crude inventories rising 2.5 million barrels while the Energy Department reported a rise of 1.6 million. The API claimed gasoline inventories rose 213,000 barrels, while the government announced a build of 300,000 barrels. The API's figure for distillates was a drop of 1.4 million barrels while the energy department reported a drop of 1.5 barrels. A drop in distillates had been expected after last week's chilly weather, and as refineries begin gearing up to produce motor gasoline in anticipation of increased demand in the summer months.

Crude costs proved somewhat volatile before and after the announcement. Although the drawdown in distillates was expected and the increase in crude inventories was higher than expected, some focused on demand and geopolitical developments ahead of next week's OPEC meeting. For a number of fifteen-minute periods before and after the announcements, candles showed long tails either direction with small candle bodies forming near $62.00, but crude eventually dipped to a low of $61.48 before bouncing to a new day's high and then retreating off that high again. At the Nymex close, the front-month crude contract was trading at $61.97, up from yesterday's close at $61.41. As this report was prepared, it was last at $62.20.

Car manufacturers released reports on last month's sales from late morning until early afternoon. Ford (F) announced that February's U.S. car and truck sales were down when compared to last year's sales, by 1.4 and 5.4 percent, respectively. Total U.S. sales declined 4 percent versus the year-ago levels. Land Rover sales increased 27.8 percent, but sales of other models fell.

DaimlerChrysler (DCX) sales increased 4 percent. Mercedes-Benz sales pulled the group higher, but Chrysler sales also increased. General Motors (GM) reported that sales declined 2.5 percent in February, a disappointment when market watchers had expected a 1.3 percent increase. DCX climbed, but both F and GM inched lower.

Tomorrow's economic reports include the 6:00 EST Monster Employment Index, the 7:30 EST Challenger Report, the 8:30 Jobless Claims and the 10:30 Natural Gas Storage numbers. During the day, we'll be seeing chain store sales and the semiconductor billings number will also be released, usually after the market close.

Companies reporting earnings include CATS, CAV, CIEN, CWEI, COST, CMOS, DLM, DT, MDS, NXST, NOVL, PBY, TLB, UVN, and RMIX, among others.

I can only repeat the mantra that I've been repeating for a while. The SPX, OEX and Dow are not going to fall too far as long as the TRAN is moving higher. The TRAN should have reached strong resistance week before last, but it continues to move higher, having broken out of a weekly envelope that had previously always held it since mid-1997. With an inverted yield curve, crude prices that should be causing problems and increasing geopolitical tensions, I remain skeptical of that breakout, but not skeptical enough to bet against it myself or advise others to do so. With the SOX having produced numerous gaps on the way to its January high, I'm suspicious of that index's climb, too, especially ahead of this week's book-to-bill number, but the SOX recently completed a successful test of its 50-sma, and it's attempting an upside breakout of a possible bull flag. The SOX was stopped at the top of its last big gap. Gap resistance held, a suspicious event, but the SOX still climbs.

Remain skeptical enough that you keep raising stops as appropriate if long, but don't assume that bearish positions are right until the markets give you proof. First steps toward that proof would consist of sharp pullbacks in the TRAN and the SOX. Instead, both attempt upside breakouts. Add the BKX and BIX to your radar screen, as it's possible that their strength is flagging, but there's been a phenomenon that Keene Little likens to bathtub sloshing in the markets lately. One index leads until it breaks through some significant level or formation. Then its strength flags, and then all the momentum seems to flow to another index or sector, and the same occurs. When each has broken above levels that some would consider significant, it is left alone to fend for itself for a while, while efforts are made to support another. It seems a juggling act of sorts, and perhaps it can continue perpetually, but be careful if the master juggler drops too many indices at once.
 


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

Ashland - ASH - close: 65.98 change: +0.71 stop: 64.75

A rebound in the markets today helped ASH bounce from the $65.00 level. Aggressive traders might want to consider bullish positions here. We are going to wait. We're suggesting a trigger to buy calls at $67.05. If triggered then we'll target a rally into the $72.00-72.50 range.

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/31/06 (confirmed)
Average Daily Volume = 689 thousand

---

Beazer Homes - BZH - close: 63.71 change: +0.26 stop: 62.65

As a group the homebuilders did not truly participate in the broad-based rally today. Shares of BZH are still hovering above technical support at their 200-dma. We are not suggesting new bullish positions at this time.

Picked on February 15 at $ 65.05
Change since picked: - 1.34
Earnings Date 01/19/06 (confirmed)
Average Daily Volume = 1.2 million

---

Cephalon - CEPH - close: 81.03 change: +1.55 stop: 74.99

CEPH traded to a new high today and today's 1.95% gain puts the stock within striking distance of our target. We're aiming for a move into the $82.00-82.50 range. More conservative traders may want to consider exiting for a profit right here.

Picked on February 23 at $ 76.65
Change since picked: + 4.38
Earnings Date 02/14/06 (confirmed)
Average Daily Volume = 2.5 million

---

Cigna - CI - close: 122.85 change: +0.10 stop: 119.90

CI's failure to bounce higher with the rest of the market today is not a good sign. Traders should be careful here. More conservative traders may want to consider using a tighter stop under $122.00. We will leave our stop loss at $119.90 for now. We're not suggesting new bullish positions at this time.

Picked on February 26 at $124.57
Change since picked: - 1.72
Earnings Date 02/08/06 (confirmed)
Average Daily Volume = 944 thousand

---

F5 Networks - FFIV - close: 67.92 chg: +0.12 stop: 63.85

We are a little surprised that the rally in the computer networking sector, driven by big gains in CSCO and JNPR, somehow managed to leave FFIV behind. We're not suggesting new bullish positions at this time. We plan to exit in the $69.95-70.00 range. More aggressive traders may want to aim higher say the $72.50-75.00 region.

Picked on February 26 at $ 67.16
Change since picked: + 0.72
Earnings Date 01/19/06 (confirmed)
Average Daily Volume = 1.0 million

---

Hartford Fin. Srv. - HIG - cls: 83.50 chg: +1.12 stop: 79.95

The bounce from $82 might be used as a new bullish entry point but be aware that HIG appears to have some resistance near $85-86 and its 50-dma now at 84.72. Our target is the $87.50 level.

Picked on February 14 at $ 82.12
Change since picked: + 1.38
Earnings Date 01/26/06 (confirmed)
Average Daily Volume = 1.1 million

---

MDC Holdings - MDC - close: 61.19 chg: -0.10 stop: 61.15

There is no change from our weekend update for MDC. The homebuilders continue to see profit taking and MDC is slipping toward the $60.00 level. We remain on the sidelines with MDC. Our plan is to catch the next leg higher with a trigger to buy calls at $65.05. If triggered we will target a rally into the $69.50-70.00 range.

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/18/06 (unconfirmed)
Average Daily Volume = 856 thousand

---

Altria Group - MO - close: 72.05 chg: +0.15 stop: 71.85

There is no change from our previous update on MO. We are still spectators at the moment. Currently our plan suggests readers buy calls on a breakout over $74.00 with a trigger at $74.10. However, we will be watching to see if MO bounces from technical support at its rising 200-dma currently near 71.00.

Picked on February xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 04/19/06 (unconfirmed)
Average Daily Volume = 8.1 million

---

Occidental Petrol. - OXY - cls: 92.64 chg: +1.10 stop: 85.95

Oil stocks managed to bounce with the rest of the market. The OIX index added 1.7% and the OSX oil services index added 1.9%. Shares of OXY rebounded with a 1.2% gain and look ready to push past the $94 level soon. Our target is the February highs in the $97.50-98.00 range.

Picked on February 21 at $ 92.00 *gap higher*
Change since picked: + 0.64
Earnings Date 05/09/06 (unconfirmed)
Average Daily Volume = 3.4 million

---

Potash - POT - close: 97.27 chg: +1.52 stop: 92.49 *new*

POT pushed past resistance at the $96.00 level again on strong, above average volume. The stock looks ready to make a run at our target in the $99.50-100.00 range. We are raising our stop loss to $92.49.

Picked on February 23 at $ 93.05
Change since picked: + 4.22
Earnings Date 04/29/06 (unconfirmed)
Average Daily Volume = 826 thousand

---

Prudential - PRU - close: 76.07 change: -0.97 stop: 74.59

Uh-oh! PRU displayed some relative weakness today and lost 1.2%. Watch for a bounce from the $75.00 level as a potential entry point but more conservative traders may want to wait for a new move over $77.00 before considering new calls. Our target is the $82.00-82.50 range. We do expect some resistance near $80.00.

Picked on February 24 at $ 77.10
Change since picked: - 1.03
Earnings Date 02/08/06 (confirmed)
Average Daily Volume = 1.9 million

---

Total - TOT - close: 126.94 change: +0.81 stop: 124.95

We expected TOT to bounce from support and it did today but the rebound was a little anemic. Influencing the rally in TOT was a downgrade from Goldman Sachs. Aggressive traders might want to consider new bullish positions here. More conservative types could wait for a move over the 100-dma (128.62) or still wait for a move over $130.00 and/or its 50-dma.

Picked on February 16 at $127.61
Change since picked: - 0.67
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 836 thousand
 

Put Updates

None
 

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.)

---

Building Materials - BMHC - cls: 67.35 chg: +0.05 stop: n/a

We see BMHC's relative weakness today as a positive sign but a bounce back to $70.00 would not be a surprise. We recently adjusted our target to breakeven at $8.20 but aggressive traders may want to aim higher. We are not suggesting new strangle positions. 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.

Picked on December 18 at $ 80.95
Change since picked: -13.60
Earnings Date 02/07/06 (confirmed)
Average Daily Volume = 527 thousand

---

Encana Corp. - ECA - close: 41.80 chg: +0.49 stop: n/a

We are not suggesting new strangle positions. Our strangle strategy involves the April $50 calls (ECA-DJ) and the April $40 puts (ECA-PH). Our estimated cost is $3.45. We are aiming for a rise to $5.95.

Picked on January 10 at $ 45.56
Change since picked: - 3.76
Earnings Date 02/15/06 (confirmed)
Average Daily Volume = 4.4 million

---

Loews Corp. - LTR - close: 93.99 change: +1.73 stop: n/a

Yesterday we suggested that LTR looked ready for an oversold bounce and today's market rebound was all the excuse LTR needed. We are not suggesting new strangle positions. Buying this strangle was a bet that LTR will be trading at more than $102 (above resistance) or less than $88 (under support) by March expiration. The options in our strangle are the March $100 calls (LTR-CT) and the March $90 puts (LTR-OR). Our estimated cost is $1.75.

Picked on February 13 at $ 95.72
Change since picked: - 1.73
Earnings Date 02/16/06 (confirmed)
Average Daily Volume = 513 thousand

---

Ryland Group - RYL - close: 69.70 change: -0.05 stop: n/a

We are not suggesting new strangle positions at this time. Our play involves the April $80 calls (RYL-DP) and the April $70 puts (RYL-PN). Our estimated cost is $7.00. Our target is $12.00.

Picked on January 22 at $ 75.19
Change since picked: - 4.50
Earnings Date 01/24/06 (confirmed)
Average Daily Volume = 1.1 million
 

Dropped Calls

Amer. Science. - ASEI - cls: 83.55 chg: +7.46 stop: 69.99

Target achieved. Wednesday was a big day for ASEI. The stock soared to new highs adding 9.8% on big volume. Driving the move was both news and analyst comments. This morning ASEI announced it had won a $45 million contract from a Middle East customs agency to install their X-ray detection systems at strategic borders, seaports and airports. Plus, before the opening bell two analyst firms reiterated their positive ratings on ASEI and raised their price targets into the $90s. Our short-term target on ASEI was the $79.75-80.00 range.

Picked on February 23 at $ 74.05
Change since picked: + 9.50
Earnings Date 02/08/06 (confirmed)
Average Daily Volume = 178 thousand

---

Tenaris S.A. - TS - cls: 167.25 chg: +7.10 stop: 153.45

Target achieved. TS was strong from the start this morning and shares pushed through resistance at the $165.00 level to hit new highs. The MACD has produced a new buy signal. Our target was the $164.00-165.00 range but we mentioned earlier that more aggressive traders may want to aim higher since a move over $165.00 would be seen as a new bullish breakout.

Picked on February 21 at $156.22
Change since picked: +11.03
Earnings Date 03/01/06 (unconfirmed)
Average Daily Volume = 516 thousand
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Technical Indicators: MACD, a Last 'Oscillator'

Not that the Moving Average Convergence Divergence Indicator, generally known by it's initials 'MACD' and pronounced 'macdee', is last in any sense except that this Trader's Corner is the last of a series of three (LINKS to the earlier two articles at bottom) articles devoted to the 'oscillator' type indicators. The prior dates are the Option Investor Daily e-mails of 2/15 & 2/22.

Each of my three articles, examines the use of oscillators in general (used to determine price momentum as well as suggesting when an Index or stock is 'overbought' or 'oversold'), as well as looking at how each of the 3 most common oscillators are constructed; i.e., their formula.

The other two are the Stochastics Indicator, which means almost always the 'slow' variation or 'Slow Stochastics', and the Relative Strength Index or RSI. [When you see the Stochastics indicator on a chart, it almost always is 'Slow Stochastics'; the name is important only when you have to chose one to put on a chart and there are multiple 'Stochastic' choices.]

Sorry for the boring repetition readers, but in a nutshell Oscillators like MACD, measure how fast is the rate of (price) change, or up/down MOMENTUM. Readings of the RSI and Stochastics 'oscillate' only between zero and (a maximum high) of 100, although neither the Slow Stochastics or Relative Strength Index (RSI) Indicators will ever reach these absolute maximums.

Extreme readings, ranging from below 20 to above 80 in the Stochastics model, or below 30 and above 70 in the RSI, are typically used in default settings in PC charting applications or on web sites that use these studies, to indicate an 'overbought' or 'oversold' condition in stocks and stock indexes.

The Moving Average Convergence Divergence Indicator or MACD for short is the third of the oscillator type technical indicators. This indicator measures overbought/oversold also, but its formula is not set to produce a number between 0 and 100. With MACD we need to look at how low or high this indicator has been relative to past weeks, months and years. The MACD was originally thought (by it's originator) to be especially useful on Weekly charts.
More on the MACD further on ...

But first, a brief update on the current market. And we're still more or less whipping back forth, but the Nasdaq Composite (COMP) has come on stronger this week as it rebounds to play catch up with the S&P, while the narrow blue chip Dow 30 (INDU) has fallen back.

A MIDWEEK TECHNICAL UPDATE:
The Dow has been leading the market up, but the question in my mind has been whether this was a "solitary walk of the Dow" as its sometimes been called. It's been unusual for the Dow 30 Industrials (INDU) to lead the market higher for any prolonged periods, especially in the last decade or so.

Sure enough INDU this week has corrected after its run up to a new high and a lower (up) swing high was established on the first rally attempt. If INDU holds the 11050 area of its early-Jan high, as it did today by the close, the Average is maintaining a 'minimally' bullish chart; prior resistance 'becoming' support.

However, to re-establish its prior upside momentum, the Dow would have to pierce its down trendline at around 11100, as seen on the HOURLY chart below.

The S&P 100 (OEX) presents a mixed picture. On one hand, the rally from early-Feb is bullish on balance until this last price dip when the chart picture suggests to bulls to be on alert to OEX building another top.

The Index has to close above 588-589 to gain some upside traction again. A dip below 580 suggests that we're again at the top of OEX's trading range. Stay tuned on that! Looks like a top on the HOURLY chart below, but sellers aren't pushing it.

Calls were good bought in low-570 area of course but an exit was warranted after multiple tops were seen at 586-587. I haven't been convinced to buy puts. There is just not enough bearish news coming out to push the S&P down for long it seems and only mixed bearish signals technically.

The Nasdaq Composite (COMP) managed to clear today its earlier highs around 2315. The January peak just over 2330 is not too far away and an uptrend is intact. COMP is still bullish in its technical pattern as long as the uptrend seen on the HOURLY chart below remains intact and is not pierced.

COMP support around 2285 is key. The prior high in the 2332 area is pivotal on the upside. A close or two above 2330 is needed to suggest a bullish breakout. Volumes look too low to accomplish this currently. Buyers arent that aggressive, just doing some nibbling type buying after how much some of the key Nas stocks fell from their recent peaks. Many of them were OVERBOUGHT!

The Nas 100 (NDX) rallies have been lackluster as can be seen by on the HOURLY chart below, but the primary technical consideration is that hourly lows have established a bullish UP trendline; an uptrend is defined not only as a series of higher highs, but a series of lower pullback lows as well. An index can always take out the prior peak sometime down the road. But if the pullbacks start going to lower lows its time to be in puts on rallies.

NDX has to clear 1720 then establish some support on pullbacks to this same area to suggest that the Index was in a position to challenge its early January top around 1760. I'm not looking for this anytime real soon.


BACK TO OSCILLATORS AND THE MACD:
I always try to emphasize that the concept of 'overbought' and 'oversold' that you see associated with Stochastics, RSI and MACD indicates a POTENTIAL vulnerability (to a reversal) only. A stock or an Index can stay oversold or overbought for a relatively long period in a strongly trending market.

It is also true that RAPID and STEEP advances or declines are usually not sustainable for a long period. The market will correct at some point after a steep rise or fall, but WHEN is an open question.

This point is important because there is a tendency to think that the first time or two that an oscillator reaches an extreme reading, whether using an hourly, daily or a longer-term weekly chart, it might be time to EXIT that stock or Index.

However, we see many instances where the trend takes prices significantly higher or lower before there is a correction. Moreover, a 'correction' may turn out to be a SIDEWAYS move ONLY or a lateral consolidation. And, which has been going on for weeks, broadly speaking, in the current market.

Oscillators 'work' best in terms of timing and buying dips in a downswing and selling rallies in an upswing in a trading range market of two-sided price swings, rather than one trending strongly in one direction.

THE MACH FORMULA AND USE:
The MACD indicator is calculated by taking the difference between two 'exponentially smoothed' moving averages of closing prices of 12 and 26-day duration; usually these are the only values ever used, although I would note that Gerald Appel, the market technician who formulated the MACD indicator, suggested that a slightly different set of values to be used as a sell 'signal'.

A 'purist' who relies heavily on this indicator might be concerned about using a variation for this purpose. I haven't yet seen evidence that constructing this slight variation and applying it in declining trends adds significant value.

The MACD line is the difference between the longer average (26) and the shorter (12). A moving average of 9 periods then is calculated of this differential (the result of the subtraction), which is called the "signal line", resulting in a faster moving MACD line. The exponential smoothing technique weights the most recent prices changes more heavily and is therefore quicker to track the latest price changes.

The signal line will be slower because it is a simple moving average of the last 9 values of the differential and is not weighted. There is usually a third line plotted, which is a "histogram" (these are the vertical bars) used to show the difference above and below a midpoint line of the difference between the MACD line and the signal line; this line is included in the 'standard' MACD indicator to better see the points where there is an upside (the bars go above the midpoint) or downside (bars are below the center or zero line) CROSSOVERS.

Most often I dispense with the histogram because it clutters up my charts when the size of the chart window is small - the zero line can be seen anyway.

The chart below is from my book (Essential Technical Analysis). What the chart is doesn't matter, nor price levels, only the Indicator explanatory notes and it's PATTERN for now:

The reason to INCLUDE the histogram is that those bars may present a clearer picture of when the difference of the two moving averages is at the widest and narrowest points however, often it is difficult to see these details given how much is shown on the MACD indicator, which often occupies a small section of a price chart.

Its common as you gain experience, to use indicators with minor modifications such as I describe, but this is an individual thing and relates to how much practice you have or the way in which you use the indicator for example if you use the MACD in order to generate a crossover buy or sell 'signal' only, then the narrowing or widening of the differential is less important.

As the inventor of MACD, Appel thought that the MACD was especially useful on WEEKLY charts. From the 'good old days', here's another chart and explanatory notes of the MACD Indicator.

The use made of MACD is similar to the crossover technique of other moving averages a buy indication or 'signal' is generated when the MACD line crosses above the slower signal line and a sell indication is suggested when the MACD line crosses below the signal line.

This 'crossover' use is similar to the trend-following usefulness of moving averages that define and track the dominant trend, either up or down. I suggest MACD use on either daily or weekly charts but tend to favor its use on longer-term weekly charts as a good measure of the momentum of the primary trend.

Once there is a weekly chart buy or sell crossover signal and I am not in the market in question yet or want to add to my position, I may take the first MACD crossover signal on the daily chart, that is in the same direction as the weekly signal.

The foregoing is a use of the MACD as a trend-following indictor, but we are focused here on its use as an OSCILLATOR and, as such, want to employ it for bullish strategies when the index or stock we are following is oversold and for bearish strategies when the MACD suggests an overbought condition and confirmation is seen in price and volume patterns.

The way this is done is to define "overbought" and "oversold" zones as ABOVE or BELOW the Zero line respectively. There are times when the two MACD lines are above or better, well above, the zero line and have crossover 'signals'. Conversely, there are times that the MACD lines have crossover sell signals below or well below the zero line. These are the crossover buy and sell indications that are the most like the Stochastics indicator.

CURRENT S&P 500 (SPX) WEEKLY CHART:
A couple of good buy and sell crossovers of the Weekly MACD is seen on the weekly S&P 500 chart below. Since mid to late 2004, the MACD hasn't shown SPX have been in a longer term oversold condition, absent a dip under the zero line.

There have been upside crossovers of the weekly MACD which may have reinforced major buy decisions. Some downside crossovers occurred also. 'Timing' options trades on weekly charts is not going to be of much practical use, so we need switch to a daily chart example.

CURRENT S&P 500 (SPX) DAILY CHART:
There were a few excellent buy/sell crossovers seen in the daily chart below. There was one sell side (or buy put) signal that was worthwhile. As with other oscillators, like Stochastics and RSI, the MACD is best used not as a 'mechanical' signal but as a reinforcing indicator to what is showing up in the chart pattern; e.g., trendline breaks.

You may note instances above relating to when the MACD did not accompany prices to a new high, or a new low and thereby warning of an upside or downside REVERSAL to come. Bullish or bearish divergences can be seen in the MACD at times; e.g., the bearish price/MACH divergence of late-July/early-August.

MY PRIOR TWO TRADER'S CORNER ARTICLES ON OSCILLATORS:
Two Wednesdays' back (2/15)I went into the Stochastics Indicator use and its calculation; this is viewable by clicking here.

Last Wednesday, I wrote on the Relative Strength Index or RSI, which has an added usefulness in highlighting the occasional bullish or bearish price/RSI divergence which is a frequent 'divergence' well correlated with trend reversals that may lie ahead. Last Wednesday's (2/22/06) article can be found in your e-mailed Option Investor Newsletter (OIN) of last week; or, can be viewed online at the OIN web site by clicking here.

** E-MAIL QUESTIONS/COMMENTS **
Please send any technical and Index-related questions for possible use in my next Trader's Corner article to support@optioninvestor.com with 'Leigh Stevens' in the Subject line.

** Good Trading Success! **
 

Today's Newsletter Notes: Market Wrap by Linda Piazza, Trader's Corner by Leigh Stevens, and all other plays and content by the Option Investor staff.

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