Option Investor

Daily Newsletter, Wednesday, 05/03/2006

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

Mixed Reviews

Tuesday ended with articles trumpeting the Dow's six-year closing high. Wednesday opened with articles proclaiming another multi-year high: a 25-year high in gold futures. A weaker dollar certainly contributes to higher prices in gold futures because it takes more of those weak dollars to buy the same amount of gold. The dollar had declined in the wake of the G7 meeting, although many of the finance ministers around the globe have spoken out, saying that the statement coming out of that meeting, perceived to be dollar negative, had been misunderstood.

In addition, higher crude prices contribute to inflation concerns, prompting a rise in gold. Heightened geopolitical concerns drive safe-haven investing in the commodity, too, which in turn prompts short covering. Perhaps helped by a moderate bounce in the dollar against some currencies, gold futures were to close at a nearly 26-year high, at $668.50 an ounce, after hitting an intraday high of $679.80. The day's action produced a long-legged doji, a signal of indecision as gold futures test these levels.

Investors faced a combination of higher commodity prices, nervousness ahead of Fed Chairman Bernanke's address today and economic releases, mixed Asian and European overnight performances, and some upbeat comments and outlooks from selected companies. That led to a mixed pre-market outlook on how U.S. equities might perform.


31 Closed Trades; 28 Winners

Jonas Ferris picks good companies whose insiders are buying, too. With this record, it's easy to see that tracking insiders works; now see how we make it easy.


The day ended with indices showing mixed performances, too, as investors sorted out the impact of stronger-than-expected economic releases, mixed earnings releases, and a drop in crude that also sent oil-related indices such as the XOI and OIX lower. Most sectors eased today, although the transports and semiconductors were notable exceptions and the RUT ended higher by $0.12.

Decliners led advancers on the NYSE, AMEX and Nasdaq. Jim Brown has been pointing to some areas of concern in the new highs/new lows figures when considering the health of the long-in-the-tooth rally, but today the number of new 52-week highs held relatively steady when compared to yesterday while the number of new lows rose slightly. The evidence was mixed, as it was to be on many fronts on Wednesday.

Other analysts are beginning to mention such concerns about breadth measures, too. In a Marketwatch.com article, Marc Pado of Cantor Fitzgerald remarked that momentum and money flow oscillators were not confirming gains. If bulls might be nervous, scorched bears must be more so, however, because so far no sign of an impending pullback, no matter how reliable in the past, has proven reliable now. Even today's malaise was greeted by tepid bounces that moved indices off their lows and proved that bears still can't produce any follow-through even if the bounces weren't conclusively bullish.

Annotated Daily Chart of the Wilshire 5000:

Annotated Daily Chart of the SPX

Annotated Daily Chart of the Dow

Annotated Daily Chart of the Nasdaq

Annotated Daily Chart of the SOX

The earliest economic report of the day was issued by the Mortgage Bankers Association, the MBAA. That report came on a day when other surveys are showing that home inventories in the Midwest are reaching record levels in what one analyst still prefers to call a correction rather than a slowdown. That MBAA survey showed mortgage application volume recovering, rising 8.8 percent in the week ending April 28. Other components also jumped, but four-week moving averages still suffer from the previous nine weeks of declining volume and dropped. The refinance share of activity fell to 35.2 percent of all applications, with this percentage at an almost two-year low, likely due to the increase to 6.57 percent in the interest rates for 30-year fixed-rate mortgages.

The DJUSHB, the Dow Jones Home Construction Index has been testing the weekly 100/130-ema's, currently at 821.64 and 775.86. The index last tested these averages in early 2003, but hasn't produced a weekly close beneath them as long as QCharts carries the data. While testing these averages, the index also approaches the April 2005 low of 781.17, with yesterday's low at 784.02 and today's close at 797.84. Market bulls of any stripe want to see the interest-rate sensitive DJUSHB hold those support levels on weekly closes. So far, the pullback can be characterized as a pullback to long-term support, but too much lower and it will look like something more bearish.

Next in the day's economic releases came April ISM services and March factor orders. ISM services rose to 63.0 percent versus 60 percent in March, handily beating the consensus expectation of 59.6 percent. New orders rose to 64.6 percent versus March's 59.5 percent. Inventories rose, too, however, to 59.0 percent versus March's 54.0 percent. The price index jumped to 70.5 percent from the previous 60.5 percent, indicating an increase in inflation pressures. That, obviously, is unwelcome news when markets still appear sensitive to rate-hike jitters. The ISM services number isn't considered as predictive of GDP growth as is the ISM factory number, but today's release certainly corroborated the growth predicted by the factory number released earlier in the week.

March's factory orders also rose more than expected, by 4.2 percent against an expected 3.7 percent. That was pegged as the largest gain in almost a year, sending orders for the first three months of the year higher by 9.6 percent when compared to the year-ago level. February's factory orders were revised higher, up 0.4 percent versus the previous 0.2 percent, so the increase was rendered even stronger. Shipments and inventories both rose, by 0.8 and 0.7 percent, respectively, keeping the inventory-to-shipments ratio at a steady and low 1.17. Durable goods orders, an important component, rose 6.5 percent. Nondurable goods rose 1.5 percent, and capital equipment orders gained 3.9 percent. The numbers predict strong production in the next months and confirm high growth in the U.S. factory sector, also not entirely welcome news ahead of next week's FOMC meeting.

Bonds reacted immediately, losing ground, as yields popped higher. The yield on the ten-year, already flirting with recent highs, shot to a new four-year high of 5.17 percent, closing at 5.14 percent. Bernanke wasn't destined to provide clarification, no matter how jittery markets might have been before his midday talk. He wasn't slated to address interest-rate concerns when speaking at the Anacostia Economic Summit, and no question-and-answer session was included. My forex news source usually reports in depth on any FOMC committee members who speak and it was still silent mid-afternoon on the subject of Bernanke.

Ahead of the release of crude inventories, ExxonMobil's chairman and chief executive Rex Tillerson accepted an invitation to speak on the Today show. He's a brave man, considering that politicians and reporters have been in a tar-and-feather mood concerning the oil majors lately. Jim Brown has reported lately on the thinner margins that these companies have when compared to some others and the massive expenses they face, so I won't belabor that point.

While speaking on the Today show, Tillerson denied any price manipulation among oil majors. He commented that although the company had reported windfall profits, the government had also already collected windfall taxes from those profits. He noted the company's responsibility to protect shareholder interest, and noted that many pension plans, teacher retirement plans and individual investors depended on the company's performance.

According to CNBC, forecasts predicted declines of 400,000 barrels in crude inventories, 200,000 barrels in gasoline and 600,000 barrels in distillates. Figures from other sources differed, with the forecast drop in crude supplies smaller from some analysts. Instead, gasoline inventories surprised to the upside, building for the first time in nine weeks. Those inventories rose 2.1 million barrels, according to the Energy Department, but that build still kept gasoline inventories 4.8 percent below their level a year ago. Crude inventories also rose, by 1.7 million barrels, but distillates fell a greater-than-expected 1.1 million barrels. Refinery utilization inched up to 88.78 percent.

The American Petroleum Institute's numbers pinned the rise in crude inventories at 2 million barrels and gasoline inventories at 4 million barrels. The API said distillates fell 1.3 million barrels.

Crude for June delivery had been slipping toward the 15-minute 100-ema (all sessions) ahead of these reports, off yesterday's $74.99 intraday high, and it fell through those averages after the report, erasing some of the built-up premium due to the Iran standoff. Industry watchers were already commenting that the build in inventories might be temporary and might even be partially attributed to refineries' tendencies to rid themselves of their supply of winter-grade gasoline.

The crisis meeting precipitated by Bolivia's decision yesterday to nationalize its oil and natural-gas businesses was to include presidents from that country, Brazil and Venezuela, and had the possibility of adding back some of that premium, but crude futures' attempts to climb were met by resistance at those same 15-minute 100/130-ema's that had previously served as support. Brazil and Spain have invested heavily in Bolivia, and Bolivia also supplies half of the natural gas consumed in Brazil.

The TRAN had zoomed above 4700 again late yesterday and had continued its climb early Wednesday morning, but it was to show some volatility through the day. Rising crude costs and valuation concerns led Morgan Stanley to trim its rating on TRAN component FedEx Corp. (FDX) to an equal-weight one and to cut its estimates of fourth-quarter earnings. Airlines were reporting April air traffic and load factors, and were showing mixed performances, including those that are components of the TRAN. Late in the day, however, the TRAN, with the bounce at least partially led by a FDX bounce, zoomed up just above that previous intraday high, only to face immediate selling.

Earnings from insurer Cigna Corp. (CI) showed falling revenue and net income. However, revenue of $4.11 billion appeared in line with expectations of $4.1 billion, and adjusted earnings from operations of $2.11 a share appeared to beat expectations of $1.89 a share. CI weighed on the healthcare sector, however, dropping steeply and closing at $90.00, near the low of the day, far below the $118.52 close just six trading days ago. Bausch and Lomb (BOL) weakness also weighed down the sector. Reports of new infections among those using BOL's products hit the company's stock and sent it to a new 52-week low.

Clorox's (CLX) third-quarter report was deemed disappointing, and it gapped lower. Time Warner's (TWX) reported earnings that rose 59 percent, but that gain was helped by asset sales while revenue missed estimates, falling 7.8 percent. AOL and film sales declined. A media analyst blamed the decline partially on tough comparisons. Revenue had been expected to be $10.89 billion and came in at $10.46 billion. Earnings, however, were $0.26 a share when certain charges and discontinued operations were excluded, with expectations for $0.20 a share.

Proctor & Gamble (PG) raised the midpoint of its full-year outlook by $0.02, with the new range $2.61-2.63, prompted to do so by better-than-expected third-quarter results. However, the midpoint is now in line with previous analysts expectations of $2.62 a share, and investors didn't appear happy with that "raising" of guidance, with the stock's price gapping lower. PG closed at $56.22, well off the low of the day, but far below yesterday's $58.11 close and the 200-sma at $57.32. The company reported third-quarter income of $0.63 a share against expectations of $0.61 a share. Sales of $17.25 billion appeared to be shy of the expected $17.6 billion, according to one source, but another headlined the company's report by saying that it showed strong sales and EPS growth.

Qwest Communications (Q) reported earnings of $0.05 a share on revenue of $3.48 billion, with expectations at $0.01 a share on revenue of $3.49 billion. The company said the improvements over the previous quarter's results were produced by strong sales in high-speed Internet, advanced data, long distance and wireless sections. Q closed lower today but essentially chopped between nearest support and nearest resistance.

After last night's earnings report, CIBC cut its rating for Adobe Systems, Inc. (ADBE) to sector perform, down from its previous sector outperform. Although the firm still had good things to say about ADBE, it felt that a slowing in demand could impact results for late in the summer. ADBE lost 8.57 percent. J.P. Morgan raised its rating on specialty chemicals company Mosaic (MOS), liking what it saw in the group's handling of its phosphate unit. The new rating is an overweight one, up from the former neutral rating. The company's stock gained 4.09 percent. Banc of America raised Motorola (MOT) to a buy rating while leaving its price target for the company unchanged, with MOT gaining 3.05 percent today.

In a market-impacting development, Microsoft (MSFT) produced another new 52-week closing low, closing down 3.49 percent. The beleaguered stock dropped after reports that it might take a stake in Yahoo (YHOO). In a day that was characterized by mixed evidence, it wasn't surprising to find that the MSFT effect was somewhat countered by a positive reaction to Qualcomm's (QCOM)'s raising of its outlook for the third quarter's EPS. QCOM gained 1.35 percent.

Many of the companies who disappointed or were downgraded today plunged in the morning, but had bounced strongly off their lows by the end of the day. While a change from earlier in the year, when even a disappointing report might be greeted with a buy-the-fact response, sellers are punishing companies that disappoint them. Bears shouldn't become too fearless just yet, however, because dip-buyers clearly still snap up such bargains after prices have been pushed sharply lower. I consider this reaction one that should have bulls perking up their ears, watching for the signs of the matadors, but not clearly bearish as yet.

Thursday's reports include initial claims and preliminary first-quarter productivity at 8:30 and natural-gas inventories at 10:30. Companies reporting earnings will include ATVI, AU, BRL, CTIC, CWEI, CNO, CVS, EK, RDEN, GMST, GLBL, GT, ITWO, ICOS, KMG, LCUT, MCK, OLGC, TSG, SU, SFY, TYC, UBS, UVN, VPHM, and OATS, among others. More important will be Friday's reports, and tomorrow could be more about positioning ahead of those reports than about what happens tomorrow.

Although indices showed mixed performances, market-leading indices, the TRAN, RUT, and SOX all gained, although the RUT's gain was far from encouraging and the SOX still churns inside its triangle. The TRAN verges on a new breakout, however. As the day closed today, the TRAN struggled with Keltner and historical resistance. I truly don't understand its unrelenting climb in the face of higher crude costs, but that triangle looks like a bullish right triangle at the top of a climb and I'm not going to argue with my dollars as long as the TRAN still climbs.

For early tomorrow morning, the TRAN's 30- and 60-minute nested Keltner charts look as if the TRAN is more likely to pull back slightly than it is to climb, but the 15-minute chart suggests that it hit short-term support at the end of the day. The SPX looks more likely to pull back, perhaps only to 1307, but perhaps to 1301-1303.70. The DOW's outlook is mixed, with the Dow looking about as likely to go on challenging resistance at 11,412 as it is to dip to 11,389 or perhaps even 11,381. The Nasdaq's Keltner support just keeps sliding lower, and the Nasdaq had just hit resistance at 2306 on 15-minute closes at the end of the day, looking as if it might be time for it to ease at least toward 2302.

As should be apparent, even the shortest term views give no consensus about what might happen next, or at least give mixed outlook for various indices. So far, as this report is prepared, after-hours developments, including ERTS miss and subsequent decline, do not seem to be strongly impacting futures. The daily chart shows the Nasdaq poised on long-term support, so as long as the SOX and RUT gain, any tests of the 100-sma at 2291 might occasion tentative dip-buying. I certainly wouldn't count on that dip buying if the SOX and RUT turn tail and dive tomorrow, however. If you're participating in that dip-buying, keep stops tight, and anything other than a quickly reversed dip below the Nasdaq's 100-sma should worry bulls.

As long as the TRAN is gaining, and particularly if it breaks to a new high again and sustains it, any Dow dips to the 10-sma might occasion dip-buying, too. If you're participating in that activity, keep positions light and stops tight. The same is true of SPX dips to the 30-sma, with those perhaps occasioning dip-buying as long as the TRAN continues to gain. If the TRAN drives lower after the late-day test of the previous record high, I wouldn't participate in any dip-buying.

Here's my real impression. Other than the TRAN, resistance is looking as important as support lately, and investors are beginning to react more negatively when they're not pleased with earnings or developments. Many indices are at the top of rising regression channels, and it may be time for indices to drop back toward stronger support at the bottom of those channels again, even if indices are to remain strong and continue climbing within those channels. The Wilshire 5000's behavior since November after consolidations such as the recent one are in keeping with the possibility of a dip toward support. Keep those bullish stops tight, but be aware that bears don't yet have any evidence that they're on the right side, other than in short-term plays.

New Plays

New Option Plays

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

New Calls

Red Hat - RHAT - close: 30.82 chg: +1.05 stop: 28.81

Company Description:
Red Hat, the world's leading open source and Linux provider, is headquartered in Raleigh, NC with satellite offices spanning the globe. The most trusted name in open source, CIOs and other senior-level IT executives have ranked Red Hat as the industry's most valued vendor for two consecutive years in the CIO Insight MagazineVendor Value study. Red Hat is leading Linux and open source solutions into the mainstream by making high quality, low cost technology accessible. Red Hat provides operating system software along with middleware, applications and management solutions. Red Hat also offers support, training and consulting services to its customers worldwide and through top-tier partnerships. (source: company press release or website)

Why We Like It:
We do not have a very bullish market bias at the moment but there is no denying RHAT's relative strength today. The stock has been consolidating under resistance at the $31.00 level with a multi-week pattern of higher lows as it bounces along technical support at the 100-dma. Shares look poised to breakout over resistance and we want to be ready to catch the breakout. We are going to suggest a trigger at $31.11, which would be a new five-year high. A breakout to a new high could spark some short covering. The latest data puts short interest at more than 10% of RHAT's 168-million share float. If triggered our target will be the $34.75-35.00 range.

Suggested Options:
We are suggesting the June calls. We prefer the $30's.

BUY CALL JUN 30.00 RCV-FF open interest=23352 current ask $2.20
BUY CALL JUN 35.00 RCV-FG open interest= 2902 current ask $0.40

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 06/27/06 (unconfirmed)
Average Daily Volume = 3.4 million

New Puts

None today.

New Strangles

None today.

Play Updates

In Play Updates and Reviews

Call Updates

Apple Computer - AAPL - close: 71.14 chg: -0.48 stop: 68.45

AAPL continues to consolidate under resistance at the $72.00 level. We do not see any changes from our previous updates. Our strategy is using a trigger to buy calls at $72.25. If triggered then we'll target a rally into the $77.45-80.00 range.

Picked on April xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/19/06 (unconfirmed)
Average Daily Volume = 36.0 million


Progressive - PGR - close: 106.56 chg: -0.59 stop: 103.95

Friday is our last day for this play. We plan to exit on Friday near the closing bell to avoid holding over the earnings report on Monday. More conservative traders may want to exit early (tomorrow) on any bounce higher.

Picked on April 23 at $106.46
Change since picked: + 0.10
Earnings Date 05/08/06 (unconfirmed)
Average Daily Volume = 846 thousand

Put Updates

Affiliated Mangers - AMG - cls: 96.89 chg: -1.49 stop: 102.55

We expected AMG's oversold bounce to near the $100 level but shares displayed new relative weakness today and lost 1.5% on above average volume. We do see two obstacles for the bears. The simple 100-dma, currently at 93.93, and the $95.00 level might offer some support. Conservative traders may want to exit near the 100-dma. We would expect a bounce near $95. Our target is the $92.00-90.00 range.

Picked on May 01 at $ 97.45
Change since picked: - 0.56
Earnings Date 04/26/06 (confirmed)
Average Daily Volume = 637 thousand


Amazon.com - AMZN - close: 33.96 chg: -0.42 stop: 36.51

AMZN posted another loss today but shares pared their losses with an intraday rebound off its lows. Today marks the fourth decline in a row and it may be time for an oversold bounce. Watch for the $35.00 level to offer short-term overhead resistance. Our target is the $31.00-30.75 range.

Picked on May 01 at $ 34.85
Change since picked: - 0.89
Earnings Date 07/25/06 (unconfirmed)
Average Daily Volume = 6.3 million


Atheros Comm. - ATHR - close: 25.65 chg: +0.13 stop: 26.51

The semiconductor sector was one of the best performing sectors today yet there was barely any follow through in shares of ATHR. The stock remains under short-term resistance at $26.00. However, we're still urging caution. Yesterday's bullish reversal puts the shorts in danger! We're not suggesting new plays.

Picked on May 01 at $ 23.77
Change since picked: + 1.88
Earnings Date 04/24/06 (confirmed)
Average Daily Volume = 1.6 million


Research In Motion - RIMM - cls: 74.93 chg: +0.49 stop: 79.01

RIMM is still bouncing after Monday's sell-off. Watch for the failed rally under $77.00 as the next bearish entry point to buy puts. Our target is the $71.00-70.00 range but more aggressive traders may want to aim lower.

Picked on April 30 at $ 76.63
Change since picked: - 1.70
Earnings Date 07/06/06 (unconfirmed)
Average Daily Volume = 5.8 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.)


Fedex - FDX - close: 114.18 chg: -1.90 stop: n/a

Transports in general trekked higher today on a 3% pull back in oil prices but not so for FDX. Before the opening bell FDX was downgraded to an "equal weight" and the stock gapped lower. Bulls defended the stock near technical support at its rising 50-dma. Our suggested entry zone to open strangle positions was the $114.50-115.50 range. We were suggesting the June $120 calls and the June $110 puts. This is a bet that FDX will trade significantly north of $120 or under $110 by June option expiration. Our estimated cost is about $2.60.

Picked on April 30 at $115.13
Change since picked: - 0.95
Earnings Date 06/21/06 (unconfirmed)
Average Daily Volume = 1.4 million

Dropped Calls

Rackable Systems - RACK - close: 48.60 chg: +0.55 stop: 47.39

Continued weakness in the tech sectors helped push RACK toward the late April lows. The stock broke down under the $48.00 level and hit our stop loss at $47.39. Traders might want to consider bearish positions if the stock closes under the simple 50-dma.

Picked on April 30 at $ 51.39
Change since picked: - 3.34
Earnings Date 04/27/06 (confirmed)
Average Daily Volume = 825 thousand

Dropped Puts

Whole Foods - WFMI - close: 62.15 chg: +0.51 stop: 64.01

Time is up. It was our plan to exit this afternoon near the closing bell to avoid holding over WFMI's earnings report out after hours tonight. The company beat earnings estimates by a penny. The stock is trading higher after hours around $65.00 a share.

Picked on April 23 at $ 63.91
Change since picked: - 1.76
Earnings Date 05/03/06 (confirmed)
Average Daily Volume = 1.8 million


XM Satellite Radio - XMSR - cls: 17.51 chg: -0.94 stop: 20.55

Target achieved. XMSR continues to sell-off. The stock dipped to $16.85 and closed with a 5% loss on very strong volume today. Our target was the $17.55-17.45 range.

Picked on May 01 at $ 19.65
Change since picked: - 2.14
Earnings Date 04/27/06 (confirmed)
Average Daily Volume = 7.9 million

Dropped Strangles


Trader's Corner

Wedge Patterns

I got a SUBSCRIBER E-MAIL asking me to explain what a bearish 'rising wedge' pattern is. This came up due to my musings in my most recent (4/30) Index Trader column to the effect that chart pattern of the S&P 500 (SPX) looked a lot or a bit like such a 'wedge' formation.

There was another question I received as to whether the S&P 100 (OEX) had or was forming a bullish inverted or reverse Head & Shoulder's pattern. I'll answer this one first after the following note about my most recent Index Trader column.

My other column: my INDEX TRADER articles:
This Wednesday Trader's Corner article also serves as an adjunct to my weekend 'Index Trader' column, an online (only) section at the Option Investor.com web site; bookmark or add to 'favorites' at this LINK.

In my Trader's Corner article I typically also do a brief technical midweek update to my weekend Index Trader. Especially so when I can demonstrate the technical/trader tools discussed here.

You will normally also see a web LINK to the Index Trader at the top of your weekend Option Investor Daily e-mail but was NOT the case for my most recent article of Sunday (4/30). This column can be seen by going to our web site using the above LINK when connected to the Internet.

S&P 100 (OEX) DAILY CHART: A possible (bullish) Inverted Head & Shoulder's pattern?

What is outlined below on the daily OEX chart does look EXACTLY like a reverse or 'inverted' Head & Shoulder's (H&S) bottom formation. The Head & Shoulder's is most often seen as a topping pattern where the middle 'Head' is ABOVE the neckline.

The Head & Shoulder bottom formation is the reverse or mirror image of the H&S Top: there is a minor rally and sideways trend (the left shoulder), a decline to a new low and enough of a sideway move after that to suggest an INVERTED or upside down 'head'. This is in turn followed by another rally and a sideways trend that forms the right shoulder. The highs made on the left and right shoulders forms a straight line even if it slopes up a bit and this is the 'neckline'.

A decisive upside penetration of the neckline leads to a further advance that, at a minimum typically, is equal to the distance from the tip of the head to the 'neckline' which, if it happens, would give an upside target to 615.

All well and good EXCEPT that a reverse/inverted Head & Shoulder's suggests a bottoming pattern after a decline of some duration. NOT a pattern that forms after an uptrend going on since the October low of last year. Some technical analysts will say definitely that 'without a prior downtrend to reverse, there cannot be a head and shoulders bottom formation.'

However, me I'm struck sometimes by possible unconventional interpretations. It's remotely possible that this pattern shown on the chart above will turn out to meaningful as a way to measure a possible 'minimum' upside objective for OEX, assuming that the Index breaks out above the 598 level of the current neckline.

Summing up: the inverted Head and Shoulder's pattern is not usually seen as part of bullish 'consolidation' pattern, prior to another (upside) break out in the direction of a long standing up trend.

The following historical chart (the date at the top was when I ran it last year, the period shown was well before that date) is presented. The lower dashed downward sloping (cyan) line connects the lows of the Left and Right shoulders of the H&S top pattern and is considered to be the 'neckline'.

The distance from the tip of the Head to the neckline in the Q's chart below is distance 'a'. That same distance measured from the pierced neckline down is noted as 'b'; hey, the classic 'a = b'!

Wedge patterns are usually 'reversal' type patterns, suggesting that the existing trend is susceptible to a trend reversal. One such pattern, while not seen all that often, but which tends to be predictive for a bottom or top is the rising or falling 'wedge' pattern.

The wedge pattern of a "rising" bearish type is usually seen after an uptrend has been underway for some months, whether in a stock or an Index. [Sometimes, not as often, a wedge formation will suggest a potential trend reversal even before the emerging trend has gone on very long, such as just a few weeks.]


In a rising wedge, prices move gradually higher but form converging trendlines and a "narrowing in" pattern of higher highs and lower lows, such as seen in the TWO opposite wedge pattern shown below; the first, that of a rising wedge, as seen in the daily Dow 30 (INDU) chart back in mid-2004.

I don't remember seeing a back to back example like this in an Index, where a rising wedge was followed by an opposite bullish 'falling wedge':

The upward sloping or bearish wedge is normally bearish in its implications for future price action. There is a "measuring" rule of thumb for a price objective also; in the case of the bearish rising wedge seen above, prices should decline to the start of the formation, or at least to the lowest prior low. This is only a 'minimum' downside objective.

The wedge pattern should have at least 2-3 upswing highs and downswing lows that comprise the points through which the trendlines are drawn the more points than this minimum number the better, in terms of drawing two well-defined converging lines.

What is being suggested in the rising, bearish wedge is that buying is being met with stronger and stronger selling as prices edge higher. When prices fall below the lower up trendline that of a rising wedge pattern, a trend reversal is suggested prices may rebound to the trendline again, but will typically not get back above it.

A possible bearish rising wedge pattern, suggesting a top?

Well, the pattern in the S&P 500 (SPX) chart looks a lot like a bearish rising wedge. This is speculation unless or until the lower rising trendline is pierced at its current intersection at 1294.

If this were to happen the outlined pattern below, interpreted as a bearish rising wedge, would have given advance warning technically of a significant top with an ultimate downside objective at least back to the 1255 area. Stay tuned on that!

I should also note that technically for the SPX index as seen above, the intermediate trend would not be considered to have reversed until and unless the prior 1286 low Close was exceeded.

There was another example of a bearish falling wedge pattern setting the stage for an upside reversal, in the QQQQ chart for the early part of the year I used in an article a couple of years back. The implied 'measuring' implications of the wedge, as back to the start of the (falling) wedge formation, was just fulfilled:

Please send any technical and Index-related questions for answer in Trader's Corner articles 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