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Daily Newsletter, Wednesday, 05/17/2006

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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

Take a Breath

Most indices violated short-term consolidation patterns established just this week, plunging to heart-stopping levels while the VIX, the CBOE Market Volatility Index, soared up to levels not seen since last October. Many retail traders must have been holding their breath. Bulls dumped positions, leading to trading curbs being established on the NYSE. Dismal breadth indicators coupled with strong volume looked scary. It's time to take a breath and assess the damage.

Clearly some damage was done, but matters had looked much more positive heading into the trading day. Early beneficial influences on the market consisted of positive reactions to Hewlett-Packard's (HPQ) earnings and supposedly also to Applied Materials' (AMAT) earnings, strong performances on Asian bourses and hope for tame CPI inflation data. In addition, some chart characteristics suggested that it was time for a bounce attempt. Some concern was expressed over rising commodity prices, including crude, a sinking dollar, and European bourses that struggled to hold onto gains.

However, an hour before the cash markets opened, economists were proven wrong in their predictions for tame inflation data, with both the core and headline Consumer Price Index numbers stronger than expected. That data transformed that number into an early negative influence on the markets from which the markets never recovered. The reaction sent futures into retests of lows hit in overnight trading Sunday night, and those lows ultimately would not hold. Bonds declined and yields bounced. Interest-rate-sensitive financials were to take a hit when the cash markets opened. They led indices lower.

The end-of-day news reports deplored the Dow's more-than-200-point drop, the worst decline since March 2003; the Nasdaq's erasing of 2006 gains; and the SPX's four-month low. Taking that deep breath, let's also take a longer-term look at the SPX, as seen on its weekly chart.

Annotated Weekly Chart of the SPX

The bounce potential for tomorrow would have looked stronger if the SPX had bounced more from today's low. Strong volume on a decline coupled with a strong bounce off an intraday low often indicates that big-money people are using the decline to accumulate positions. Momentum can still carry prices much lower than most of the rest of us would want to follow, but that accumulation can be important to spot when it occurs. However, the bounce wasn't conclusive enough, and intraday nested Keltner channels show that the SPX ended the day without improving its outlook Keltner-wise. All day, it had closed 15-minute periods below a diving-lower line currently at 1274.36 on 15-minute closes. It needs to close above that line and then retest it before bulls will have much confidence. Still, the support being tested suggests a bounce or steadying attempt might not be impossible.

Annotated Daily Chart of the Dow

Before the bell but after the CPI number, techs were expected to hold up better than other sectors, but fear of tomorrow's Dell earnings and semi book-to-bill numbers helped to create some nasty chart characteristics on the Nasdaq.

Annotated Daily Chart of the Nasdaq

According to almost any measure, the selling on the Nasdaq's stocks has been overdone. Candlestick theory uses a measure that counts the number of record days, or days with a lower low than the previous day, and that theory would suggest that a steadying or oversold bounce should be in the works soon, but it doesn't promise it tomorrow. The Nasdaq's bounce off its low was minimal, even though the Nasdaq was testing important 2190-ish support, and that doesn't look good. Like other indices, the Nasdaq hadn't managed to create a hint of a bounce in the works on intraday nested Keltner channels, either, by the close, with the Nasdaq closing each 15-minute period below a diving-lower Keltner line at 2213.55. These lines are dynamic and so will shift up and down a little as prices do, but the Nasdaq bulls' first task will be to close a 15-minute period above that line and then successfully retest it. That daily chart gives absolutely no hint of a bounce or steadying in the making, but I wouldn't be surprised to see it, with opex activities providing the wildcard.

One index that did show an attempt to steady today was the SOX, with the SOX's intraday nested Keltner support beginning to show tentative signs of firming. The SOX needs to close a 15-minute period above the line at 489.14, however, before it even begins to change its tenor.

Annotated Daily Chart of the SOX:

After the NAHB/Wells Fargo Housing Market Index fell to 45, an 11-year low, and below the 50 boom-or-bust benchmark, in May, industry watchers wanted to see what the Mortgage Bankers Association would have to say about mortgage applications when it released the numbers. The NAHB's chief economist was still talking about an "orderly cooling-down process" when he was quoted in a Reuters article earlier in the week. Unfortunately, the MBAA's site did not post information on last week's data. The DJUSHB, the Dow Jones U.S. Home Construction Index, continued its cascading fall today, but the CPI data offered plenty of reasons for that interest-rate sensitive index to dive without mortgage application volume contributions.

April's CPI rose 0.6 percent, with the core rate gaining 0.3 percent, with both numbers higher than anticipated. CPI numbers had been expected to rise 0.5 and 0.2 percent, respectively. A 3.9 percent rise in energy costs led to the higher headline number, and a 0.3 percent rise in shelter costs contributed to the rising core number. Other cost increases included a 2.4 percent rise in transportation costs, with a 1.6 percent increase in airline fares. Over the last 12 months, CPI has risen 3.5 percent, and the core number has climbed 2.3 percent, with both numbers representing slight increases over the 3.4 and 2.1 percent figures from March. Most interpret the core inflation rate as now being at the top of the Fed's comfort zone.

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These numbers were not cheerful ones to the market watchers hoping for a pause at the next FOMC meeting, and futures immediately dove, with the ES contract diving more than ten points within a 15-minute period after the release. Before the morning was over, Fed fund futures were predicting a more than 50 percent chance of a rate hike at the next FOMC meeting. If memory serves correctly, one week ago, just before the FOMC decision was handed down, Fed fun futures had predicted only a 36 percent chance at the next meeting, but that rose immediately when the statement was released and rose further today. Although the ten-year's yield closed well off its 5.19 percent intraday high, closing at 5.15 percent, it did bounce, and so did the thirty-year, closing at 5.27 percent. None exceeded the recent highs on their intraday bounces, however.

With sensitivity both to interest rates and to economic expectations, the TRAN dove more than a hundred points today, dropping through March and April's resistance level, all the way to its 50-sma, where it steadied. When the TRAN hit 5000 on FOMC day, this writer wondered if that level would finally be the electric fence for the TRAN, and it appears that it was. The TRAN has violated its important 30-sma, but steadied just under its even more important weekly 10-sma, currently at 4683.50. Since that average is a weekly one, it will be important to see whether the TRAN bounces from it or falls below at the week's close. The TRAN closed at 4670.97, not helped by crude's decline.

As Jim Brown mentioned in last night's Wrap, expectations for crude inventories varied, with some industry analysts having expected a build in gasoline inventories of 2.1 million barrels. The Energy Department said that crude inventories dropped 100,000 barrels, gasoline supplies rose 1.3 million barrels and distillates dropped 100,000 barrels.

Between those forecasts and the inventories release had come a lowered demand forecast from OPEC. Early Wednesday, OPEC lowered its forecast for growth in global demand. In North America, OPEX expects growth in demand to decline by 200,000 barrels a day. In China, growth is expected to rise by 500,000 barrels a day, however.

In another release, the American Petroleum Institute announced that U.S. gasoline deliveries declined 1.9 percent in April. That decline suggests that demand also decreased, with consumers likely cutting back on driving as prices moved higher. The API report also noted that April's petroleum deliveries dropped 1.5 percent from the year-ago level. While lower demand and so possible lower prices might seem to be market friendly, many worried that rising crude costs will hamper economic growth as consumers face higher prices and marshal their outing and other spending patterns.

Refinery utilization also dropped, to 87.7 percent, down from the 92.6 percent levels of last April. As those reading Jim Brown's Wraps will likely recall, the International Energy Agency had already, as of last week, trimmed its own estimates for global demand growth to 1.25 million barrels a day from the previous 1.47 million barrels.

With gasoline supplies not rising as much as some had hoped but with demand also forecast to drop, the classic supply versus demand battle was engaged. Throw in expiration concerns, and the opportunity was set for volatility in crude prices. QCharts shows a close of $68.69, well off both the day's high and day's low.

In another economic development, Treasury Secretary Snow presented testimony to the House Financial Services Committee. A portion of his testimony was reserved for dealing with China's part in "addressing global imbalances." He avowed that China's exchange rate policies remain too rigid and that the country needs to make other economic reforms related to balanced growth and financial sector modernization. China's growth is too reliant on external demand, for example.

Snow didn't stop with China. He also said that the International Monetary Fund needed to do a better job of watching over exchange rate policies, as well as reforming its own policies and governances. He wants growth in emerging economies to be better represented. Snow wants a limited ad-hoc increase for the members most under-represented, but said that he would support it only if fundamental reforms would follow.

The U.S. has to do its part in addressing global imbalances, too, he asserted. Snow claims that fiscal 2006's deficit will "come in well below the estimate of $423 billion." He believes the U.S. remains on track to cut the deficit by a half by 2009, a goal proposed by the Bush administration while some still doubt its achievability.

Treasury Secretary Snow also addressed trade issues, mentioning the Doha round of trade negotiations that had begun in 2001. He believes that the negotiations may have reached an impasse and that the European Union bears the burden of moving the negotiations forward again. Negotiations over agricultural issues have proven particularly prickly.

Altogether, the day stunned some into breath-holding episodes. HPQ helped keep the Dow's losses from being deeper than they were, with the company reporting earnings yesterday. AMAT's earnings report, viewed positively by some during the pre-market period, didn't please those analysts concerned about the company's outlook and decelerating bookings. The stock fell 5 percent in today's trading. Other corporate developments included an appeals court decision to order a new trial for Philip Morris, a unit of Altria Group (MO). A jury had awarded the estate of Michelle Schwarz $150 million in punitive damages, but a Multnomah County Circuit judge decided the award was excessive and reduced it to $100 million. The appeals court ordered the judge to reinstate the full amount.

After-hours developments don't give a strong sense of direction for tomorrow. Intuit announced declining profits, although the company blamed options expensing and tax rates. Napster said sales rose more than 50 percent and that its loss had narrowed. Retailer Hot Topic posted a loss..

Economic reports for tomorrow include initial claims for the week ending May 13, reported at 8:30; April's Leading Indicators, reported at 10:00: natural-gas inventories at 10:30, and May's Philly Fed number, reported at noon. Most expect a 12.5 reading for the Philly Fed, down from the previous 13.2 reading. Later in the day, the semi book-to-bill number will be released.

Earnings for tomorrow include ARO, BKS, BRCD, CLE, CPWM, DELL's after-the-market report, GPS, LTD, MRVL, SHLD, and PLCE, with many of those reporting companies being retailers.

Throw in tomorrow's after-hours Dell report, the semi book-to-bill report, option expiration and the recent stunning declines, and many walking wounded may be stumbling around tomorrow, undecided. It's probably best to move into a sell-the-rally mode, but the extent of the decline urge bears to protect profits by aggressively moving stops lower and bulls to show some patience or else deep pockets if guessing at bottoms.

While charts don't suggest rally quite yet, that possibility exists and the possibility for a steadying certainly does. As you have been advised many Wednesday's now, watch the TRAN for guidance on the SPX, OEX and Dow, and the SOX and RUT for guidance on the Nasdaq.

Early in the Wrap, I mentioned that the VIX had soared up to levels not seen since last October. Perhaps you remember what happened last October: on October 13, the VIX hit an intraday high of 17.19 and the SPX hit an intraday low of 1168.20, and then the SPX churned around for a few more days and began climbing. It usually doesn't work that cleanly, and I'm certainly not suggesting that it will this time, either. The VIX did not pull back from today's intraday high the way it did on October 13, but the VIX did hit 240-minute Keltner resistance at 15.96. Another chart suggests a possible upside of 18.28 for the VIX as long as it maintains daily closes above 14.93, so the evidence is mixed. Taken together, however, this evidence suggests that a bounce or steadying could be possible, too, with option expiration throwing in a major wild card for the VIX. Bears, protect those profits. Bulls, either have deep pockets or very small positions, and be willing to be wrong. Momentum is currently to the downside.

Don't hold onto a losing position, particularly if it's a losing bullish one. Another and more dire possibility is a further cascading fall. Conservative traders might stay out of the markets entirely with opex shenanigans, Dell's earnings and the semi book-to-bill number all potentially playing havoc with the markets.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
NoneCBGNone
 NUE 

New Calls

None today.
 

New Puts

CB Richard Ellis - CBG - cls: 77.93 chg: -4.90 stop: 82.71

Company Description:
CB Richard Ellis Group, Inc., a FORTUNE 1000 company headquartered in Los Angeles, is the world's largest commercial real estate services firm (in terms of 2005 revenue). With approximately 14,500 employees, the Company serves real estate owners, investors and occupiers through more than 200 offices worldwide (excluding affiliate and partner offices). CB Richard Ellis offers strategic advice and execution for property sales and leasing; corporate services; property, facilities and project management; mortgage banking; investment management; appraisal and valuation; and research and consulting. Founded in 1906, CB Richard Ellis marks a century of excellence in real estate services this year. (source: company press release or website)

Why We Like It:
The recent sell-off in stocks has really seen the profit taking targeted at the high-flyers from the first and second quarters. CBG is one such high-flying equity and now the stock appears to be seeing a correction. The company reported a strong earnings report in early May but shares of CBG failed to react to the news. Since then volume has been growing on the down days, which smells like distribution. One positive note about the stock is the upcoming 3-for-1 stock split due on June 2nd. We'd prefer to exit ahead of the stock split but if not any option positions should triple in quantity but see the value cut to one-third post-split. Today's session is a new breakdown below the $80.00 level and technical support at its 50-dma. Volume was more than double the daily average. The P&F chart points to a $68.00 target. Our target is the rising 100-dma, currently at 72.89. Since the 100-dma is a moving target we're going to use 73.25-72.75 as our exit range. Please note that we are very cautiously suggesting new bearish positions. Our concern here is after several down days in the market today's session might be a short-term capitulation and the major indices could surprise us and rebound sharply tomorrow. More conservative traders may want to wait for a decline under $77.50 before opening plays.

Suggested Options:
We are suggesting the June puts.

BUY PUT JUN 80.00 CBG-RP open interest= 368 current ask $5.10
BUY PUT JUN 75.00 CBG-RO open interest= 210 current ask $2.70

Picked on May 17 at $ 77.93
Change since picked: + 0.00
Earnings Date 05/02/06 (confirmed)
Average Daily Volume = 613 thousand

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Nucor - NUE - close: 105.40 chg: -5.61 stop: 112.81

Company Description:
Nucor and affiliates are manufacturers of steel products, with operating facilities in seventeen states. Products produced are: carbon and alloy steel - in bars, beams, sheet and plate; steel joists and joist girders; steel deck; cold finished steel; steel fasteners; metal building systems; and light gauge steel framing. Nucor is the nation's largest recycler. (source: company press release or website)

Why We Like It:
The high-flying steel and metal stocks have also been targeted for profit taking. Shares of NUE were already showing signs of trouble with several days of failed rallies near the $120 level. Recently the stock has been sliding on rising volume (distribution) and now shares have broken under support at the 50-dma. Volume on today's session was very strong. The P&F chart has produced a new sell signal that points to a $90 target. We are going to aim for the $95.50-95.00 range. Please note this is a HIGH-risk play. We are using a wide stop loss due to today's volatile session. Plus, we are concerned that while the major market indices look bearish they're also oversold and due for a bounce. You don't have to chase NUE here. Look for a bounce back into the $107-110 region and then open put positions on a failed rally. We would prefer to exit ahead of the 2-for-1 slit on June 1st merely because stocks tend to lose their volatility after a split.

Suggested Options:
We are suggesting the June or July puts.

BUY PUT JUN 110.00 NUE-RB open interest=1602 current ask $7.80
BUY PUT JUN 105.00 NUE-RA open interest=6697 current ask $5.10
BUY PUT JUN 100.00 NUE-RT open interest=1174 current ask $3.10

or

BUY PUT JUL 105.00 NUE-SA open interest=1096 current ask $7.50
BUY PUT JUL 100.00 NUE-ST open interest=1257 current ask $5.30

Picked on May 17 at $105.40
Change since picked: + 0.00
Earnings Date 07/20/06 (unconfirmed)
Average Daily Volume = 2.5 million
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Cigna - CI - close: 93.19 change: -1.33 stop: 91.99

Normally healthcare-related stocks tend to be seen as defensive and that may have insulated shares of CI from today's sell-off. Of course there has been so much selling in CI lately that those investors who were going to sell probably have already but that's not to suggest that CI can't go any lower. The stock did lose 1.4% but overall shares still look poised to bounce. The MACD indicator even produced a new buy signal today. We would hesitate to open new call positions with the major averages looking so bearish so we'd wait for signs of a bounce first. Be advised that we do expect some resistance at the $100.00 mark so we're setting our target at $99.75-100.00. More aggressive traders may want to aim higher since the $105 level looks like more serious resistance and the P&F chart points to a $108 target.

Picked on May 16 at $ 94.52
Change since picked: - 1.33
Earnings Date 08/02/06 (unconfirmed)
Average Daily Volume = 1.4 million

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Getty Images - GYI - cls: 64.57 chg: -0.38 stop: 62.49

GYI held on pretty well today considering the market sell-off. Those stocks hit hardest were the high-flyers. Shares of GYI have already been beat up so most of the bad news has already been priced in. We are going to suggest a trigger at $65.21, which is above Tuesday's high (65.15). If triggered then we'll target a rally into the $69.50-70.00 range. We're worried that the $70.00 level and the descending 50-dma, currently at 70.29, will act as overhead resistance. It is imperative that you use a stop loss. GYI has produced these bottoming formations before only to have the nascent rally get squashed, usually under the 50-dma.

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/20/06 (unconfirmed)
Average Daily Volume = 997 thousand

---

Omnicom - OMC - close: 91.54 chg: -0.38 stop: 89.99

We are still amazed by OMC's relative strength. Given its recent gains we thought for sure it would be a target of profit taking on a day like today. Shares traded mostly sideways all session under the $92.00 level. We are still urging caution. The MACD on the daily chart has produced a new sell signal. Odds are growing that OMC will dip toward the $90.00 level. We're not suggesting new positions. Our target is the $97.50-98.00 range. The P&F chart is very bullish with a $110 target.

Picked on May 15 at $ 92.05
Change since picked: - 0.51
Earnings Date 07/25/06 (unconfirmed)
Average Daily Volume = 1.1 million
 

Put Updates

Amazon.com - AMZN - close: 31.61 chg: -1.15 stop: 34.85*new*

The INX Internet index lost 1.75% and broke down under technical support at its simple and exponential 200-dma(s), which is a bearish development. Contributing to the index's weakness was AMZN, which lost 3.5% to close near its lows of the session. We're going to lower our stop loss to breakeven at $34.85. More conservative traders may want to consider a stop closer to $34.00 or consider taking profits right here. Our target is the $31.00-30.75 range.

Picked on May 01 at $ 34.85
Change since picked: - 3.24
Earnings Date 07/25/06 (unconfirmed)
Average Daily Volume = 6.3 million

---

Apollo Group - APOL - close: 51.97 chg: -0.72 stop: 55.05

Our bearish play in APOL is now open. Shares broke down under support at the $52.00 level and hit our trigger to buy puts at $51.75. Technically this is a breakdown under the neckline of its bearish head-and-shoulders pattern but there did not seem to be a lot of follow through selling. Our stop loss is at $55.05 but more conservative traders might want to consider one closer to $53.50. Our target is the $47.75-47.50 range.

Picked on May 17 at $ 51.75
Change since picked: + 0.22
Earnings Date 06/22/06 (unconfirmed)
Average Daily Volume = 2.1 million

---

Franklin Res. - BEN - close: 87.69 chg: -1.30 close: 92.55

Investment-related stocks were big losers today with the XBD index losing 2.9%. Shares of BEN did better than some of its peers with a 1.46% decline. It looks like the bounce from its lows this afternoon was struggling with the $88.00 level so we're looking for some more weakness tomorrow assuming the major averages don't bounce too high. Volume continues to come in above average, which is bearish. Our target is the $85.00-84.50 range.

Picked on May 14 at $ 89.30
Change since picked: - 1.61
Earnings Date 07/27/06 (unconfirmed)
Average Daily Volume = 1.1 million

---

IDEXX Labs - IDXX - close: 77.15 chg: -0.67 stop: 79.51

We have been very cautious on IDXX the last couple of days given the bullish reversal but today's market crash helped stall the rebound. Shares remain under short-term resistance at its 10-dma. We're still not comfortable suggesting new put positions here. More conservative traders may want to exit early right now or significantly tighten their stops.

Picked on May 11 at $ 77.93
Change since picked: - 0.78
Earnings Date 04/28/06 (confirmed)
Average Daily Volume = 125 thousand
 

Strangle Updatess

(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: 109.92 chg: -5.51 stop: n/a

The high-flying transport stocks got crushed today. The DJ Transportation index lost 2.65%. Leading the way was FDX, which fell 4.77% and is testing support near $110 and its simple 100-dma. Volume on today's sell-off was nearing three times the daily average. We are not suggesting strangle positions at this time. The options involved in our strangle are 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 was about $2.60. We would exit if the puts rose to $4.55 or higher. More aggressive traders may want to aim higher since the puts are currently trading in the $4.10/4.20 range.

Picked on April 30 at $115.13
Change since picked: - 5.81
Earnings Date 06/21/06 (unconfirmed)
Average Daily Volume = 1.4 million
 

Dropped Calls

Autoliv - ALV - close: 54.70 change: -2.00 stop: 54.99

ALV's recent bullish reversal was no match for a market-wide sell-off. The stock plunged through potential support at the 50-dma and the $55.00 level. We would have been stopped out at $54.99. Nimble traders may now want to consider bearish positions given today's breakdown! Look for support near the 100-dma and again near $50.00. We offer kudos to any traders who exited at our conservative target near $60.00 several days ago.

Picked on May 04 at $ 57.53
Change since picked: - 2.83
Earnings Date 04/27/06 (confirmed)
Average Daily Volume = 513 thousand
 

Dropped Puts

Merrill Lynch - MER - close: 70.49 chg: -2.21 stop: 75.55

Target achieved. MER lead the brokers lower with a high-volume 3% decline. Volume came in about twice the daily average. Shares hit $69.85 before bouncing. Our target was the $70.50-70.00 range.

Picked on May 11 at $ 74.00
Change since picked: - 3.51
Earnings Date 07/18/06 (unconfirmed)
Average Daily Volume = 4.7 million

---

USG Corp. - USG - close: 91.97 chg: -0.78 stop: 100.01

Target achieved. It was another volatile day for USG. Shares dipped to $90.45 before bouncing back to challenge the $95.00 level and then fail again. Currently shares are resting on technical support at its 100-dma. Our target was the $92.00-90.00 range.

Picked on May 15 at $ 99.75
Change since picked: - 7.78
Earnings Date 07/25/06 (unconfirmed)
Average Daily Volume = 888 thousand
 

Dropped Strangles

None
 


Trader's Corner

'Solitary Walk of the Dow' and Other Technical Updates

I got this OIN SUBSCRIBER E-MAIL with a question on follow up regarding updating downside technical objectives and where possible support may be found on the major indices. This was in regards to my predictive comments made in my weekend 'Index Trader' Column. I usually don't just do a midweek chart update in this column, rather look at latest price action relative to the technical principle(s)I'm talking about in my Trader's Corner column. However, given the spine tingling action of seeming market free fall, I will look at my charts and update while weaving in whatever technical aspects might be of telling interest, including a web link reference to any Trader's Corner past columns that might also pertain to the subject.

"Would yu update any trendlines or envelopes, whatever might suggest where a temporary or final bottom might come in the market? You talked about 11120 in the Dow being an area where you would take profits on DJX puts. Still think so?"

Since this references my most recent Index Trader article, which most of you know is a section ONLY seen on the Option Investor.com web site, my Saturday (5/13) article can be seen online by clicking here.

I've written recently, especially in this last article referenced above about what tends to happen when there is a 'solitary walk of the Dow'. This is when the Dow is going up like gangbusters but the rest of the blue chips and the broader NYSE market, as reflected in the S&P indexes, is lagging or underperforming.

What drives this? It's usually in times like this, where there's an uncertain outlook for the economy and stocks. This might be in situations like now where inflationary or anticipated inflationary pressures are also present; and the Fed is raising interest rates to ward off the inflation bogeyman.

In times like this, there may be a tendency for the general public to not be huge market participants; unlike, say in 1999-2000. That period was definitely NOT a Dow (INDU) led rally. In times like now where public participation in the market tends to be more through their contributions to mutual funds, who tends to be in the market driver's seat so to speak, are the professional fund managers. A mostly trend following and sometimes timid lot due to the fear they will UNDER-perform the major averages.

Since the big cap 30 Dow stock performance gets a lot of press and investor attention (not always deserved!) AND can absorb a lot of buying from the behemoth funds, most investment attention gets focused in this small selection of stocks which is the Dow Average (and not capitalization-weighted even). There are other factors too of course, since these companies' earnings tend to hold up better in uncertain periods, plus many pay some return in the form of dividends.

Anyway, the Dow becomes the 'engine' driving the market higher. However, strength in INDU tends to also pull up the S&P 500 (SPX) and 100 (OEX) and the tech heavy Nasdaq Composite (COMP) and 100 (NDX) more than they would otherwise advance. Fund managers tend to have to FOLLOW the indexes. If they are going up, they will put more money to work there also, especially in SPX. They are graded on and their jobs can fall on, their relative quarterly performance/underperformance to the S&P.

The whole dynamic then collapses if a few Dow stocks get hit by heavy selling, as portfolio managers shift money out of stocks that have had big gains; when their PE's get to way over-inflated levels. Major market rallies that are led pretty much solely by the Dow tend to end in sharp corrections.

I don't think however, that the market is going to go into free fall for a lengthy period, although the Nasdaq looks like it is. There is not the rampant speculation and hyper-bullishness that sets the stage for this kind of situation.

However the market often adjusts ALL AT ONCE. Many casual market observers wonder why the market will go up, or hold up, for many weeks or months, and then give back all those gains in a few days. Mostly, this is reflected in the fact that money is committed to the market gradually and piece meal. As the market continues to advance, more and more accumulation goes on.

If ExxonMobil (XOM) keeps advancing on balance month after month week, there might be 10-15 buys of the stock by a fund manager until they're are weighted or over-weighted as much as they want to or can be in energy.

However, if oil prices start to break, demand falls, windfall profits taxes get considered, etc., a manager might decide to go from over-weighted to in-line or even under-weighted overnight. This adjustment can lead to huge selling and tends to be more of a 1-time or few days event. Selling of 3-5-10 stocks in the Dow 30 can set off an avalanche of selling when the market gets overextended, overbought, whatever you care to call it.

Other fund managers tend to then follow along in the selling and it can even reach a slightly panic stage. Why are you selling? Because everyone else is! Well they always have many seemingly well-informed reasons they will give you...if you think I don't have an especially high opinion of most money managers, you would be right.

Now for some chart talks and updates. First and foremost of course is the daily chart of the Dow Industrial Average, symbol INDU, as seen below. It was no accident that the Dow reached the top of its uptrend channel and reversed there. This is common technical action, only the reasons change; basically the market has a certain amount of upside momentum based on current perceptions of fundamentals and that's it. Technical analysis can show the 'that's it' price area.

Remember the opposite, high or low end of a price channel only requires one or a few points from just one period in order to construct the opposite parallel line. If in an uptrend, there's an uptrend line connecting 2-3 or more lows. A line connecting the most number of lows is an 'internal' up trendline and may cut through one or more intraday lows in the case of a daily chart.

We take the up trendline with the best 'definition' and the implied UPPER end of its price CHANNEL is a line parallel to the up trendline that touches the highest high for the period you want to examine. That's how the upper channel line was constructed in the chart below. More on constructing trend channels is found on a Trader's Corner devoted to this subject reached by a link at the bottom of this column.

Drawing a line parallel from the November peak in SPX did NOT define the area of its recent high. Since INDU was LEADING the market that is the way it worked here. A general rule of thumb is to focus on analysis of the index that is leading the market. Sometimes its the Nasdaq, sometimes the S&P, etc. Anyway, my downside target was to the LOW end of the uptrend channel or back to the area of the up trendline.

Today's INDU low is also in the area of the lower envelope line set at 1.5% (under the 21-day moving average). However, given the expansion of the price swings to a more 'normal' or more common volatility and because of the principle we can call 'as above, so below', a 2.5% envelope line is also constructed, intersecting around 11100 and which also is the area of the prior 11073 low Close. If a high was 2.5 ABOVE the 21-day average, the next low may represent the same percentage value UNDER the average. More on the ins and outs of using moving average envelopes is seen at the LINK to a prior Trader's Corner article also seen at bottom.

Getting back to the Subscriber question, the most I am looking for on the downside in INDU is to the 11100 area before a countertrend rally sets up. I think the market could begin at least a short term rebound tomorrow (Thursday), perhaps carrying back up to the 11300 area.

There are a couple of scenarios that I focus on with the INDU chart above. Today's low is basically it on the decline and the Dow holds support implied by its up trendline. OR, there is a further decline, maybe after a short rally first, that will carry under today's lows made today. The 'logical' target is for a re-test of the prior intraday and/or closing lows made last month in the 11050-10773 area. I try not to get too carried away with 'logic' when analyzing the market.

The S&P 500 (SPX):
Here, in the chart below, my trading envelope lines or 'bands' are set to the usual 3% that I work with in the Dow and the S&P. The pattern here is that of a possible return or further fall at some point, to the low end of its multi-month trading range. This suggests that SPX could get back to the 1245-1255 area.

Again, this would be the 'logical' place for SPX to wind up given the substantial downside penetration of its up trendline. And, unlike INDU, SPX is now fully oversold on a daily chart basis. (Not so yet on its weekly chart). The S&P 100 or OEX (not shown) could ultimately reach 569-570, although near term it has support in the 578-579 area.

The NASDAQ COMPOSITE (COMP):

I noted before regarding the COMP WEEKLY chart pattern shown below, which suggested a possible bearish rising 'wedge' pattern, especially since the Index was stalled at the upper line of the triangular shaped wedge. A long-term trend reversal is 'confirmed' so to speak, with a weekly close BELOW 2215. Stay tuned on that. The week is not over, but today's close was 2195!

COMP DAILY CHART:
When you go to look at the area, in terms of the lower (21-day) moving average envelope lines, we usually see at least a rally attempt develop after COMP declines to a value that represents a value between 3 and 4% (4% is common historically) as seen in the Daily chart below.

COMP fell under this today and had a weak close technically, as it was also at the intraday low. However, as with the Dow, it would not be surprising to see a short-term rally set up by tomorrow (Thursday) and buying interest develop around the area of the prior intraday low at 2190.

NASDAQ 100 (NDX):

When the Nas 100 gets cranking on the downside and has one of these sharp breaks, prices can easily carry down to a 5% or more envelope from what has been it's more common 3% of the last few months at least.

I have long had a target of or thought that major support was down in the 1600 area and today's low may be at least a short-term low. If you got puts from higher levels, take the money and run; nice trade, thank you very much market, don't get greedy or unrealistic. This is not 1999-2000.


PRIOR TRADER'S CORNER ARTICLE REFERENCES:

More on Internal trendlines and constructing trend channels here:

More on Wedge patterns here:

More on Moving Average Envelopes here:

** E-MAIL QUESTIONS/COMMENTS **
Please send any technical and Index-related questions for answer in Trader's Corner articles to Click here to email Leigh Stevenssupport@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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