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Daily Newsletter, Monday, 07/03/2006

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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

New Concerns or the Right Time for Profit Taking?

As July 4th fireworks exploded across the U.S. Tuesday night, North Korea test-fired at least six missiles early on their Wednesday morning. A seventh was fired this morning. Those missiles included a long-range Taepodong-2 missile.

All missiles fell harmlessly into the Sea of Japan, with the U.S. claiming that the Taepodong-2 missile failed. Some expect further tests in the next days. The U.S. government termed the tests a provocation, Tokyo cautioned that the U.N. could impose economic sanctions on North Korea and the U.N. Security Council set an emergency meeting. NATO warned that the tests could threaten the region's and even the globe's stability. Russia noted its deep concern.

Many blamed the firing of the missiles for a pullback in equity indices across the globe, but it may have been time for some profit-taking, too. Others blamed this morning's release of the ADP index on payrolls for weakness in U.S. equities, with that index a possible harbinger of a strong jobs number on Friday. That group also assigned some of the blame to the later release of May's stronger-than-expected factory orders. However, futures were already lower by the time that ADP number was released and equities had headed lower before the factory orders, too, since that occurred after the cash open. Futures had displayed a tendency to dip on any bad news. The geopolitical and inflation concerns certainly weighed on markets, with crude rising to a new high of $75.40 and closing at $75.19, but investors were also ready to pull back and determine where support would hold.

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Despite several reports that disappointed Monday--an ISM index, a report on construction spending and a Wal-Mart Stores (WMT) forecast--indices had rallied on the light-volume, holiday-shortened session. In this climate in which each report is scrutinized for its dovish or hawkish connotations, some traders on Monday may have speculated that the headline ISM number would allow the FOMC to take a less aggressive stance on raising interest rates. Bond traders might not have been convinced, however. Bonds dropped and yields bounced. Although Monday's bounce remained tepid, yields were already building on Monday's gain before equities opened this morning. Since there was no Wrap on Monday, I also wanted to note that a 2.3 percent gain in Alcoa (AA) also helped the Dow on Monday, with a J.P. Morgan analyst speculating that the company might be a takeover target.

This has been the first Wrap to report on Monday's ISM, so a paragraph on that number seems appropriate. The Institute for Supply Management's June index fell to 53.8, below the prior 54.4 and much lower than the predicted 54.4-55.0. The number remained above the boom-or-bust 50 benchmark. The prices-paid component dropped less than forecast, however. In addition, the Commerce Department reported that May's spending on construction projects fell 0.4 percent, its biggest drop in almost two years. Economists had predicted that construction spending would rise by 0.2 percent.

If Monday's economic reports had encouraged equity traders to ignore what they saw going on with bonds, today's wouldn't allow that dovish outlook to continue any longer. Bonds and equities dropped while bond yields climbed. It's time to see how much damage, if any, was done on equity indices, starting with the SPX.

Annotated Daily Chart of the SPX:

Since last Wednesday afternoon, the SPX had bounced from each approach to the five-minute 100/130-ema's, with those averages serving as good bullish/bearish benchmarks for short-term traders in the last ten days or so. They may no longer be such good benchmarks, however, as the day's actions zig-zagged prices across them. On that five-minute chart, the SPX may be forming a H&S with the shoulder level represented by those averages. Such zig-zagging across support and resistance is sometimes indicative of chop that will narrow into a smaller range, but that potential regular H&S on the five-minute chart argues otherwise.

Note that fulfilling a regular H&S on the five-minute chart is completely in keeping with that potential inverse one on the daily chart. Chop is expected when a right shoulder is formed, and dropping down to the daily 200-sma and perhaps a little below, fulfilling a target for a regular H&S on the five-minute chart, is in keeping with the formation of the daily chart's right shoulder.

Also note that while it's important to watch these formations, it's equally as important these days to discount any eventual target predicted by such a formation. They're just not reliable any longer, their predictability distorted by the fact that these are such well-known formations and can be used now to trap bulls or bears by those with the deep pockets to do so. I do still find it helpful, however, to notice when a right shoulder is extending too far to the side without confirming, as that's often a fairly good predictor that the formation will not be confirmed. That hasn't happened yet.

The Dow also forms a potential inverse H&S, not so long after confirming a regular one and dropping. It did not quite meet its downside target on that one, at least so far, illustrating my point about not counting on targets being hit. Now it's back above the neckline of that formation confirmed in early June.

AAnnotated Daily Chart of the Dow:

Leading into today's action, the Dow had shown the same bullish/bearish benchmark pattern with respect to its five-minute 100/130-ema's as had the SPX. Today, the Dow also chopped through those averages, also perhaps forming a H&S with the shoulder level at those averages. It's just chop now, spoiling the benchmark status of those averages.br>
AAnnotated Daily Chart of the Nasdaq:

The three-minute versions of the 100/130-ema's had looked like a better short-term bullish/bearish benchmark for the Nasdaq than did their five-minute counterparts, but today it was the five-minute versions that rolled the Nasdaq's afternoon bounce down again. Those averages were at 2159 and 2159.67 at the close. br>
Techs were hurt by several developments. Marvell Technology (MRVL) received a letter of informal inquiry from the SEC. A grand jury also subpoenaed documents related to its stock option grant practices. The SOX component closed lower by 7.87 percent today, but did close off its low. Chip giant and SOX component Intel also weighed on the index, dropping after UBS cut its EPS estimate for the stock. INTC closed lower by 3.15 percent. UBS also cut Advanced Micro Device's (AMD) price target from its previous $33 to $29. AMD closed lower by 2.84 percent.

The SOX's weekly chart shows some troubling tendencies, but the important weekly 200-sma has held up as support so far. It looks likely to be retested soon, however.

AAnnotated Daily of the SOX:

On all the charts displayed so far, I see prices tentatively perched above support, with equity traders being jittery and liable to send indices one way or another. An index poised just below a new breakout status is the TRAN, however.

AAnnotated Weekly Chart of the TRAN:

Although today's reports were of the type often ignored, they weren't ignored today. Some, however, were postponed. At 7:00 on Wednesday's, the Mortgage Bankers Association usually releases its weekly mortgage application volume survey for the previous week, but that information was not available this morning. The release was perhaps postponed a day due to yesterday's holiday. Investors focused on inflation concerns proposed by the two other releases. The first was the ADP index. br>
Macroeconomic Advisers uses anonymous payroll data to calculate the ADP index. June's index showed an increase of about 368,000 private-sector nonfarm payrolls. That figure may worry some looking forward to Friday's jobs figures, although Jim Brown pointed out some wide variations in predictions about Friday's number in last weekend's Wrap. The ADP and Labor Department figures don't always exactly coincide, although both surveys are conducted the same week and use similar techniques and the ADP supposedly has a strong correlation with the other number. Macroeconomic Advisers surveys more businesses than does the Labor Department, but its intention is to mirror the government's survey.

After the cash markets opened, the Commerce Department released May's factory orders. Economists had predicted a 0.1 percent rise in those orders, but they surprised by rising 0.7 percent instead. Core capital goods rose 0.5 percent, and ex-trans orders climbed 1.2 percent. Factory inventories were flat but shipments of core capital goods fell 0.3 percent while remaining 7.6 percent higher than the year-ago level. The shipment numbers is sometimes used as a proxy for GDP capital expenditures, my forex news source notes.

Non-durable orders increased by 1.6 percent, with that component prompting that surprise number. Durable goods had been expected to drop 0.3 percent, but they dropped only 0.2 percent. Delving deeper into the durables category showed that orders for primary metals rose 4.6 percent; construction materials, 1.2 percent; and new machinery, 2.5 percent. IT orders dropped 3 percent, however, with orders for PCs and related electronics dropping 2.5 percent, and that outcome might also have hurt the beleaguered techs today.

Keep in mind, however, that the surprising jump in factory orders is now compared to a revised-lower April number, with April's number revised to a 2.0 percent drop, down from the previous 1.8 percent. Treasuries didn't give much credence to the comparison to a revised-lower April number, however. They reacted to the strength shown in May's number and the hawkishness of that number, by dropping further, sending yields higher.

Another release, Redbook Research's indicator of national retail sales, did not quite meet expectations, however. Those sales rose 1.8 percent in June, inching below the expected 1.9 percent increase. The International Council of Shopping Centers chain sales index for the week to July 1 fell 0.7 percent below the previous week's numbers. Many retailers also released same-store sales. Although WMT forecasts disappointed on Monday, Walgreen's (WAG) reported same-store sales that gained 9 percent for the month, with pharmacy same-store sales gaining 11.6 percent and total sales gaining 14.2 percent. Wendy's (WEN) beat expectations for same-store sales, one source reported, but also announced that the company's Q2 profit would decline below that seen a year-ago.

Tomorrow's economic releases include initial claims at 8:30, June's ISM Services number at 10:00 and crude and natural gas inventories at 10:30, with the crude inventories pushed back to tomorrow due to the holiday this week. With crude costs hitting a new all-time high and the TRAN approaching an all-time high, a battle has been engaged. For a long time, however, the TRAN has seemingly reacted more to economic prospects than to crude costs.

Economists expect 59.00 for ISM Services, down from the previous 60.1, but they didn't get Monday's number right, and they might not have this one right, either. Tomorrow will be mostly about positioning ahead of Friday's jobs numbers, and avoiding any paintballs thrown by companies warning ahead of the upcoming earnings season.

Logic, typical "positioning" behavior before an important economic number and chart characteristics all suggest the possibility of continued chop into Friday and maybe even extending into next week. Will that chop be of the type encountered by ocean-going vessels sailing into a storm or of kayakers paddling around in a calm inland lake?

This week's pattern so far has vividly illustrated the hyperactive way the markets react to any hint of increasing inflation or any calming of inflation worries, sailing here and there, depending on the data. Charts suggest that consolidation is due. Typically by tomorrow, a day ahead of an important number, that consolidation would narrow prices into a formation such as a triangle, ready to be broken Friday morning, but neither Monday nor today demonstrated any tendency yet to narrow the wide swings. Therefore, although I'd usually be warning that tomorrow could be an untradable, narrow range day, I'm concerned that instead it may be a much touchier but still untradable day. The narrowing-range type of day gains slightly in probability, but it feels risky to even grant it a slight edge over the wilder swinging type of chop.

I'm concluding with a last chart that demonstrates some of my observations for the benefit of short-term traders. I don't think that markets have yet decided on an intermediate direction, not until they chop their way out of the recent consolidation zones.

AAnnotated 15-Minute Keltner Chart of the SPX:

RSI on this chart measures 49.12, a middle-of-the-road levels that tells nothing about direction. This chart suggests that without a big shove one direction or the other, the SPX could indeed spend tomorrow morning, at least, rattling back and forth between the gold line and the upper purple one, perhaps beginning to hammer out one of the infamous and deadly dull triangles that often are built ahead of and just after important economic news is announced. So, this chart, at least supports the idea that the usual narrowing could be seen, even if Wednesday's example shows how easily this market can blow prices right out of a channel. br>
If there is a narrowing, watch for a break to judge short-term direction, but keep stops tight because this market is jittery. Watch bond yields for the best indicator, with equities reacting negatively to anything that bond traders perceive as hawkish and suggesting higher yields to come. Don't ignore the TRAN, either. The TRAN is one of those indices that can lead the markets. With a daily ATR a whopping 88.04 points currently, the TRAN would have to stretch beyond that ATR by only a little over four points to achieve a new intraday high beyond the 5013.67 one achieved in May. It's also close enough that it could be sent lower now and be considered a failed double-top test. The daily RSI has an ominous potential H&S. Watch it tomorrow, particularly after the crude inventories are released.

Like the SPX, the Dow dropped back inside its nested Keltner channels today, and lines are aligning on either side in a fairly symmetrical array. The Dow's differs a little from the SPX's, however. Support may look firmer near 11116-11130 than the SPX's support. The SPX has firmer nearby resistance, too, up to about 11161, but if it can get past that on 15-minute closes (and the level will change during the trading day), then resistance above that is actually weaker than on the SPX.

The Nasdaq ended the day right on crucial Keltner support. That support looks firm, but if negative futures action gaps the Nasdaq below about 2150 on the first 15-minute close tomorrow morning and if today's low doesn't hold, then the Nasdaq may be quickly vulnerable to 2125 or so.
 


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

Armor Holdings - AH - close: 54.43 chg: -0.35 stop: 51.99

AH was looking pretty strong last Friday but shares have spent the last two sessions failing to breakout past the $55.00 level and on low volume. It's as if investors are waiting for something. Could it be Friday's employment report? Our previous update suggested readers buy a bounce from $54.00 as an entry point. We got a chance to do that this morning. We remain bullish with AH above its simple 10-dma but more conservative traders may want to wait for a move past $55.00 first. Another concern is potential resistance at the sliding 50-dma still overhead. Our target is the $59.50-60.00 range. We do not want to hold over the July earnings report.

Picked on July 02 at $ 54.83
Change since picked: - 0.40
Earnings Date 07/20/06 (unconfirmed)
Average Daily Volume = 656 thousand

---

Allegheny Tech. - ATI - cls: 68.61 chg: -0.72 stop: 64.95

Wednesday morning traders bought the dip in ATI at $67.40 near its simple 50-dma. Right now we'd wait for a most past $69.25 or 70.50 as a new entry point to buy calls. The stock might just trade sideways near the $70 level as the markets wait for Friday's economic reports. Our target is the $75.00-76.00 range. The P&F chart currently points to an $83 target. We do not want to hold over the July earnings date.

Picked on June 29 at $ 70.01
Change since picked: - 1.40
Earnings Date 07/26/06 (unconfirmed)
Average Daily Volume = 3.8 million

---

Burlington N.Santa Fe - BNI - cls: 78.68 chg: -0.64 stop: 74.90

BNI experienced some profit taking this morning like most stocks and was slowly on the rebound by Wednesday's closing bell. We remain optimistic but would wait for a move past $79.00 and probably the $80.00 mark before initiating new call positions. Our target is going to be the $84.90-85.00 range although more aggressive traders might want to aim for the April highs near $87.50. The P&F chart currently points to a $93 target. We do not want to hold over the July earnings report.

Picked on June 29 at $ 79.09
Change since picked: - 0.41
Earnings Date 07/25/06 (unconfirmed)
Average Daily Volume = 2.3 million

---

Bear Stearns - BSC - cls: 140.92 chg: -1.90 stop: 134.95*new*

BSC turned in a big session on Monday's shortened trading day with a breakout over $140.00 and a close near $143. Today's market drop at the open sent BSC lower to fill the gap from Monday. Shares consolidated sideways around the $140 level. Ideally we'd like to see broken resistance at $140 act as new support but it would not surprise us to see BSC consolidate lower and test its rising 10-dma (currently near 137.50). A bounce from $140 or from the 10-dma could be used as a new entry point to buy calls. Our target is the $144.50-147.50 range. Please note that we're raising the stop loss to $134.95.

Picked on June 29 at $137.51
Change since picked: - 3.41
Earnings Date 09/14/06 (unconfirmed)
Average Daily Volume = 1.5 million

---

Chipolte Mex Grill - CMG - cls: 59.35 chg: -1.04 stop: 57.99*new*

Warning! The consolidation in CMG is growing weaker. The close under $60.00 is bearish and the close under its 50-dma is even more bearish. Shares are testing technical support at the bottom of their rising channel. We're raising our stop loss to $57.99. More conservative traders may just want to exit now to cut their losses.

Picked on June 18 at $ 61.76
Change since picked: - 2.41
Earnings Date 07/20/06 (unconfirmed)
Average Daily Volume = 384 thousand

---

Google - GOOG - close: 421.46 chg: - 1.74 stop: 394.99

Monday proved to be a positive session for GOOG with shares rising toward $424. Traders appeared to use the Wednesday morning weakness as a new entry point to buy the dip. We remain optimistic, especially with the close over $420 but we're not suggesting new positions right here. More conservative traders may want to seriously consider taking some profits right here! There is potential resistance in the $425-430 region with its trendline of lower highs. We are aiming for the $440 level.

Picked on June 21 at $401.00
Change since picked: +20.46
Earnings Date 07/20/06 (unconfirmed)
Average Daily Volume = 9.8 million

---

Goldman Sachs - GS - close: 150.95 chg: -1.50 stop: 146.45

We are still sitting on the sidelines with GS. The stock was strong on Monday but shares have still not broken out past the $153.00 level. Our suggested trigger to buy calls is at $153.05. Aggressive traders may want to jump in early with a bounce from the $150 level. We're suggesting two targets. Our conservative target is the $157.50 level. Our aggressive target is going to be the $164.00 level. If shares of GS can trade over $154 it will produce a new buy signal on the P&F chart.

Picked on June xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 09/12/06 (unconfirmed)
Average Daily Volume = 5.0 million

---

MicroStrategy - MSTR - cls: 96.46 change: -2.19 stop: 91.74

MSTR continued higher on Monday but that strength was reversed today. Wednesday's session looks like a bearish failed rally for MSTR. At this time we would expect the stock to retest broken resistance and hopefully new support at the $95.00 level. Wait and watch for a bounce from $95.00 as a new bullish entry point to buy calls. Our target is the $108.50-110.00 range. We do not want to hold over the late July earnings report. The stock can be volatile sow we're using a wide (aggressive) stop loss.

Picked on July 02 at $ 97.52
Change since picked: - 1.06
Earnings Date 07/27/06 (unconfirmed)
Average Daily Volume = 333 thousand

---

Reynolds American - RAI - cls: 114.36 chg: -0.63 stop: 109.69

One of the first things we noticed on Wednesday was that volume for RAI came in below average. Chart readers will also notice that traders bought the dip near its rising 10-dma. This may be a new bullish entry point but if you're initiating new positions here you might want to use a tighter stop loss. RAI has already hit our conservative target at $115.00. Right now we're aiming for our aggressive target at the $119.00 level.

Picked on June 15 at $111.15
Change since picked: + 3.21
Earnings Date 07/26/06 (unconfirmed)
Average Daily Volume = 632 thousand

---

Union Pacific - UNP - close: 92.12 chg: -0.11 stop: 87.45

Traders were quick to buy the dip near $90.50 this morning (actually they bought the dip right at its 10-dma, 90.39) and we see today's rebound as a new bullish entry point to buy calls. Our target is the $96.00-97.00 range. The P&F chart is bullish with a bounce from support and a $110 target. We do not want to hold over the July earnings report.

Picked on June 29 at $ 91.54
Change since picked: + 0.58
Earnings Date 07/20/06 (unconfirmed)
Average Daily Volume = 1.6 million

---

Wynn Resorts - WYNN - close: 72.34 chg: -1.36 stop: 69.75

WYNN is trading pretty close to how we expected it might. We expected a dip and the stock produced one this morning. The good news is that traders bought the dip near its rising 10-dma. We see this rebound as a new bullish entry point to buy calls. Our target is the $79.50-80.00 range. The P&F chart has a spread triple-top breakout buy signal with an $86 target. We do not want to hold over the early August earnings report.

Picked on June 29 at $ 73.64
Change since picked: - 1.30
Earnings Date 08/02/06 (unconfirmed)
Average Daily Volume = 1.0 million
 

Put Updates

Apple Computer - AAPL - close: 57.00 chg: -0.95 stop: 60.05

AAPL has spent the last three days churning sideways in a $1.75 range. Thus far shares remain in a bearish pattern of lower highs but we feel somewhat hesitant to suggest new plays here. It might pay off to wait for a new decline under $56.00 before initiating new put positions. AAPL came out today with news of a new iMac for less than $1,000 to be available before the back-to-school shopping season begins. Naturally, this sounds like a positive for the company.

Picked on June 28 at $ 56.85
Change since picked: + 0.15
Earnings Date 07/19/06 (unconfirmed)
Average Daily Volume = 33.1 million

---

Amgen Inc. - AMGN - close: 65.49 chg: -0.30 stop: 67.25

We are not suggesting new plays in AMGN at this time. However, the stock has failed to breakout past its 21-dma for the last three days in a row. Aggressive traders might want to consider new puts if AMGN trades under $65.00 again - although if you're opening new positions now we'd suggest aiming for the $60 region. Our target is the $62.65-62.25 range.

Picked on June 05 at $ 67.48
Change since picked: - 1.99
Earnings Date 07/18/06 (unconfirmed)
Average Daily Volume = 8.9 million

---

Digital River - DRIV - cls: 40.96 change: -0.60 stop: 42.05

Volume continues to come in very light for DRIV. We're not sure what investors are waiting for. The stock has been bouncing around the $40-42 range for a while. We are not suggesting new plays and more conservative traders might just want to cut their losses early right here! Currently our target is the $35.25-35.00 range. The P&F chart is bearish and points to a $26 target.

Picked on June 19 at $ 39.45
Change since picked: + 1.51
Earnings Date 07/19/06 (unconfirmed)
Average Daily Volume = 1.0 million

---

Intl. Bus. Mach. - IBM - cls: 77.77 chg: -0.25 stop: 78.75

We are expecting IBM to report earnings in less than two weeks. That doesn't give us a lot of time. At this point in the game we're not suggesting new put positions. Our target is the $73.50 level. We do not want to hold over the mid July earnings report.

Picked on June 06 at $ 78.75
Change since picked: - 0.98
Earnings Date 07/18/06 (unconfirmed)
Average Daily Volume = 5.2 million

---

IDEXX Labs - IDXX - close: 75.31 chg: -0.24 stop: 78.05

IDXX displayed a little bit of volatility this morning. Interestingly enough instead of trading lower like the major indices, shares of IDXX traded higher. Yet the rally failed and failed pretty quickly once IDXX tested its two-month trendline of lower highs. This may be a new entry point for puts but we're not suggesting new plays at this time. Our conservative target at $75.25 has already been hit and we're now aiming for the $72.00 level.

Picked on June 12 at $ 77.95
Change since picked: - 2.64
Earnings Date 07/28/06 (unconfirmed)
Average Daily Volume = 144 thousand
 

Strangle Updates

None
 

Dropped Calls

United Tech. - UTX - close: 63.85 chg: -0.14 stop: 59.95

Target achieved. UTX has spent the last couple of days trading sideways in a relatively narrow range around the $64.00 region. Our target was the $64.00-65.00 range and UTX has traded above $64 multiple times in the last couple of trading days. More aggressive traders might want to aim for the May highs above $66.00.

Picked on June 08 at $ 60.13
Change since picked: + 3.72
Earnings Date 07/19/06 (unconfirmed)
Average Daily Volume = 3.7 million
 

Dropped Puts

Group 1 Auto - GPI - close: 55.66 chg: -1.59 stop: 58.01

We have been stopped out of GPI at $58.25. On Monday morning the stock gapped open higher at $58.25, which was above our stop at $58.01. If we had left our stop at breakeven (58.46) we'd have been okay. The action over the last two sessions looks like a big failed rally and new entry point for puts.

Picked on June 11 at $ 58.46
Change since picked: - 2.80
Earnings Date 08/01/06 (unconfirmed)
Average Daily Volume = 498 thousand

---

Oshkosh Truck - OSK - close: 47.02 chg: +0.39 stop: 50.51

Target achieved. OSK dipped to $45.26 this morning before bulls bought the dip. Our target was the $45.50-45.00 range. We would be very careful if you did not exit yet. The bounce this afternoon has produced a bullish-reversal candlestick and we would expect to see some follow through higher tomorrow.

Picked on June 13 at $ 49.49
Change since picked: - 2.47
Earnings Date 08/01/06 (confirmed)
Average Daily Volume = 737 thousand
 

Dropped Strangles

None
 


Trader's Corner

Volume Studies

I wrote in my Index Trader column this past weekend in my summary section (the 'Bottom Line') that I thought that trade this week would likely be quiet, since many key participants would likely be off or not fully engaged in trading. My weekly Wednesday Trader's Corner article also serves as an adjunct to this (Index Trader) column, which is seen in an online (only) section at the Option Investor.com web site. This column can be seen by clicking here.

I was then thinking last night in the quiet before the fireworks I was waiting to see, that did I think that it would be a low VOLUME week and not much follow through to the upside; or, just that prices would not likely follow surge much higher for awhile, after the strong rebound of the week before? More the later.

I knew from looking at the charts of the major indexes that I didn't want to chase rallies and only buy good-sized pullbacks such as back into the upside 'gaps' that occurred when prices finally rebounded sharply in the week before last; ditto on buying pullbacks only in any individual stocks. There hasn't yet been a huge volume surge to suggest big buying coming in. Maybe selling is drying up some, but it still takes concerted buying to lift em.

Then a SUBSCRIBER E-MAIL found its way into my Inbox with the following query about would I:
"... summarize what factors ar important with volume to alert to shifts in stock and index trends. Are there any studies that you use that relate to trading volume?"

RESPONSE:
I think about volume more than many, since technical analysis, my way mostly of studying the market and making option trading decisions, works with ONLY two inputs: Price and Volume. There is the study of 'sentiment' or market outlook or we could say investor/trader psychology; how bullish or bearish market participants are. But even here, I largely base my concepts of bullish or bearishness on daily call to put option VOLUME ratios.

Some basics or basic rules on volume, as it relates to the dominant trend, are:

1. Volume should expand in the DIRECTION of the trend. A rising trend will generally see higher volume on up days and lesser volume on down days. A falling trend will tend to see the reverse: jumps in volume on declines, lesser volume on up days.

2. Jumps in, or expansion of, daily volume on new highs or new lows is usually telling us that the (existing) trend will continue. But there is such a thing as a 1-day buying or selling 'CLIMAX' when there is a HUGE final jump in volume, followed by a reversal in trend the next day or in the next 2-3 days.

3. High volume 'clusters': when there is a cluster of high volume days after an index or stock has had a considerable run, especially if prices slow their rise or fall, this may be near the end point of the existing trend: this is when all the volume 'comes out' so to speak. Most who are going to buy have done so and not much buying 'power' is left; conversely, near tradable bottoms, a cluster of heavy volume days may occur and suggest that most of those long who are inclined to sell have done so, paving the way for an 'oversold' rebound.

There are two 'Show Me' indicators in the TradeStation software I use that alert to the jumps in volume relative to a certain moving average of volume; e.g., a 50-day average.

One study is called a 'Volume Breakout', where a dot is placed at the high price of a price bar when that period's (e.g., a day) volume is at least 50% higher than the average volume of the last 50 bars. Another study, that is shows a less frequent chart marking (a dot) is called a 'Big Volume' bar, where that bar or trading period had volume equal to at least twice the average daily volume of the last 50 days.

NASDAQ 100 Tracking Stock (QQQQ), Daily chart
(Volume and 'Volume Breakout' study applied)

In the QQQQ daily chart below, the first noteworthy aspect related to volume and price comparisons is that the advancing trend from mid-March to early-April was NOT accompanied by a rising trend in daily volume during that same period. Volume was relatively 'flat'. There was not the cluster of higher than average 'volume breakout' days seen later on during the first and later parts of the mid-April to early-June decline.

Volume rose steadily into the biggest volume day of early-June. This highest volume day, was a noticeable jump over all the other volume 'bars' and was suggestive of a 'selling climax', especially in that the further price decline for that day and in that immediate period was not huge. Rather, it just looked like the bulls threw in the towel.

General Electric (GE) Daily chart.
(Red Dot = occurrence of a 'Big Volume Bar')

Note the first cluster of the cyan dots (Nov-Dec) that show above average volume days relative to GE's 50-day average of daily volume; i.e., a 'volume breakout' day. This was the peak. High volume 'churning' that was probably caused by some savvy market participants selling into strength. When volume grows after a good-sized advance, but prices are not going up, this is a DIVERGENCE that could be suggesting a trend reversal.

Note again the cluster of high volume days in Jan-early Feb; the reverse of the situation at the prior top: sizable volume 'coming out', but prices not slipping a whole lot further, suggesting bottoming action. As well, the large January 1-day spike in volume suggestive of a possible selling climax.

A bearish price/volume DIVERGENCE in GE's chart above is seen in April-May when prices were going UP and volume was going DOWN. The last part of the decline came on steady volume, suggesting a possible turnaround, at least short-term.

WAL-MART (WMT) Daily Chart:

The sharp downside break in WMT came on a Big Volume day. There was a selling climax at the Sept. bottom after many high volume days. A cluster of high volume days occurred then coming into the May top. Any rallies since then have not occurred with any pronounced volume spikes.

Some minor jumps in volume have come on the recent break in Wal-Mart (above chart). What we are seeing in volume is only a minor encouragement to the bulls. This stock seems likely to slip lower still.

JP MORGAN (JPM) Daily chart:

A cluster of high volume days in Sept-Oct was highly encouraging to get long JP Morgan (JPM) stock and its calls. The early-year slide on some high volume days was worrisome for the bulls, but JPM held prior lows/technical support. The recent top was accompanied by some heavy volume days. Recent chart action and volume are in synch and bullish for a move still higher such as back up to the $45 area.



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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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