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Daily Newsletter, Wednesday, 08/16/2006

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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

Once Again, Bad News Is Good News

(Linda and I (Keene) have switched Market Wrap nights so I'll be writing tonight's and Linda will take tomorrow.) We all know the market is not logical. It's a living, breathing organism that's made up of millions of us people. It has the collective emotions of all who trade it. And like an individual human being, the market doesn't always react rationally to events or news. Take the inflation data as an example, which is the reason we're being told the market has rallied so strongly the past two days. First of all, the inflation data by the PPI yesterday showed a drop in inflation. Today's data was a little more of a mixed message but the CPI was up +0.4% from +0.2% for June and is higher by 4.2% than a year ago. Even core CPI, at +2.7% year-over-year, is the highest reading since December 2001.

So if the market rallied strong on the drop in PPI why did it rally strong on the rise in CPI? Silly me for asking such a logical question and expecting a logical answer. Trading the news is a hit or miss proposition for traders. The market does what it does regardless of the news. The commentators then try to fit the market's moves into a neat little package that they can explain. What's really amazing is that many of these people believe what they're saying.

How about this? It's opex week, there were many funds who had sold calls as part of their monthly option writing exercise and they had to cover their positions once their strike positions were threatened. Those who felt least bullish about the market were the ones forced to do the buying the past 2 days. How ironic. We know the mega banks' trading teams have been doing extremely well over the past few years (since they've been able to remove market risk from their trading). If they want to move the market in a certain direction they have enough firepower to do it. If they position for opex with a lot of deep in-the-money sold puts and cheap front-month long calls, and they know that they can probably get the market up high enough to trigger a bunch of stops, then it's easy to see how they've been able to remove risk from the market. I would venture to say they've had this plan all along for this week and the market would have done this regardless of the inflation data. Yesterday's and today's conflicting inflation data supports my contention.

Furthermore, if the Fed is being successful in slowing down the economy, which inflation data is used as one of their gauges, does it make sense to buy stocks when growth is slowing? Of course not, but that's one of those logical considerations that the market ignores. The recognition will come later and that's why the market is consistently lower 6 and 12 months out from the time the Fed stops raising rates. If the Fed has stopped as of August that means in February and August of 2007 we will be in a market that is below today's prices. Those are the statistics. So again one may ask why the market is rallying so strongly. Silly question.

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The bond market has been rallying strong as well. That of course drives yields down. What the bond market is predicting is a drop in interest rates instead of a further increase. If the Fed turns around and starts to drop rates we'll know they've recognized the signs of a too-fast slowing economy. If anything that's what the bond market is telling me. But that's all in our near future. For now (opex week at least) we've got a rally on our hands and we all know better, I hope, than to argue our point with the market. Price rules and we do our best to get on the right side of those moves.

In addition to the inflation data this morning we had some housing data. None of it was particularly good but that didn't prevent the home builders from rallying. By the way, did you catch the news yesterday that the confidence level of home builders is at the lowest it's been in 15 years. These are the people that peer over the horizon to see how the housing market is looking and they're not feeling especially rosy about the future of the housing market. We should be listening to these people.

Today's numbers showed a drop in building permits from 1862K in June to 1747K which was almost 100K less than expected. This is more evidence of the economy slowing and more bad news is good news for the equity market, for now. Housing starts fell from June's 1841K to 1795K, the lowest it's been since November 2004 and is the 5th decline in the past 6 months. With permits declining faster than housing starts, and lower than starts last month, we can see where housing starts are headed. Permits have declined 6 straight months now and is the largest drop since September 1999.

Industrial production numbers were also released this morning and showed an increase of +0.4% which was half of June's +0.8% and below expectations for +0.6%. More evidence of an economy slowing down. But hey, that means the Fed won't have to raise interest rates anymore. And that's bullish because? Capacity utilization was also reported and showed a slight tick higher to 82.4% from June's 82.3%. It was a little lower than expectations for 82.7%.

But as I said, the market (or some big players) had an agenda so the news wasn't really the reason for the rally. Unfortunately the market has been so choppy and full of whipsaws that it's been very hard to make any decent swing trades. Each time one side thinks we've started a new trend the market reverses and forces traders out at break even or at a slight loss. Now we've had a strong 2-day rally and we must wonder if it's the start of something bigger to the upside or just more of the same chop. Those bulls who got excited yesterday and today may be the ones who are stopped out tomorrow as the market takes back all their gains. Then it will happen to the bears. Rinse and repeat. This market has only rewarded those who take their profits early and quickly and play the base hits rather than the homerun plays. Let's see if we can make any sense of the charts tonight.

DOW chart, Daily

The last two times the DOW pressed up against the trend line along the highs since January 2004 (other than the big rally above it in April-May), in July and August 4th, a quick decline followed. The bulls are hoping for a different outcome this time. Stochastics and MACD support a move higher. It's always hard to tell whether or not a move during opex week is sustainable or not. If this is just opex then we can expect a quick reversal into next week. If this is the market rallying on what many perceive to be a good thing that the Fed is stopping its rate increases then it should run higher at which time it will set up a very good long term short position. But caution right now as we let this run its course.

SPX chart, Daily

We have a similar picture to the DOW except with a different trend line--one along the July and August highs and slightly higher than the March 2003 uptrend line. Each time it pressed above that trend line it dropped back down the following day. If the market is able to hold its gains tomorrow then that will be a change in behavior. But even if we're going to get a choppy summer rally the operative word there is choppy. It is unlikely to go up in a straight line (if it did I'd be soon backing up two trucks and loading up on long term put options). Opex is exaggerating moves this week so be cautious at this point about the long side. And clearly shorts are not working at the moment.

Nasdaq chart, Daily

When the COMP decided it was time to leave that down-channel it did it with gusto. Hopefully this isn't just an opex related jam to the upside to catch the bears napping. It will be important to keep this going for the bulls now. The 38% retracement of the April-July decline is at 2151 and two equal legs up from the July low is at 2154 so this makes a potentially important Fib area to watch for resistance. The move up from that July low is so far only a 3-wave bounce. If it turns back around and heads south then the EW (Elliott Wave) count on this suggests we could see a very nasty sell off. The previous dip to 2050 must hold now on any pullback otherwise the bulls could be in trouble. But until then this could develop some legs to the upside. Just remember, this is opex week. The chart of the Q's looks the same.

SMH index, Daily chart

Similar to the COMP, the 38% retracement of the decline in the semis from the January high is at 33.46 and two equal legs up in its bounce off the July low is at 33.67. At the same level is the previous bounce. Also located there is the top of a potential parallel down-channel. Therefore keep an eye on this area for a potential topping, at least for the short term.

BIX banking index, Daily chart

After breaking down from its ascending wedge pattern that it had built from the June low, the banks have now bounced back up to the lower line. Any roll back over from here will look like a perfect retest and kiss goodbye and would be an excellent short play. The bulls need to hold this up or else.

U.S. Home Construction Index chart, DJUSHB, Daily

The housing numbers were not good today but obviously traders didn't care today. Or at least bulls didn't care to hear bad news anyway. And the shorts were forced to cover so the combination created a nice day to be long the market. The home builders stopped at the 50-dma today so we'll have to see if it breaks or not. If the bulls can keep this going then I think there's a good chance we'll see this index work its way up to its downtrend line from January. If it rolls back over from here then we might see a longer sideways consolidation form before this index heads lower again.

Crude inventory numbers were released today and showed another drop in supplies. But that didn't stop the slide in crude futures to their lowest level since late June. OPEC lowered their forecast for oil demand for the rest of 2006. They cited an unexpected decline in demand from industrialized nations and this is more evidence of a slowing economy on a global scale, not just in the U.S.

Oil chart, September contract, Daily

As expected oil has now broken its uptrend line from last December. We should see oil head for about $70 where it will test its previous low and 200-dma. I'm sure we'll soon get a bounce back up to test the uptrend line and 50-dma near $74 before rolling back over.

Oil Index chart, Daily

This index gave plenty of warning about an impending decline. The negative divergence was glaring. With the drop in the price of oil we should see this index head lower as well. The 50-dma near 611 should be an initial target.

Transportation Index chart, TRAN, Daily

With the drop in oil's price the pundits were saying the Transports benefited from that. Donkey dust. The transports have rallied and declined regardless of what oil does. After a long and hard sell off there were clearly some shorts who were chased out of their positions the past 2 days. Nothing more. The trannies stopped at the 200-dma so that's resistance for now. Not shown on the chart is a downtrend line from the July high that sits just above where it closed today. We should see a pullback begin. It may consolidate near its lows for a while. But if the rally continues above 4430 and holds it above, then the 50-dma is very likely next.

U.S. Dollar chart, Daily

The US dollar bounced back up to test its 50-dma and has dropped from there. This all looks like part of the pattern for a move to a new low and I'm still waiting to see if the $83 area gets tested and acts as support for a much larger bounce back up.

Gold chart, October contract, Daily

Gold is threatening to break below its short term uptrend from June but is finding support at its 50-dma just below the line. If it drops below 620 it's probably headed for longer uptrend support near 600 for a brief bounce. I think it would then continue lower from there. If it continues to consolidate between 620 and 650 for another month then we'll probably get an upside resolution in which case we could see gold head for new all-time highs.

Results of today's economic reports and tomorrow's reports include the following:

Tomorrow's economic reports include the usual unemployment numbers to be followed by the Leading Economic Indicators at 10:00 AM and then the Philly Fed number at noon. The LEI number is one of the better numbers for an indication of how the economy will do 6 months down the road. If it comes in as expected we should not see any effect from it. Besides, the market has its own agenda this week. But use the information to help you make some longer term decisions about the market and our economy.

Today's trading volume was average and that was a bit surprising considering we usually see higher volume during opex week. For such a strong rally I would like to have seen stronger volume. At least up volume swamped down volume by nearly 5:1. That's a little excessive but certainly not of the blow-off variety. Total advancers beat decliners a little better than 2.5:1. New 52-week highs beat new lows 300 to 165 which is not great but not bad. Certainly the internals supported the price action.

My sector list was almost all green except for the utilities and energy. Leading the winners were the Transports, SOX, airliners, networkers, disk drives and other computer hardware, and biotechs.

Hewlett-Packard (HPQ 34.50 +0.44) announced earnings after the bell and reported a fiscal Q3 profit of $1.38B, or 48 cents a share, compared to $73M, or 3 cents a share a year ago. Revenue rose 5% to $21.89B from $20.8B. H-P also said its board of directors authorized a buyback of up to $6B of company stock. The stock rallied big after the cash market closed and finished at $36.40.

Many indices seem to be up against resistance of one form or another, be it trend lines, moving averages, Fibs, etc. The best thing the market can do from here is tread water or pull back in a choppy sideways/down correction (or rally of course but then that would quickly become too much too fast). That would be an indication that we're going to see these resistance levels broken. But if you're long the market you may want to tighten up some stops in case we see a reversal like so many recent times where traders give it all back.

With the strong rally this week I'm reposting the weekly SPX chart that shows one of the scenarios I was tracking for weeks with you. This is the "intermediate bullish" scenario that called for a choppy summer rally before the bears take over and maul the bulls. I had abandoned this for the past couple of weeks because it was beginning to look like we might see only a sideways consolidation through the summer before the market continued south for the winter. I'm still leaning towards this sideways scenario but I wanted to show this slightly more bullish chart again so that we can track the market's progress on it.

SPX chart, Weekly, More Immediately Bearish

This scenario calls for a new market high to finish off the EW count for the move up from August 2004. It's a long term ascending wedge that needs another 3-wave move up from the June 2006 low in order to give us a 5-wave count inside the wedge. This is a tricky pattern and difficult to count and that's why I've been considering a couple of different wave counts to see which one shows its face. The fact that the lower trend line from August 2004 held is what told me the more immediate bearish case was likely not the one playing out. Now it's between a sideways consolidation (which would mean this week's rally will get quickly reversed) or a choppy rally continuing into September. If we get the rally into September then we'll have every bull in town pounding the table why you should buy the market into the end of the year. Nothing could be further from the truth but we'll worry about that later. For now be careful about another quick reversal and deeper pullback. This is a scalper's market and not a swing trader's. That will change but not yet. Good luck and I'll see you next Thursday or on the Market Monitor tomorrow.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
BUCY None None
GS    
MSTR    

New Calls

Bucyrus - BUCY - close: 51.87 chg: +3.39 stop: 47.69

Company Description:
Bucyrus International, Inc. designs, manufactures and markets draglines, electric mining shovels and rotary blasthole drills used for surface mining. In addition, Bucyrus provides OEM parts and services for those machines. Bucyrus' corporate offices are located in South Milwaukee, Wisconsin, USA. (source: company press release or website)

Why We Like It:
The market's two-day rally on tamer than expected inflation news has really fueled a strong move in BUCY. The stock has broken out above resistance at its 100-dma in addition to resistance near the top of its range near $51.00. Today's breakout was fueled on strong volume and the move also looks like a bullish breakout from an inverse head-and-shoulders pattern. Short-term technicals have turned positive again and its P&F chart has produced a new triple-top breakout buy signal with a $65 target. Readers can choose to buy calls here or wait for a potential dip back towards $51 or $50, which may not be a bad idea after such a big two-day move. BUCY appears to have some resistance near $58.00 and again near $60.00. We're going to target a run up into the $57.50-60.00 range. Our stop is under today's low.

Suggested Options:
We are suggesting the September or October calls. You choose which strike and month best suits your trading style.

BUY CALL SEP 50.00 HBU-IJ open interest=190 current ask $4.50
BUY CALL SEP 55.00 HBU-IK open interest=279 current ask $2.10

BUY CALL OCT 50.00 HBU-JJ open interest=540 current ask $6.30
BUY CALL OCT 55.00 HBU-JK open interest=987 current ask $3.90

Picked on August 16 at $ 51.87
Change since picked: + 0.00
Earnings Date 10/19/06 (unconfirmed)
Average Daily Volume = 697 thousand

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Goldman Sachs - GS - close: 154.99 chg: +2.34 stop: 149.40

Company Description:
Goldman Sachs is a leading global investment banking, securities and investment management firm that provides a wide range of services worldwide to a substantial and diversified client base that includes corporations, financial institutions, governments and high-net-worth individuals. (source: company press release or website)

Why We Like It:
The XBD Broker-dealer index helped lead the financial stocks higher on Wednesday. The XBD is also poised to breakout over technical resistance at its 100-dma. Meanwhile shares of GS have already broken out over its 100-dma and the stock looks ready to produce a new leg higher with today's gain and move over its one-week trend of lower highs. We are suggesting calls with GS above $152.50. More conservative traders may want to wait for a move over the August high near $156.30 before initiating plays. Our conservative target is $160.00. Our secondary target is the $164.50 level. Consider selling half your position at $160 and the rest at $164.50. We do not want to hold over the late September earnings report. FYI: The P&F chart points to a $190 target.

Suggested Options:
We are suggesting the September calls.

BUY CALL SEP 150.00 GPY-IJ open interest=1412 current ask $8.40
BUY CALL SEP 155.00 GPY-IK open interest=6633 current ask $5.20
BUY CALL SEP 160.00 GPY-IL open interest=4210 current ask $2.70

Picked on August 16 at $154.99
Change since picked: + 0.00
Earnings Date 09/21/06 (unconfirmed)
Average Daily Volume = 5.3 million

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MicroStrategy - MSTR - close: 90.08 chg: +2.32 stop: 85.99

Company Description:
Founded in 1989, MicroStrategy is a global leader in business intelligence (BI) technology. MicroStrategy provides integrated reporting, analysis, and monitoring software that helps leading organizations worldwide make better business decisions every day. Companies choose MicroStrategy for its advanced technical capabilities, sophisticated analytics, and superior data and user scalability. (source: company press release or website)

Why We Like It:
The GSO software index has seen a huge bullish breakout this week. While we think the group looks ready for a minor consolidation to digest these gains the new short-term trend definitely looks bullish. If that's the case then shares of MSTR could be poised to breakout from its bearish channel. Aggressive traders may want to buy calls now above $90 or above today's high near $90.50. We still see potential resistance at its 200-dma (near $91) and the August highs near $92.00. Therefore we're suggesting a trigger to buy calls on MSTR at $92.05. If triggered our target is the $98.75-99.00 range. Traders need to be aware that the 100-dma, currently near 94.70, may also be another level of overhead resistance. The P&F chart is currently bullish with a $106 target but MSTR has significant resistance on its P&F chart near $91.

Suggested Options:
We are suggesting the September calls.

BUY CALL SEP 90.00 EOU-IR open interest=460 current ask $4.50
BUY CALL SEP 95.00 EOU-IS open interest=620 current ask $2.25

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/27/06 (unconfirmed)
Average Daily Volume = 431 thousand
 

New Puts

None today.
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

None
 

Put Updates

Autozone Inc. - AZO - close: 88.12 chg: +0.51 stop: 90.05

The market rally is still fueling a bounce in AZO but so far the stock remains under resistance at its descending 50-dma. We are not suggesting new put positions at this time. Our target is the $82.50-80.00 range.

Picked on August 08 at $ 87.73
Change since picked: + 0.39
Earnings Date 09/21/06 (unconfirmed)
Average Daily Volume = 700 thousand

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Boeing - BA - close: 78.83 change: +2.25 stop: 80.45*new*

We struggled with what to do with BA. The rebound today was pretty strong and the action in the broader market indices is suggesting a trend change higher. Yet BA, in spite of today's bounce, is still in a bearish pattern of lower highs and has a bearish P&F chart. We are not suggesting new positions. We urge more conservative traders to think about exiting early to minimize losses. We're going to lower our stop loss to $80.45, near its simple 50-dma.

Picked on August 10 at $ 75.75
Change since picked: + 3.08
Earnings Date 10/25/06 (unconfirmed)
Average Daily Volume = 4.2 million

---

Burlington Nor.SantaFe - BNI - cls: 68.99 chg: +3.29 stop: 70.25

Wow! It looks like the big drop in crude oil today helped fuel a massive rally in the transports. The Dow Jones transportation index produced a 6.2% gain today. Shares of BNI added 5% on above average volume. We warned readers that the next move in BNI might be a rally toward the top of its descending channel near $70.00. The technical picture for BNI is definitely improving. We're not suggesting new positions and conservative traders may want to jump out now!

Picked on August 08 at $ 68.06
Change since picked: + 0.93
Earnings Date 10/24/06 (unconfirmed)
Average Daily Volume = 2.7 million

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Chipotle Mex Grill - CMG - close: 53.50 chg: +2.86 stop: 54.01

The 5.6% gain in CMG today might have been a big short-squeeze. We've been warning readers to expect a rally toward the $52-53 region. Today's gain was a bit stronger than expected and the technical picture is turning more bullish. We're not suggesting new positions at this time. More aggressive traders may want to put their stop loss above $55.00 and/or its 50-dma. If the markets see any follow through higher tomorrow we would expect to be stopped out of CMG at $54.01.

Picked on August 09 at $ 50.28
Change since picked: + 3.22
Earnings Date 10/30/06 (unconfirmed)
Average Daily Volume = 414 thousand

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Intuitive Surgical - ISRG - cls: 96.92 chg: +1.36 stop: 101.55

We are a little surprised that shares of ISRG did not show more strength today. Bears remain in jeopardy with today's breakout over $95 and its 10-dma. We're not suggesting new positions on this aggressive play. More conservative traders may want to exit early.

Picked on August 10 at $ 94.90
Change since picked: + 2.02
Earnings Date 10/25/06 (unconfirmed)
Average Daily Volume = 1.1 million

---

Lam Research - LRCX - close: 41.94 change: +0.77 stop: 42.01

The SOX semiconductor index is up over 9% this week alone. The move is a big bullish breakout from its bearish channel and its 50-dma but now the group looks overbought and due for a dip. Shares of LRCX have been bouncing as well but they're under performing their peers today. LRCX remains under resistance at $42.00 and its 50-dma and 200-dma but bears are in danger if there is any follow through tomorrow! We're not suggesting new positions at this time.

Picked on August 13 at $ 39.04
Change since picked: + 2.90
Earnings Date 10/18/06 (unconfirmed)
Average Daily Volume = 3.0 million

---

MDC Holdings - MDC - close: 44.72 change: +1.41 stop: 45.15

Even after yesterday's 15-year low on the NAHB housing index and today's bearish analyst comments on the group the homebuilders still managed to produce strong gains today. MDC's 3.2% gain put it above its 10-dma and 21-dma. More conservative traders may want to exit early right here to minimize losses. We're not suggesting new positions.

Picked on August 14 at $ 42.25
Change since picked: + 2.47
Earnings Date 10/19/06 (unconfirmed)
Average Daily Volume = 991 thousand

---

NII Holdings - NIHD - close: 51.40 chg: +1.31 stop: 52.51

NIHD rallied back above the $50 level and is now challenging technical resistance at its 50-dma and 200-dma near $51.50. We are not suggesting new plays at this time.

Picked on August 07 at $ 49.90
Change since picked: + 1.50
Earnings Date 07/27/06 (confirmed)
Average Daily Volume = 2.2 million

---

Transocean Inc. - RIG - cls: 67.80 chg: +1.35 stop: 70.25

Shares of RIG are still bouncing in spite of a big decline in crude oil futures today. The stock rallied to its 10-dma and stalled. We're not suggesting new positions at this time. The stock has already hit our conservative target at $65.25. Our secondary, aggressive target is the $61 level.

Picked on August 07 at $ 69.49
Change since picked: - 1.69
Earnings Date 08/03/06 (confirmed)
Average Daily Volume = 6.4 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.)

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Bausch Lomb - BOL - close: 46.13 change: +0.70 stop: n/a

We only have two days left for this strangle and BOL's lack of movement is a not a good sign. We are not suggesting new positions. Our estimated cost on the strangle was $2.15. The options in our suggested strangle are the August $50 call (BOL-HJ) and the August $45 put (BOL-TI).

Picked on July 23 at $ 47.40
Change since picked: - 1.27
Earnings Date 00/00/06 (unconfirmed)
Average Daily Volume = 2.2 million

---

3M Co. - MMM - close: 70.79 change: +1.01 stop: n/a

Our strangle in MMM is pretty much dead. We're right back to where we started. Our estimated cost for our August strangle was $0.75. The options in our strangle are the August 65 put (MMM-TM) and the August 75 call (MMM-HO).

Picked on July 23 at $ 70.72
Change since picked: + 0.07
Earnings Date 07/25/06 (confirmed)
Average Daily Volume = 3.7 million
 

Dropped Calls

None
 

Dropped Puts

Apple Computer - AAPL - close: 67.98 chg: +1.53 stop: 70.01

We are throwing in the towel on our AAPL put play. Today's better than expected reading on the CPI produced a widespread follow through on the market's gains from Tuesday. Shares of AAPL continued higher after breaking out over its 10-dma and 200-dma yesterday. Short-term technicals are bullish. AAPL does still have resistance at the $70.00 level but this time traders might want to be thinking about buying calls on a breakout over $70.00.

Picked on August 08 at $ 64.78
Change since picked: + 3.20
Earnings Date 10/18/06 (unconfirmed)
Average Daily Volume = 28 million

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Chaparral Steel Co. - CHAP - cls: 72.49 chg: +3.02 stop: 70.01

Steel-related stocks continue to surge and it may be time to start thinking about call plays on CHAP if the stock can breakout over the $74-75 region. The stock never hit our trigger to buy puts at $65.40 so we're dropping it as a bearish candidate.

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 09/20/06 (unconfirmed)
Average Daily Volume = 510 thousand

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Cummins Inc. - CMI - close: 120.47 chg: +1.68 stop: 121.27

We are choosing to abandon our aggressive put play in CMI. Shares rallied higher on above average volume and the technical picture is turning bullish pretty quickly. CMI does still have resistance near the $123 level but traders might want to start thinking about bullish plays should CMI breakout to new highs.

Picked on August 08 at $119.77
Change since picked: + 0.70
Earnings Date 10/26/06 (unconfirmed)
Average Daily Volume = 1.2 million

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Fastenal - FAST - close: 37.24 chg: +0.44 stop: 37.26

The market's positive reaction to the CPI report this morning helped shares of FAST breakout over its descending 50-dma. We're surprised that the stock didn't hit our stop loss at $37.26 but we're choosing to exit early before it does. Readers might want to consider bullish positions on the breakout today.

Picked on August 10 at $ 34.90
Change since picked: + 2.34
Earnings Date 10/11/06 (unconfirmed)
Average Daily Volume = 1.2 million

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Hartford Fincl - HIG - close: 83.10 chg: +0.38 stop: 82.01

The market rally has powered the insurance stocks to their fifth gain in a row. Short-term HIG and the sector look overbought but the stock is a ways off from any breakdown below support at the $80 level. It was our plan to buy puts at our $79.20 trigger. The stock never hit our trigger so we're dropping HIG as a bearish candidate.

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/26/06 (unconfirmed)
Average Daily Volume = 1.5 million

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US Airways - LCC - close: 43.00 chg: +2.40 stop: 42.85

We have been stopped out of LCC at $42.85. A strong decline in crude oil in addition to market strength helped the airline index (XAL) add more than 3.5%. Shares of LCC out performed its peers with a 5.9% gain after one analyst firm started coverage this morning with a "strong buy" rating. LCC had already hit our primary target at $40.25 on last week's drop to 37.19. We kept the play open with a secondary target at $36.00.

Picked on August 01 at $ 43.54
Change since picked: - 0.54
Earnings Date 07/27/06 (confirmed)
Average Daily Volume = 1.6 million

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Ryland Group - RYL - close: 43.51 chg: +2.65 stop: 42.05

We have been stopped out of RYL at $42.05. The tame CPI data inspired new strength in the Fed is done for the year party. No more rate hikes will help the mortgage lenders and thus the homebuilders. Investors did a lot of bargain shopping today with a big rally in the homebuilders in spite of yesterday's bearish news about the NAHB's housing index and builder confidence.

Picked on August 14 at $ 39.40
Change since picked: + 4.11
Earnings Date 10/18/06 (unconfirmed)
Average Daily Volume = 1.8 million

---

Whirlpool - WHR - close: 78.60 chg: +1.87 stop: 76.26

WHR continues to bounce and the stock is moving farther and farther away from a breakdown under $74.00. Traders may want to consider buying calls if shares can push past the $80 level. The stock never hit our trigger to buy puts at $73.99 so we're dropping WHR as a bearish candidate.

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/24/06 (unconfirmed)
Average Daily Volume = 1.2 million

---

United States Steel - X - cls: 61.87 chg: +2.34 stop: 60.05

Steel-related stocks are enjoying a lot of strength during this widespread market rally. Shares of X added 3.9% to breakout over the $60.00 level today. The stock never hit our trigger to buy puts at $55.85 so we're dropping it as a bearish candidate.

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/24/06 (unconfirmed)
Average Daily Volume = 5.7 million
 

Dropped Strangles

None
 


Trader's Corner

The Money Flow Indicator

I was feeling sad and blue, thinking that my Option Investor mail box had been empty too long and low and behold, a mail came in that wasn't taking me to task for any recent bad call or anything (actually there was phrase for 8/12 Index Trader article), so I was glad again and happy to answer the following SUBSCRIBER QUESTION:

"Could you write something about money flow indicators as demonstrating divergence or big money moves in your Wednesday article?"

My first mistaken take on this question was that I don't have a Money Flow Indicator for the stock indexes, because this indicator works both with Price and VOLUME and there is not a usual link between prices of the major stock indexes and volume information; e.g., such as if this indicator could utilize the TOTAL daily volume in the SPX, OEX, DJX and NDX options (for all option exchanges).

Of course, there is the case of the Nasdaq 100 Tracking Stock (QQQQ), which being a stock, DOES have the requisite daily volume tallies. But then I realized belatedly that of course there are key and bellwether individual STOCKS that we can trade within the S&P 500, S&P 100, Nasdaq 100. And, I should of course write about the use of this Indicator pertaining to the question of our OIN Subscriber above.

WHAT IS THE MONEY FLOW INDICATOR?

This technical indicator is usually called the Money Flow Index (MFI) or just the 'money flow' indicator, which is available in various charting and technical analysis applications such as TradeStation, MetaStock, etc. and is essentially a volume-weighted Relative Strength Index (RSI) indicator.

As many of you know who follow my weekend Index Trader columns, I refer to the RSI frequently; see my 8/12 article by clicking here.

RSI, first described by Welles Wilder, is based upon the difference between the average of the closing price on X number (the 'length' setting) of up periods vs. the average closing price on X number of down period; e.g., days.

Wilder in fact used a period of 14 days as an introductory example, but other periods since have also become common. I see the 5 and 10-day setting used a lot. I use mostly the fibonacci 13 and 21 period settings; also, 8 on weekly charts.

In addition to indicating overbought and oversold levels when the indicator goes above the typical 'overbought' reading of 70 or below the typical 'oversold' reading of 30, 'relative strength' can be interpreted using other formulas, of which the MONEY FLOW INDEX (MFI) is one. It's a plus that it brings in volume info.

Traditional chart patterns are sometimes or often observed in the indicator action BEFORE they occur in the price-volume data. Head-and-shoulder tops or bottoms are one of the most reliable of all major reversal patterns and are sometimes or often found at major or at least intermediate junctures, while 'pennants' and 'flags' are continuation patterns that represent a pause in the direction of the current move. Areas of support and resistance often or usually occur in the MFI before they appear in the price action.

In addition, divergences between price action and the MFI (or RSI) may portend a very STRONG or robust turning point. When the stock price continues to rise but the MRI or RSI declines, look for a correction. This also works in the reverse fashion, at bottoms.

MFI attempts to measure money flowing into and out of a security. Money flow is calculated by determining the average price for a particular day and then comparing it to the previous day's average price. If today's average is greater than yesterdays, then the money flow is positive. If it's less, money flow is negative.

Positive money flow is the cumulative positive money flow over the specified number of periods, which is the 'length' setting. The money ratio is the ratio of the positive divided by negative money flow. The MFI is typically calculated as MFI = 100 - (100/(1+Money Ratio))

The indicator is interpreted the same as the RSI (divergences, failure swings and patterns are significant).

Average price is calculated by summing the Open (if available), Close, High, and Low and then dividing the sum by either four or three (three if no Open is available). Positive money flow occurs when todays average price exceeds yesterdays average price, and is calculated by multiplying todays volume by todays average price.

Negative money flow occurs when yesterdays average price exceeds todays average price, and is calculated by multiplying todays volume by todays average price. The positive and negative money flows are then summed over the number of bars specified in LENGTH. The Money Flow Index is then calculated as follows in the TradeStation charting application I use, which is typical:

MFI = 100 - (100/(1+(Sum of Positive MF / Sum of Negative MF)))
MoneyFlow issues a signal when a new High or Low is reached in a stock which is not confirmed by a similar new high in the Money Flow Index.

MFI VERSUS PRICE ACTION EXAMPLES: DETERMINING OR 'CONFIRMING' TREND REVERSALS

NASDAQ 100 TRACKING STOCK; DAILY CHART (QQQQ):

On the left hand side of the daily chart of the Nas 100 (NDX) index stock below (QQQQ), there is an example of a bearish price/MFI divergence. This using the commonly suggested 'length' setting of 21; this by myself and more public analyst types like Marc Chaikin and he is very good on volume studies by the way.

Back in the November-December time frame as seen in the chart below, QQQQ rallied to a new high, but when doing so, the Money Flow Index fell well shy of a similar new high. Note that the two trendlines slope in OPPOSITE directions, which is visually the easiest way to highlight these DIVERGING trends.

This bearish divergence suggested shorting the new high in the Q's, but it didn't give an exact time frame in which to do this. You have to then look to when the stock STOPS going to new highs and then starts falling, even if gradually. That is the time to go in to the trade. Place a stop or exit point just over the highest high for the shorted stock or to exit puts.

A NOTE ON OVERbought or OVERsold extremes: Getting to an 'oversold' MFI reading, uysually defined as 20 or below and the equivalent of an RSI reading of 30 or below, was too soon to be buyer of the stock for most traders. But waiting to see if a bullish divergence set up was the right indicator 'trigger' to suggest a buy of the stock or a Call purchase; or other bullish strategies like selling puts.

Such a BULLISH Price/MFI divergence did set up as the new (price) low in QQQQ below 36 was accompanied by a HIGHER low in the MFI indicator, suggesting that the stock was under ACCUMULATION, another way of saying that the stock was being bought on balance below 37 dollars.

In the bullish price versus indicator divergence, when QQQQ started stabilizing in the $36 area and starting rising, even though by very little, it was the time to pounce on the stock and buy it.

Why not wait still longer, such as to when the rising trend is more fully apparent? Well, in options, premiums are going to inflate by then. But mostly, you have a 'defined' stop or exit point that is close at hand, which is to just below the lowest low in the stock. You have to assume and here's the great value of the 'oversold' concept, that upside potential for a rebound is substantially MORE than the small amount to just below the lowest low, you are going to risk in a 'normal' trading environment (versus some rare, calamitous, event).

Looking at the Relative Strength Index (RSI) comparison to price action, we see very little difference in the chart above with the way that the bearish or bullish divergences developed in the Money Flow Index.

CISCO SYSTEMS (CSCO):

In recent years Cisco Systems (CSCO) has been one of the key 'bellwether' stocks for the Nasdaq. Note that prices were trending down in July into early August, but the Money Flow Index made a double bottom suggesting that the stock was under some accumulation. The bullish price/RSI divergence was even more clear cut.

Down in the low-$17 area I was an enthusiastic buyer of the stock, setting a sell stop in the stock just under 17.00. I wasn't so convinced that I bought the calls, which were trading very cheap. Oh well! At least I bought the stock in my margin account.

The other thing, and best would if there was always other bullish factors in a bullish trade, was the fact that the stock had been accumulated heavily before in the $17 area. I also figured that institutions were sitting on the stock in that area and would buy more. The MFI would suggest that they did start buying the stock beginning at 17.5.

GENERAL ELECTRIC (GE):
One of my favorite bellwether stocks in the S&P and Dow is General Electric, which is in so many of the mainstream businesses in our economy. Here, I will let the chart highlights and text do the talking in the FIRST divergence instance, which was the Bearish MFI and RSI divergences when GE built a top last fall.

The other more recent (July August) markings and comparison of price action versus the MFI and RSI indicators, show the indicators merely 'confirming' price action. This is often the case in comparing price patterns versus indicator patterns; e.g., new lows are simply 'confirmed' by new lows in the indicators NOT by higher relative highs in the indicators. The divergences are less common, but very valuable as trading guides when they occur!



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** Good Trading Success! **
 

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

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