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Newsletter

Daily Newsletter, Wednesday, 08/30/2006

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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

Oil Slicks on the Road

Equity bulls found few barriers in their way when they shoved prices higher this morning. Prices were still being propelled by yesterday's upside momentum and no barrier was going to stop them. The GDP revision was roughly in line with expectations. An ADP payroll survey hinted at sluggish growth in Friday's upcoming payrolls number. The sluggishness of that growth might have been reassuring to those watching the Fed hawks for signs of more rate hikes and, hey, it was growth. An upside surprise in crude inventories sent crude futures lower this morning.

Both the GDP revision and the ADP payroll survey contained information that might give some bulls pause, but those bulls still had a strong purchase on the road to higher prices during the early part of the session. Not even a profit warning from Costco (COST) was enough of a barrier to stop that early momentum.

Tech and small-cap bulls kept the momentum going much of the day, with the SOX charging up past 450 and closing at 453.77. However, crude futures bounced, and the resulting oil slicks caused SPX and Dow bulls to stumble a bit against a new barrier on the road to higher prices. That new barrier was erected by Richmond Fed President Jeffrey Lacker who spoke on Bloomberg TV. He reiterated his belief that we can't assume yet that inflation has been tamed, and that nothing he has seen since the last FOMC meeting changes his mind. He still believes that further tightening might be needed. Lacker, as you may remember, was the one member who dissented from the vote to pause. Tomorrow's deadline on the Iran matter and the late-week economic reports probably also erected some barriers of their own.

The SPX's daily candle showed the effects of those barriers.

Annotated Daily Chart of the SPX:

The SPX's daily Keltner chart shows that the SPX has been finding support on daily closes at a Keltner line that was at 1297.18 as of yesterday's close. Price action has set a tentative upside target of 1309.01-1314.01, but today's daily candle questions whether that will be reached, or at least whether the SPX will require consolidation or a pullback to support before reaching higher again. RSI signals potential bearish divergence. Until that daily support is breached on a daily close, however, the rally continues.

That's the broad Keltner outlook. Shorter-term, the SPX's prices closed roughly in the middle of nearest support and nearest resistance as often happens when the market is uncertain ahead of the next day's reports. Those support and resistance levels were at 1302.76-1303.20 and 1306.13-1306.67 on 15-minute closes. The SPX looked poised to drop toward support as it closed today, but I expect tomorrow's numbers to be more important than what's seen on this chart. If those reports don't change the setup, a potential early pullback to support is possible but not a given.

A thirty-minute Keltner channel with outer bands at 1295.11 and 1307.01 usually contains most SPX candles, so, barring a breakout, the SPX appears near potentially strong resistance. Bearish divergence is more pronounced on this chart.

The Dow's daily candle was also a small-bodied one with both upper and lower shadows, a potential reversal signal. Anyone who wants to jump on the idea of a potential pullback after seeing that candle should glance across the Dow's chart at the Dow's April 19 candle, also a small-bodied candle with both upper and lower shadows, produced at the top of a climb. That potential reversal candle was followed by a day when the Dow closed higher by almost 70 points. Look for the possibility of a short-term reversal then, as suggested by today's candle, but don't count on it yet, especially in a thin trading environment.

Annotated Daily Chart of the Dow:

The Dow's daily Keltner channels show potentially strong resistance at 11433.84 and then 11505.96, a rather wide span, but traders should be careful if the Dow pierces the first of those levels and then pulls back to any degree.

Like the SPX, the Dow ended the day with the short-term charts showing the possibility of a pullback to support, currently at 11,366.79-11,370.31 on the 15-minute chart, but with prices so nearly balanced between support and resistance that it's difficult to trust that assumption. Nearest resistance on this chart is at 11,398.55-11,403.30.

The 30-minute chart shows that, barring a breakout, the Dow will likely find resistance on 30-minute closes from 11,401.84-11,406.44, so there's a lot of Keltner resistance building near that level. Barring that breakout, then, the Dow appears close to resistance on a short-term basis.

With the techs leading the way, the Nasdaq leaped above several barriers today, but it approaches several others, one a significant 50 percent retracement of its summer decline. Those 50 percent retracements often produce consolidation or a pullback to retest support, so be careful here, following any bullish plays higher with careful stop placement.

Annotated Daily Chart of the Nasdaq:

The Nasdaq's 240-minute Keltner chart shows the most correlation with the Nasdaq's movements. That chart shows the Nasdaq testing an important level at the close, a channel at 2180.80 on 240-minute closes. Support that was at 2161.83 on 240-minute closes has been holding as support, but, barring a new breakout, it may be time for the Nasdaq to pull back and test that still-rising support. The support may have moved higher by the time it's tested. There's tentative bearish divergence on the 240-minute chart.

There's been a breakout on the 15-minute chart, with the breakout support now at 2183.31-2184.50 on 15-minute closes. That's still rising, too, so will be higher tomorrow morning if the Nasdaq opens higher. If the Nasdaq gaps down, that support might convert to resistance, and should be slightly lower. There's pronounced bearish divergence on this chart, but the rally mode continues as long as the Nasdaq continues finding support at the breakout channel lines. The Nasdaq's short-term rally may be living on borrowed time, but it was still alive and well into the close.

The Nasdaq had not broken out on the 30-minute Keltner channel, and instead kept ending 30-minute periods jammed up against Keltner resistance that it was shoving slightly higher. That resistance was at 2186.35 on 30-minute closes, as of yesterday's close. Usually that's not a good sign for short-term bearish plays, but the fast-moving Nasdaq sometimes shoves to a last new high before it retreats to any degree after it's been pushing against this barrier for a while, as it has now.

Tech-related indices can and do breakout and extend their breakouts while bearish divergences continue. The SOX is one example, having broken out of its 30-minute Keltner channels yesterday and maintaining the breakout today while RSI levels off.

Annotated Daily of the SOX:

I wouldn't be surprised to see the SOX reach for that next resistance, a potential price magnet, but, if so, the 50 percent retracement and weekly 200-ema will likely serve as enough of a barrier to require some sideways consolidation if not a pullback. It looks as if there's some historical support building in the 445-446 region, so look for first support there, and then of course watch the weekly 200-sma at 432.10.

There was nothing bearish about the RUT's daily candle, despite the slight pullback off the day's high.

Annotated Daily Chart of the RUT:

However, the RUT also approaches an important 50 percent retracement of its decline, too, with that at 727.10 for the RUT. The 30-week sma is just ahead at 725.19, and there's some historical support/resistance in the 724.50-730.80 zone. Those are joined by 240-minute Keltner resistance at 722.86 as of the close. These suggest that the RUT could be close to resistance that will cause it to pause if not retreat.

For those not familiar with Keltner resistance, the following 240-minute chart shows the channel resistance I mentioned. The various channel lines can be confusing to the uninitiated, but just concentrate on the black channel and note how the RUT tends to trade in comparison to that channel.

Annotated 240-Minute Chart of the RUT:

Not all indicator indices were jammed up against resistance on their 240-minute or daily Keltner charts. The DJUSHB, the Dow Jones U.S. Home Construction Index, dropped today, but dropped within a triangle it's been forming most of the month. After last week's disappointing results from the National Association of Realtors and the Mortgage Bankers Association, the MBAA again reported a decline in weekly mortgage application volume survey. This was for the week ending August 25. The component that measures mortgage loan application volume fell 0.9 percent on a seasonally adjusted basis from the week-ago level, 2.3 percent on an unadjusted basis, and 22.4 percent from the year-ago level.

Most other components fell, too, with the refinance component being an exception. That inched slightly higher. Refinancing activity climbed as a percentage of total application activity, too. Four-week moving averages are still reacting to increases a few weeks ago, and remain mixed, with only the purchase component lower. Average contract interest rates for fixed-rate thirty-year mortgages climbed from the previous week's 6.38 percent to 6.39 percent with points increasing, too.

Jim mentioned in last night's Wrap that the sentiment figures yesterday could be forecasting a weak jobs number on Friday. Today, the ADP payroll survey showed growth that one adviser termed "sluggish." The ADP survey said that private payroll-sector payrolls increased by only 107,000 for August, with government jobs then likely to add another 10,000 jobs. The forecast for Friday's payroll figures is currently 130,000 jobs, but the ADP figure, if accurate, would predict a slightly lower payroll number of about 117,000. This ADP figure supposedly has a strong correlation with the payrolls number, but there was a big miss a couple of months ago, back in June.

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The big economic report for today was the second-quarter revision of the GDP. The general impression among television and print commentators and economists after the report was that the economy might be pulling back a little, but it really isn't doing too badly. Expectations had been for a revision to 3.0 percent growth, up from the previous 2.5 percent estimate, with the actual reported number at 2.9 percent. For reference, the first-quarter growth had been 5.6 percent.

A slightly higher final sales figure, up 2.3 percent rather than 2.1 percent, contributed to the revision, as did higher investments in nonresidential structures and higher exports. Also contributing, however, was a rise in inventory building, which could be due either to sluggish sales or resulting from a deliberate buildup ahead of an anticipated rise in sales.

Another potentially troubling component when we know the FOMC is watching closely for signs of wage pressure is that wage and salary growth were revised higher by nearly a third, according to one report. However, the key inflation data within the report were revised slightly lower, to an increase in core prices of 2.8 percent, down from the previous 2.9 percent. Unfortunately, that inching lower on the revised number did nothing to lower the year-over-year rise of 2.3 percent, which remains above the Fed's reputed target of 1-2 percent. A Marketwatch.com article noted that this increase in core prices is the largest in eleven years. Although the market interpreted the headline number as Fed friendly, all the data might not have been.

Investments in housing moved lower, no surprise, but the 9.8 percent drop in residential investment certainly didn't reassure those who believe that the housing market remains important to consumer sentiment and spending. Corporate profits rose 3.2 percent from the previous quarter, with this figure having risen 12.6 percent in the first quarter. We've been hearing a lot about stock buyback programs, with FLIR being the latest company to report on one, and one analyst noted that companies have major stockpiles of cash. That analyst expects higher energy and labor costs to burn through some of those stockpiles, however, perhaps rapidly. That might help explain why bullish sentiment turned sour on some indices when crude turned higher.

Jim Brown spent some time this weekend and last night discussing the outlook for crude, so I won't go into any depth in this report, except to note that crude inventories rose against expectations for a decline. Crude futures had been dropping ahead of the report and dropped further afterwards. Crude inventories rose 2.4 million barrels for the week ending August 25, the Energy Department reported. Gasoline inventories rose 400,000 barrels, and distillates increased by 136.8 million. Crude futures added to their losses immediately after the report to an intraday low of $68.60, reaching below the 200-sma and down to the 200-ema at $68.59. After almost touching that 200-ema, they bounced back above the 200-sma at $69.68 by the close, closing at $70.10 (QCharts, intraday) or $70.03 (QCharts, daily). The strong spring off the day's low suggested a potential short-term reversal but remember that some of the volatility could be due to the rollover of the new contract this week.

Other writers as well as television commentators have been noting the number of buyback programs impacting earnings this quarter, and the GDP revision revived talk about that trend. Flir Systems (FLIR) joined the ranks of other companies, with FLIR noting today that since June 30, it had bought back 4.1 million shares of its common stocks.

In another development, a judge ordered that the $50 million compensatory damage award in a federal Vioxx case was so excessive that it required a new trial.

Negative news came from various sources and industries. Retailer Costco (COST) lowered guidance today. COST said that fourth-quarter earnings would be $0.68-0.71. Analysts' actions today included downgrades of homebuilder Hovnanian (HOV) by JPMorgan Chase and Lockheed Martin (LMT) by Prudential. JPMorgan Chase downgraded HOV to a neutral rating from its previous overweight one and Prudential downgraded LMT to an underweight rating from its former neutral rating.

Tomorrow's economic releases will prove numerous, but perhaps not quite as important as today's GDP or Friday's non-farm payrolls and ISM index. One exception might be the core deflator that's part of July's personal income, one of the two reports issued at 8:30 tomorrow morning. Jim pointed out this weekend that this is a key indicator watched by the Fed. The other 8:30 release is the usual jobless claims, this one for the week ending August 26.

Releases will continue throughout most of the day, however, with August's chain store sales among them. At 9:00 the August NY NAPM will be released, followed at 10:00 by August's Chicago PMI and July's factory orders and help-wanted index. The NAPM and Chicago PMI might also garner a bit of attention. Natural gas inventories for the week ending August 25 come next, at 10:30, with August's Kansas Fed Manufacturing Survey appearing thirty minutes later. August's agricultural prices will not appear until 3:30.

What may prove more important than those economic reports is a speech by FOMC chairman Ben Bernanke. The speech will include a question-and-answer session, so there is more potential to impact markets. The speech begins at 12:30 EST, I believe.

Earnings are dwindling, but tomorrow's lot includes CIEN, DLM, DG, HRB, HNZ, TIF and ZLC.

I heard a CNBC correspondent argue today that markets are counting too much on an end to rate hikes, and that, if tomorrow's PCE deflator indicates a too-hot number and especially if Bernanke says anything too hawkish, markets could be set up for a pullback. I wouldn't argue with that conclusion, not with the SPX producing a small-bodied candle with both upper and lower shadows at the top of the rally. Someone was undecided ahead of tomorrow's numbers.

Techs and small-caps are driving this rally, though, performing the leadership role they often provide. Few of the other typical indicator indices--the RLX, TRAN and BIX, for example--agree with the techs, however, and that's a bit troublesome to those nourishing bullish hopes. Until they begin to do so, we have a bifurcated market, and it's unclear whether techs and small caps will pull other indices higher or those others will pull techs and small caps lower again. The techs and small caps are telling us that the early momentum players are betting on a rally, but the RLX, TRAN and BIX just don't agree as yet.

Techs and small caps need to provide continued momentum to the markets, so watch them closely. The RUT and COMPX ended the day jammed up against 240-minute Keltner resistance, so they're ready to either pull back or initiate another breakout. Which direction they go will prove particularly important without other leadership and with the SPX and Dow showing some hesitation and potential reversal signals.

Tonight, JDSU had fallen in after-hours trading after it reported a loss of $0.03 a share, a narrowing of its year-ago loss of $0.10 a share. As I type, it was trading at $2.23, down $0.40 from its $2.63 regular-hours close. The Nasdaq-100 After Hours Indicator had dropped, too. For guidance, watch how the Nikkei and DAX react, with those more indicative than the tech-light FTSE 100 would be of tech weakness and strength.
 


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

The Andersons - ANDE - close: 39.76 chg: +0.14 stop: 37.49

Unfortunately, there is still no change in ANDE. The stock continues to churn sideways on either side of resistance at the $40.00 level. Volume continues come in below average. Consider waiting for another move over today's high (40.24) before initiating new call positions. A dip and bounce anywhere above $37.50 could be used as a more aggressive entry point to buy calls. Our target is the $44.50-45.00 range.

Picked on August 28 at $ 40.26
Change since picked: - 0.50
Earnings Date 10/27/06 (unconfirmed)
Average Daily Volume = 900 thousand

---

AstraZeneca - AZN - close: 64.81 change: +0.50 stop: 59.95

The rally in AZN continues. The stock added another 0.77% and is now challenging potential round-number resistance at the $65 level. Normally we would expect a pull back here and traders can watch for a dip toward the rising 10-dma near 63.30 as another entry point. More conservative traders might want to take some profits as AZN nears $65. Our target is the $68.00-69.00 range but our time frame is mid-October.

Picked on August 20 at $ 62.99
Change since picked: + 1.82
Earnings Date 10/26/06 (unconfirmed)
Average Daily Volume = 1.1 million

---

Cameco - CCJ - close: 39.63 change: +0.21 stop: 37.95

We are starting to see a little bit of improvement in CCJ but the stock is still struggling with round-number resistance at $40.00. More aggressive traders might want to use the afternoon bounce from the $39.00 level today as a new entry point to buy calls. We would wait for a move over $40.00 or $40.50 before initiating new positions. More conservative traders may want to consider tightening their stops toward the $38.80 level. Our target is the $44.50-45.00 range.

Picked on August 22 at $ 40.33
Change since picked: - 0.70
Earnings Date 07/28/06 (confirmed)
Average Daily Volume = 1.9 million

---

Cognizant Tech. - CTSH - close: 70.70 chg: +0.15 stop: 68.45

Traders bought the dip near $69.75 on Wednesday and the afternoon bounce might be used as a new entry point for bullish positions. However, we are still suggesting that readers wait for another breakout over $71.50 before buying calls. Our target is the $76.50-77.50 range.

Picked on August 29 at $ 71.55
Change since picked: - 0.87
Earnings Date 11/01/06 (unconfirmed)
Average Daily Volume = 1.4 million

---

Cymer Inc. - CYMI - close: 39.97 chg: +0.69 stop: 39.95

The rally in semiconductors continued on Wednesday and the SOX hit a new two-month high. Sector strength helped inspire a 3.7% rally in shares of CYMI. The stock broke out above short-term psychological resistance at $40.00 and is now challenging its 50-dma and the August highs. Aggressive traders might want to buy calls now. We're sticking to our plan with a trigger to open positions at $42.55. If triggered our target is the $47.00-48.00 range.

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/24/06 (unconfirmed)
Average Daily Volume = 1.0 million

---

Freeport McMoran - FCX - close: 57.08 chg: +0.06 stop: 53.95

Gold and metal stocks saw a bounce today. Both the XAU and GOX indices produced a follow through gain on yesterday's rebound from their three-month trendlines of rising support. Meanwhile shares of FCX continue to consolidate under resistance at the top of its trading range near $58.00. More conservative readers may want to wait for a breakout over $58.00 before initiating plays. Our target is the $62.50-63.00 range. Traders should also note that we do expect some short-term resistance near $60.00 and a retest of the 100-dma, once broken as resistance, should act as support.

Picked on August 23 at $ 57.51
Change since picked: - 0.43
Earnings Date 10/17/06 (unconfirmed)
Average Daily Volume = 5.1 million

---

MicroStrategy - MSTR - close: 91.81 chg: +0.27 stop: 87.40

MSTR is trying to breakout higher from what looks like a bullish flag pattern. Unfortunately, volume was very low today and the stock is still struggling with its 200-dma and 100-dma overhead. More conservative traders might want to tighten their stop loss. We're thinking about adjusting our stop near $89.40. Currently our target is the $98.75-99.00 range.

Picked on August 16 at $ 92.05
Change since picked: - 0.24
Earnings Date 10/27/06 (unconfirmed)
Average Daily Volume = 431 thousand

---

Piper Jaffray - PJC - close: 57.52 change: +1.68 stop: 51.65

PJC continues to out perform the market and its peers in the broker-dealer/investment sector. The stock broke out over resistance at the top of its trading range near $56.00. This is a bullish move and could have been used as a new entry point. Our target is the $59.90-60.00 range.

Picked on August 20 at $ 55.70
Change since picked: + 1.82
Earnings Date 10/18/06 (unconfirmed)
Average Daily Volume = 300 thousand

---

FreightCar Amer. - RAIL - cls: 57.38 chg: +0.52 stop: 54.95

The Dow Jones transports and the railroad index both traded flat to down today. That left RAIL to trade on its own strength and the stock posted a 0.9% gain but failed to breakout over technical resistance at its 100-dma or 200-dma immediately overhead. Aggressive traders might want to buy this bounce. We would wait for a move past the 200-dma and 100-dma near $58.00 before buying calls.

Picked on August 20 at $ 59.13
Change since picked: - 1.75
Earnings Date 10/26/06 (unconfirmed)
Average Daily Volume = 475 thousand

---

Ryland Group - RYL - close: 42.31 change: -0.33 stop: 39.95

We do not see any changes from our previous updates on RYL. Shares continue to consolidate sideways and we're waiting for a bullish breakout above resistance at the $45.00 level. Currently our trigger to buy calls is at $45.15. If triggered then our target is the $49.90-50.00 range.

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/18/06 (unconfirmed)
Average Daily Volume = 1.7 million

---

United Ind. - UIC - close: 53.80 change: +0.15 stop: 49.45

UIC continues to march higher. Shares are nearing our primary target in the $54.75-55.00 range. We're not suggesting new plays because UIC looks a little short-term overbought and due for a dip. The 10-dma and 100-dma, both near 51.20, should act as short-term support. Our secondary target is $57.50. We would suggest selling half or more of your position at the first target and the rest at $57.50. The P&F chart points to a $64 target.

Picked on August 27 at $ 51.77
Change since picked: + 2.03
Earnings Date 08/01/06 (confirmed)
Average Daily Volume = 198 thousand

---

VF Corp. - VFC - close: 69.59 change: -0.51 stop: 68.45

Danger! Shares of VFC gapped open higher at $70.35 this morning and then promptly spiked lower. The stock closed with a 0.7% loss and the move looks like a bull trap and false breakout. VFC has resistance near $70.00 and we have been suggesting a trigger to buy calls at $70.25. Today's gap higher (on no news we can find) opened the play but the sell-off looks like a short-term bearish reversal. Aggressive traders might want to adjust their stop wider so the stop is under the 50-dma. We are not suggesting new plays at this time and would wait for a move past today's high (70.35) before considering new positions. If there is any follow through lower tomorrow we could be easily stopped out at $68.45.

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/18/06 (unconfirmed)
Average Daily Volume = 567 thousand
 

Put Updates

Boeing - BA - close: 75.02 change: +1.24 stop: 78.05

BA produced a 1.6% oversold bounce today. The stock continues to trade in a bearish pattern but we would not suggesting new positions right here. We continue to target the $70.50-70.00 range. More conservative traders might want to tighten their stops.

Picked on August 10 at $ 75.75
Change since picked: - 0.73
Earnings Date 10/25/06 (unconfirmed)
Average Daily Volume = 4.2 million

---

Burlington Nor.SantaFe - BNI - cls: 65.01 chg: -0.32 stop: 70.25

We can expect another significant move in BNI relatively soon. The stock's consolidation is narrowing and soon we expect to see a breakdown under $64.00 or a breakout higher through resistance at the top of its bearish channel. Given this scenario we're not suggesting new plays at this time. More conservative traders may want to tighten their stops (maybe near $68 or $67). Our target remains the $62.50-60.00 range. The P&F chart currently points to a $49 target.

Picked on August 08 at $ 68.06
Change since picked: - 3.05
Earnings Date 10/24/06 (unconfirmed)
Average Daily Volume = 2.7 million

---

Chipotle Mex Grill - CMG - close: 50.26 chg: +0.46 stop: 52.55

This sideways trading in CMG has not been so great for our option premiums. Hopefully today's failed rally just above $51 will herald the beginning of a new leg lower. We would wait for a move back under $50 or even under $49 before considering new put positions. We are targeting a decline into the $45.50-45.00 range.

Picked on August 09 at $ 50.28
Change since picked: - 0.02
Earnings Date 10/30/06 (unconfirmed)
Average Daily Volume = 414 thousand

---

Intuitive Surgical - ISRG - cls: 92.41 chg: +0.08 stop: 97.75

We do not see any changes from our previous updates on ISRG. The stock is essentially trading sideways but we do note a bearish, short-term trend of lower highs. We're not suggesting new positions at this time. The Point & Figure chart is bearish and points to a $60 target. We are only aiming for a decline into the $87.75-87.50 range.

Picked on August 10 at $ 94.90
Change since picked: - 2.66
Earnings Date 10/25/06 (unconfirmed)
Average Daily Volume = 1.1 million

---

Johnson Controls - JCI - close: 70.30 chg: -0.41 stop: 75.51

JCI is slipping back toward round-number support near the $70.00 level. We're not suggesting new plays at this time. Our target is the $68.50-67.50 range. The P&F chart, with its triple-bottom breakdown sell signal, points to a $61 target.

Picked on August 22 at $ 72.96
Change since picked: - 2.66
Earnings Date 10/19/06 (unconfirmed)
Average Daily Volume = 1.3 million

---

Radian Group - RDN - close: 59.95 chg: -0.25 stop: 61.51

There is no change from our weekend new play description on RDN. We are still suggesting a trigger to buy puts at $58.99. If triggered our target is the $55.15-55.00 range. We do not want to hold over the mid October earnings report.

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/18/06 (unconfirmed)
Average Daily Volume = 722 thousand

---

Transocean Inc. - RIG - cls: 65.77 chg: -0.75 stop: 70.25

Oil stocks continued to pull back on Wednesday. Shares of RIG dipped to $65.11 intraday making it the third time shares have hit our conservative target at $65.25. Our secondary, aggressive target is the $61 level. Currently the P&F chart points to a $49 target.

Picked on August 07 at $ 69.49
Change since picked: - 3.72
Earnings Date 08/03/06 (confirmed)
Average Daily Volume = 6.4 million
 

Strangle Updates

None
 

Dropped Calls

None
 

Dropped Puts

AutoZone - AZO - close: 90.17 change: +1.79 stop: 89.05

AZO is showing too much strength so we're dropping it as a bearish candidate. It was our plan to buy puts on a breakdown below support at the $86.00 level. That never occurred so the play is unopened. Today's rally in the stock (+2%) was fueled by an analyst firm upgrading the stock to a "buy". Chart readers will notice that the technicals on the weekly chart are growing more bullish.

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 09/21/06 (unconfirmed)
Average Daily Volume = 663 thousand
 

Dropped Strangles

None
 


Trader's Corner

Point and Figure Charting (1)

I am working on answering some question from my Subscriber 'mailbag'. Last week (see the 8/23 Option Investor Daily e-mail or go to the web site) I wrote on the use of market 'sentiment' as an aid to seeing impending trend changes or continuations of the existing trends. This week I'll answer the question on the basics of how to construct and interpret Point & Figure (P&F) charts, which OIN's Jeff Bailey uses a lot.

By the way, I saw an encouraging CBOE equities call to put volume figure yesterday (Tues): put volume jumped, possibly as a result of the S&P 100 (OEX) nearing its prior high (and the possibility of a 'double top') and the overbought RSI reading seen in my first chart below. The resulting dip in my (equities call/put) sentiment indicator, in the face of an ongoing and still-strong advance, I took as an indication that there would be breakouts to new highs for this move, which did in fact happen today in all the major indices except for the OEX.

Very often it's the case that the strongest moves occur when there is trader 'caution' on the way up. Market sentiment or the outlook on the near to intermediate trend by traders especially, is a good, if the not the best, way to measure if bullish sentiment is getting extreme on a rally. It's not here, as seen by how far under yet my lowermost (sentiment) indicator is from the upper line of an extremely bullish sentiment, which would be a situation suggesting an 'overbought' extreme and where we need be wary of a (downside) reversal.


CONSTRUCTING POINT & FIGURE CHARTS

INTRODUCTION
Point and Figure (P&F) is an old charting technique. Not as old as Candlestick charts which goes back to medieval Japan, but it was around in Charles Dows day over a hundred years ago and appears to have predated bar charts in 1896. 'Figure' charts were made by recording each price (figure) change on paper as prices changed.

Later, 'Xs', referred to as 'points', were inserted in the place of prices: this technique became known as the "point and figure" method of charting. As with Candlestick charting, the full subject is better covered in an introductory technical analysis book at least; dare I suggest mine: Essential Technical Analysis!

If you get keenly interested in this charting technique and have charting software that displays the price data correctly for this chart type, I would suggest further reading and study of P&F charts. Chartcraft as far as I know is still sending out weekly updated P&F chart books on stocks to subscribers using the '3-point' reversal standard.

Point and Figure (P&F) charts essentially views all trading as a single stream of prices and ignores the time duration it take to get from price point A to point B. You can also apply to P&F many of the technical analysis techniques that relate to chart patterns and chart 'markings' like trendlines. Some, or many analysis techniques CANNOT be used as they reference the passage of time; e.g., moving averages. Also, volume (of trading) is never accounted for either. On the other hand there are some techniques of projecting future price movements that are unique to P&F charting.

CONSTRUCTION
A Point and Figure chart is constructed by a serried of Xs and Os as can be seen below. Each X or O represents a price move of some amount, for example, '1', as in 1 Index point (a move from 600 to 601) in the chart of the S&P 100 (OEX); this amount is called the 'box' size.

On the chart, every X or O is equal to a price move of ONE index point: an X is an advance of this amount, an O is a decline of this much. As long as prices continue to advance by one point (or $1 in the case of stocks) or more, an X is added above the X in the box below it in the same column.

Boxes do not get filled in partially, but new Xs or Os keep getting filled in as long any NEW high or low is equal to or more than the box size. The chart here reflects price changes that occur based on HOURLY data. It could be DAILY data as well, which in fact is most common. I happen to save a LOT of hourly data; for example, I can go back 3 years of more in this manner. If you have the data for it, you can in most charting applications specify that the box size apply to prices registered in a period less than a day, as in this chart based on hourly price changes.

The most notable thing with the OEX P&F chart here is that, based on this chart type, OEX broke out to a new high today. You can compare this to the daily bar chart above, where this is NOT the case and the possibility of a double top formation is of more concern; especially to those holding OEX calls!

Trendlines, such as seen above, are used in P&F charts as frequently as in 'line' (close-only) charts, bar and candlestick charts.

THE REVERSAL CRITERIA OR AMOUNT

The second key element besides the box size is the reversal amount, which is most often quoted as a multiple of the box size amount; e.g., 3 in the case of the commonly used 1X3 P&F chart above.

This means that when the market is advancing and there is a price decline equal to 3 index points (or $3 or more in a stock) BELOW the value represented by the highest high and the topmost X, a new column of at least 3 Os is made and recorded in the next column to the right in a descending manner.

The reverse is true of descending boxes with Os: a rally from the lowest box with an O of 3 points or more (or, whatever is the reversal amount), will result in a new column to the right with 3 or more Xs plotted.

You may notice that the X and O columns always begin one box up or down from the end of the prior column its a convention of P&F charting to start the new column this way. The box size and reversal size is described as 1 by 3 (1 X 3) as noted above the chart. The box and reversal size could be 1X5, 1X6, 2X10, etc. In the OEX 1X3 P&F chart above, the number of Os will have to equal AT LEAST 3, but will be whatever the decline is in terms of the box size (e.g., 5, 10, etc.) BEFORE the next reversal occurs that's equal to what has been set as the reversal amount.

Youll note that there is a reference to dates on the bottom, on the time (horizontal) axis. This is not a time 'scale' in the sense in which it is normally used; i.e., one that marks regular increments of time, say days or weeks. Rather, the dates noted to the right of the little slash marks represent the beginning of a new column. A 'pure' P&F chart would have NO dates noted at all. However, a time reference is useful and no doubt what most traders use; my TradeStation charting application gives such dates automatically.

A box size could be greater than or less than 1. An example of a box size of .25, allows the recording of smaller price moves and is especially useful in the case of lower priced stocks, is shown below with Cisco Systems (CSCO). Here, each X or O denotes a quarter point price change. DAILY data was used only to construct the CSCO .25X3 P&F chart; as opposed to intraday price changes such as hourly.

It's interesting to note that once the leftmost down trendline was pierced to the upside, a subsequent pullback to that trendline acted as support and was a good spot to buy calls. While a bar chart more or less indicated the 'line' of support that kept showing up in CSCO around 17-17.25, this was MOST clear or pronounced on the P&F chart below.

The 'reversal' size of 3 remains the same in the chart above as in the prior chart: it takes a reversal in price of 3 times .25 or .75 to cause another column shift to the right and a change to the opposite figure such as from Xs to Os. The result of this is that we now see that a more detailed view of the price changes that occurred in the stock.

Variation of the reversal size will also make a significant difference and a large reversal amount can encompass many years of trading as can be seen in my next chart.

This next chart, which is of IBM, also has a box size of 1, but a reversal size of 10 and displays about 8 years of price history on the same size chart as the earlier examples. Some or much of the detail is lost and only the bigger trend changes are seen.

This is suitable for an investor with a long-term horizon; a larger reversal amount is going to be preferred. A chart with a large reversal amount shows the broad long-term price trend, which in this case is still down, relative to the late-90's/2000 top, in line with the S&P.

This is a good stopping point, as I will follow up in my next week (Wednesday) Trader's Corner article and go into the unique advantages of Point and Figure charts, which to me especially centers on determining upside or downside objectives by using horizontal measurements ACROSS the chart to determine upside or downside price targets.

Meanwhile, I suggest that you might look at some to the stock or indexes you follow closely and chart the same items with a Point & Figure chart, starting with the common 1X3 box/reversal size. The idea is to note what shows up in the P&F chart that is different and potentially useful relative to the standard bar or candlestick charts; for example, a clearer definition of support, of resistance, trendlines, etc.

In the meantime, Good Trading Success!

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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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