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Daily Newsletter, Wednesday, 11/22/2006

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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

Ding, Dong Dell

The Dell bell rang for the markets this morning, sending futures and enthusiasm for equities higher. The University of Michigan's sentiment figure was to dampen the bell's peals, however, if not muffle the bell entirely.

Introduction

Dell's preliminary earnings and Alcoa's decision to lay off five percent of its workforce and spin off one of its businesses as part of a restructuring effort rang in a positive sentiment during the overnight and pre-market sessions. Dell's (DELL) preliminary results, released Tuesday, had shown a 12-percent increase in Q3 profit as the company beat expectations. DELL gapped higher, with today's huge DELL volume producing higher up volume than down on the Nasdaq although Nasdaq decliners outnumbered advancers. Although that's not an indication of strong breadth for the Nasdaq, Dell was to help carry the Nasdaq into positive territory and close it there.

Positive performances had been the norm during the overnight session. Hong Kong's bourse had hit a new high. The Nikkei had rebounded Wednesday night, although it still has far to go to erase its almost 700-point tumble from last Thursday's intraday high to last night's intraday low, with that low produced soon after the open. The rebound from that point had occurred after the government said that Japan's economy had grown for the 58th consecutive month, the longest period of growth since World War II. However, the government also cited recent weak private consumption figures as a worry, downgrading its assessment of the economy. It was into that climate, one of growing concern about the consumer, that the University of Michigan's sentiment number was released.

The University of Michigan's sentiment number slipped against expectations that it would rise. That dampened the early enthusiasm. In addition, jobless claims had risen, and the TRAN was dropping ahead of the crude inventories. Although the early gains were erased by mid-morning on many indices, they didn't slip far past Tuesday's close, either, setting indices up for an end-of-day run into positive territory for most. Some stayed positive all day. The SOX chopped higher almost all day, climbing into a retest of Monday's high.

Mostly, however, ennui had set in as traders headed out early for the Thanksgiving holidays. The rest of the day was to produce small-bodied candles like musical notes, trailing sideways to sideways-up across the intraday charts.

Charts

The SPX continued in its typical consolidation pattern after a rise, the same pattern that has been followed by upside breakouts so many times.

Annotated Daily Chart of the SPX:

Whether or not the SPX will bounce again and rise to another new recent high is unclear. The SPX, if following recent patterns, does begin to look overdue for a pullback to test its 10-sma. If breadth measurements support such a tactic--and only if--that's the place to test the waters with a new bullish entry if you're so inclined. Be careful, though, and absolutely step right back out if the SPX rolls over again. While the VIX can stay low for longer than bears can stay solvent, it's at least signaling caution.

The SPX is going to pull back one of these days and it's not going to send out invitations to exit your bullish plays at a profit before it does. Absolutely do not step in with a new bullish entry automatically at the 10-sma if breadth indicators don't support such a play as the bullish side grows more extended, particularly if the SPX is plunging. Assess the water's conditions first.

As the SPX and other indices have been climbing in recent months, I've been urging nothing more bearish than protecting your bullish profits, if some judge that as bearish. I haven't been suggesting bearish entries and have been pointing out the continuations of patterns that have resulted in bullish behavior. Yet, I'm growing more cautious about suggesting new bullish entries as the rally extends and as the VIX dips.

The choppy pattern from this week has scrambled many intraday charts. They and their indicators are not particularly useful in a light-volume environment anyway, so I wouldn't want to mislead any by suggesting levels to watch from an intraday chart.

That's even truer of the Dow than of the SPX.

Annotated Daily Chart of the Dow:

RSI doesn't look strong in relationship to its former rising trendline, but the RSI has a limited upside level and it can't rise above that level. It couldn't climb that trendline indefinitely. Still, its empirical level, while not a sure-fire sign of an imminent retreat, does signal to bulls that they need to have their profit-protecting plans in place, just in case.

Otherwise, the chart setup is similar to the SPX's. The Dow looks overdue for a test of its 10-sma and maybe even the bottom of its rising channel. "Overdue" and "coming right away" are not synonymous, but the Dow's RSI behavior does urge bulls to be cautious. Keep ratcheting those stops higher with each Dow move higher.

I'm not sure when a pullback will occur. RSI has reached its current level many times during the Dow's climb without anything more serious than a test of support in store before another climb. There's nothing here to indicate that this time is any different. As was said with the SPX, it will happen sometime, and I'm not sure whether it will begin after a sideways correction fails to resolve to the upside, as has been the pattern, or whether it will begin after sellers capitulate in a wild buying frenzy. If you're in long-term bullish positions, you're in luck, however. You don't even have a decision to make. Let those ratcheted-higher stops take you out when they're hit and happily pocket all the money you've made.

The Nasdaq reached again for the top of its rising price channel, breaking above the resistance of its latest consolidation pattern. It did not, however, break above this resistance with a strong daily candle, but rather one that is a potential reversal signal.

Annotated Daily Chart of the Nasdaq:

Unlike some other indices this year, the Nasdaq's RSI doesn't tend to trend at its current level. If in bullish positions, know where your account-appropriate stops should be and adhere to them. You don't want to see the Nasdaq close beneath its 30-sma.

Although the 10-sma offers light support for the Nasdaq, that 30-sma is stronger and more important support. If you want a new bullish entry and the internals are good on a test of the channel's midline and the 10-sma, a partial entry might be okay, but be aware that a bottom-of-the-channel test might be needed. I don't like a new bullish entry with the RSI at this level, either, so I wouldn't suggest such an entry.

There's nothing confirming that potential reversal signal on the Nasdaq yet, not enough in this bullish environment to test new bearish positions. There's just enough to prepare trading plans if in bullish positions.

The SOX attempted a breakout of a recent bullish right triangle, but the RSI wasn't fully convinced.

Annotated Daily Chart of the SOX:

This was a breakout, if a minimal one, but there's still that pesky RSI level to worry about because of the importance of that level in the SOX's trading pattern. If there's a pullback, bulls would like to see support maintained at 489.40-490. Failing that, they want to see support at the 10-sma.

Obviously, a break out of a bullish formation is a bullish event. My hesitation, however, proceeds from that RSI level and the fact that the SOX has been acting strangely, counter to technical signals, for a couple of months. I didn't trust that we'd see downside follow-through and now I don't trust that we'll see too much upside follow-through, although technicals suggest that a retest of that former supporting rising trendline is in store.

The RUT, too, maintains a bullish stance if traders consider the fact that it's holding support at a trendline that was formerly resistance.

Annotated Daily Chart of the RUT:

Nothing appears on this chart to suggest a bearish entry, at least not yet, although the RSI level does urge protection of bullish profits. This advice comes both because of the RSI's level and because of the bearish price/RSI divergence. Remember, however, that RSI can climb only so high, unlike MACD, so a strongly trending market is going to produce some price/RSI divergences.

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Today's Developments

A number of economic releases were scattered throughout the day, some a day ahead of schedule.

After its survey results showed another strong improvement last week, today the Mortgage Bankers Association said that its weekly mortgage application volume survey revealed a 3.7-percent decline in volume, with this figure on a seasonally adjusted basis. On an unadjusted basis, the volume increased 5.1 percent week over week but eased 0.1 percent year over year.

Other components fell on a seasonally adjusted basis, with the refinance component producing the biggest decline, a 4.3-percent decline. Refinancing volume did increase as a percentage of total volume, however, perhaps due to last week's decrease in the 30-year, fixed-rate mortgages' rate to 6.13 percent. Rates for ARMS increased, a combination that probably also furthered some refinancing activity. Influenced by recent gains for several weeks, the four-week moving averages still rose for all components. The DJUSHB, the Dow Jones U.S. Home Construction Index, jumped today into a retest of its 200-ema. The 200-sma is just ahead at 713.11. With the index approaching the top of the channel in which it has climbed off its July low as well as those important averages, this is an important level for the index. The bounce off the summer's low looks like a bear flag, but it hasn't broken down and so we can't assume that's what it is. RSI has reached levels that have indicated that a downturn through the channel is approaching, but no sign of such a downturn has occurred, and there's of a bullish formation setting up over the last couple of months. I would guard bullish profits in homebuilders right now, nevertheless.

The Labor Department released initial claims a day early due to tomorrow's U.S. holiday. The Labor Department reported that those claims rose to their highest in several weeks, increasing by 12,000 to 321,000, above expectations. The four-week moving average also rose. Continuing claims rose to their highest reading in more than two months, increasing to 2.45 million. The four-week moving average of continuing claims also rose. The numbers remain broadly within the year's results, but at least one economist predicts that jobless claims should start trending higher.

The University of Michigan November sentiment was next. It eased to 92.1 from the earlier 92.3 and from October's 93.6. Economists had expected a rise to 93.3. Although there was a decline, the decline was nominal, perhaps too nominal to account for the halt in upward momentum that it seemed to produce. Perhaps some of that loss of early momentum and midday stall should also have been attributed to a decline in crude futures and energy-related stocks that were only to be exacerbated by the release of inventories numbers a few minutes later.

Late yesterday, tankers were loaded with crude oil from the Trans-Alaska pipeline's Valdez port. The process was begun with two vessels. However, it wasn't clear whether the weather-related problems that had caused a 75-percent reduction of its capacity had eased enough to allow a flow nearer the port's capacity. The port facility had been nearing its 7-million barrel inventory limit in crude due to the problems loading tankers.

Today Marathon Oil (MRO) said that it had partially restarted its North Sea Brae Alpha platform off the coast of Scotland. That platform had been shut down Monday after it had developed a minor gas leak. MRO and some other energy-related stocks rose in early trading, but that rise wasn't to last long, and particularly not past the release of crude and natural-gas inventories. Natural-gas inventories were released a day ahead of schedule because of tomorrow's U.S. holiday. MRO dropped heavily after the crude release. When other indices bounced later in the day, it did, too, although it never achieved the intraday high again and closed in negative territory.

Industry experts expected crude inventories to increase, gasoline inventories to fall, and natural-gas inventories to decline by 7 billion cubic feet. The Department of Energy reported, however, a big increase of 5.1 million barrels in crude supply, way out of line with expectations. The DOE said that motor gasoline inventories rose 1.4 million barrels and distillates fell 1.2 million barrels.

The American Petroleum Institute's figures always differ from the Department of Energy's, but this time there was a huge difference in one component. The API said that crude supplies declined by 1.7 million barrels, motor gasoline inventories fell 766,000 barrels, and distillates declined 1.4 million barrels. The difference in the DOE's estimate of the change in crude supplies and the API's is 6.8 million barrels.

Crude futures for January delivery dropped, taking many stocks in related sectors down with it. Without the leadership of those stocks, indices such as the SPX stalled. Not the TRAN, however. The TRAN had begun dropping sooner than had many other indices, but it was to bounce after the inventories numbers had been released. It wasn't to beat out the early morning high until mid-afternoon, however, after the Nymex's close. The CL contract was to close at $59.20 a barrel according to one quote source, down nearly a point from the previous day's $60.17 close.

Natural-gas inventories also surprised. They did decline, but only by 1 billion cubic feet, rather than the much higher predicted number. NG futures also dropped, although they stayed above the ascending trendline off the late-September low.

In company-related developments, the United Steelworkers Union late Tuesday announced its support for Russia's Evraz's bid to buy out Oregon Steel (OS). The union believes the deal would increase members' job security. Oregon Steel's board has also endorsed the deal.

Another deal appears to be in the works. Kirk Kerkorian's Tracinda Corp. reportedly plans a $55.00-a-share bid for 15 million of MGM Mirage's shares. Tracinda already owns 56 percent of MGM's stock. MGM gapped higher and closed at $54.21, up from Tuesday's $49.00 close.

The news hits GM, however. Some speculated that Tracinda was trimming its position in GM in order to obtain the money for an increased position in MGM, a speculation that was confirmed by Tracinda's SEC filing. Tracinda has reduced its position in GM's stock to 7.4 percent, down from the previous 9.9 percent. There was something behind GM's decline this week, and that something was Tracinda's unloading of stock. Investors who had hoped that the effect was priced into GM's stock already were to be disappointed. GM closed at $30.81, down from Tuesday's $32.61 close.

In other news, U.S. District Court Judge Eldon Fallon decided that the litigants saying that Vioxx caused heart attacks and other conditions can't be joined together in a Federal class action suit to be tried in New Jersey. He did not rule on whether the litigants in each state could band together in a class-action suit for each state and the District of Columbia, however. Some viewed this as a victory of sorts for Merck, as the company has wanted to try each case separately. However, Merck (MRK) couldn't hold onto its post-decision-announcement gains, although it did close in positive territory. It closed at $44.38, up from its Tuesday close of $44.21.

In early trading at least, the stock to watch was Dell's, although if you weren't in the stock ahead of Tuesday's announcement, there wasn't much opportunity to capitalize on a day trade today unless one was an adept scalper who got in and out at just the right time. After the first 30 minutes' volatility, DELL's price settled into a tight range. DELL closed at $27.13, up from Tuesday's $24.82 close.

Needham upgraded Dell's (DELL) stock to a buy rating after the company reported preliminary earnings yesterday. Reportedly, markets hate uncertainty, but that reaction must have been pass for the day at least. Investors were ready to gap Dell's stock higher despite the company's admission that results could be changed depending on the outcome of the federal securities regulator's probe into its accounting practices. With volume as high as it was today and with DELL's pullback from the day's high, I'd suspect that there was some selling into the day's bounce. That's not necessarily a sign that DELL's stock will collapse since the overhead supply could be exhausted at some point, allowing the stock to climb higher, but that combination of high volume and a pullback near a recent market top does urge bulls to plan their strategies in case sellers eventually prevail. The pattern could resolve just as it did after August 16 produced a similar volume/price-action pattern, so bulls should plan how they want to react to such a development.

Friday's Economic and Earnings Releases

No economic releases are scheduled for Friday according to a published schedule. Only seven companies are scheduled to report earnings Friday, too.

What about Thursday and Friday?

Tomorrow, equity futures close at 11:30 am EST, Eurodollar interest rate futures and currency futures close at 1:00 pm EST, and energy futures close at 1:15. Reportedly all futures re-open at their regular evening opening times.

Friday? Unless traders love turning the roulette wheel and taking their chances, it's not a day for day trades. Both bond markets and the Nymex will be closed Friday, leaving equities mostly on their own and perhaps directionless, although some energy futures will trade electronically. The U.S. Equities markets will be open only until 1:00 EST.

Volume will be low, which can result in odd and unpredictable market behavior. Sometimes light holiday volume results in narrow-range behavior, sometimes it results in big swings, and sometimes it results in narrow-range behavior that explodes out of its range and runs wildly. Whatever tact is taken by the markets, the behavior is often not amenable to technical analysis. Some little hedge fund can upturn everything technical analysis has been showing so that traders are relegated to trading on faith that their guesses will result in a profitable trade. I've spent this week paper trading a new type of combination option play I want to try. I suggest that unless you're already in the market and watching to protect your position, you do something similar. For what it's worth, the Friday after Thanksgiving tends to have a bullish tenor, but if you want to trade on that thin evidence, I won't be joining you.

As I did this weekend, I want to wish our U.S. readers a Happy Thanksgiving.
 


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

Akamai Technologies - AKAM - cls: 51.01 chg: +0.36 stop: 47.95

Markets were little changed on Wednesday ahead of the Thanksgiving holiday in the U.S. tomorrow. Technology stocks still managed to out perform and AKAM rose 0.7% after traders bought the dip near $50.00 this morning. We don't see any changes from our new play description from Tuesday night. The P&F chart is bullish with a $56 target. We would label this as an aggressive, higher risk entry point since AKAM does have short-term resistance at $52.00 and again near $53.00. More conservative traders may want to decide and wait for further strength before considering new positions. Our short-term target is the $57.00-60.00 range.

Picked on November 21 at $ 50.65
Change since picked: + 0.36
Earnings Date 01/25/07 (unconfirmed)
Average Daily Volume = 5.3 million

---

Bear Stearns - BSC - close: 158.42 chg: +2.26 stop: 151.89*new*

The string of new highs in the broker-dealer stocks continued on Wednesday. Shares of BSC rose 1.44% to a new all-time high and the stock came within 50 cents of our target in the $159.00-160.00. Odds are good that BSC will hit our target on Friday but more conservative traders may want to jump the gun and exit early to lock in a gain now. We are raising our stop loss to $151.89.

Picked on November 14 at $151.89
Change since picked: + 6.53
Earnings Date 12/14/06 (unconfirmed)
Average Daily Volume = 1.5 million

---

CNOOC - CEO - close: 86.62 change: +0.68 stop: 84.45

Shares of CEO experienced something of a volatile session in spite of sleepy U.S. markets. The Hong Kong Hang Seng index turned in a strong session on Wednesday and that would account for CEO's gap open higher in the U.S. markets this morning. Unfortunately, a drop in crude oil futures deflated CEO's rally attempt. We would watch for a dip back toward the $86.00-85.50 region as a new entry point to buy calls. Our target is the $89.50-90.00 range.

Picked on November 21 at $ 85.94
Change since picked: + 0.68
Earnings Date 03/23/07 (unconfirmed)
Average Daily Volume = 261 thousand

---

FedEx - FDX - close: 118.63 chg: +1.05 stop: 113.90

FDX is finally starting to show some strength after four days of consolidating sideways. We remain optimistic but we are expecting some resistance at the $120 level. Don't be surprised to see FDX hit $120 and then dip back toward the $117-118 region, which we would use as a new entry point to buy calls. More conservative traders might want to consider a tighter stop loss. Our target is the $124.00-125.00 range. The P&F chart is more optimistic with a $153 target. FYI: We do not want to hold over the December earnings report.

Picked on November 15 at $117.15
Change since picked: + 1.38
Earnings Date 12/21/06 (unconfirmed)
Average Daily Volume = 1.9 million

---

Fomento Econo. - FMX - close: 105.60 chg: +0.14 stop: 99.49

We don't see any changes from our previous updates on FMX. The stock continues to look bullish with a relatively steady trend of higher highs and higher lows. One thing we have noted is how volume has risen over the last couple of days while the stock hasn't. If this continues (high volume, no movement) we could be seeing distribution and a potential top. We would only consider new plays on a bounce from the rising 10-dma. Our target is the $107-110 range.

Picked on November 08 at $102.09
Change since picked: + 3.51
Earnings Date 10/27/06 (confirmed)
Average Daily Volume = 314 thousand

---

KLA-Tencor - KLAC - close: 52.43 chg: +0.52 stop: 48.49*new*

Semiconductors reversed their weakness from Tuesday and the SOX index rose 1.2%. Shares of KLAC rose 1% and managed to close at a new eight-month high. Please note that we're raising the stop loss to $48.49. Our target is the $54.50-55.00 range. The stock appears to have solid resistance at $55.00.

Picked on November 14 at $ 50.81
Change since picked: + 1.62
Earnings Date 01/00/07 (unconfirmed)
Average Daily Volume = 3.9 million

---

Sepracor - SEPR - close: 55.30 chg: +0.02 stop: 50.75

SEPR followed the markets and traded sideways on Wednesday. We don't see any changes from our previous updates. SEPR has significant resistance near $60 so we're aiming for the $59.50-60.00 range as our target.

Picked on November 19 at $ 54.69
Change since picked: + 0.59
Earnings Date 01/25/07 (unconfirmed)
Average Daily Volume = 2.3 million

---

Thomas & Betts - TNB - close: 52.83 chg: -0.10 stop: 49.90

TNB also churned sideways on Wednesday and the stock continued to hug its rising 10-dma. If you're feeling optimistic shares were bouncing higher into the closing bell. Readers may want to use this rebound from the 10-dma as a new bullish entry point. Our target is the $56.00-57.00 range. Currently the P&F chart points to a $77 target.

Picked on November 12 at $ 51.36
Change since picked: + 1.47
Earnings Date 01/23/07 (unconfirmed)
Average Daily Volume = 471 thousand
 

Put Updates

Cardinal Health - CAH - cls: 62.16 chg: +0.28 stop: 64.05

There are no changes from our previous updates on CAH. The trend is still down but we remain wary and we're not suggesting new put positions at this time. Our target is the $58.00-57.50 range.

Picked on November 10 at $ 61.99
Change since picked: + 0.17
Earnings Date 10/27/06 (confirmed)
Average Daily Volume = 1.3 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.)

---

Caterpillar - CAT - close: 62.79 chg: +0.60 stop: n/a

Dow-component CAT managed to show some strength. The stock rose 0.96% and actually closed over its late October high by a penny. CAT has begun the process of "filling the gap" but now the stock has to contend with potential technical resistance at its 50-dma just overhead. We're not suggesting new strangle positions in CAT. The options in our strangle are the December $65 call (CAT-LM) and the December $55 put (CAT-XK). Our estimated cost was about $0.75. We want to exit if either options rises to $1.50. Don't forget that December options expire in about three weeks.

Picked on November 08 at $ 60.10
Change since picked: + 2.69
Earnings Date 01/19/06 (unconfirmed)
Average Daily Volume = 7.7 million

---

Blue Nile - NILE - cls: 36.27 chg: +0.15 stop: n/a

We don't see any changes from our previous updates. We're not suggesting new strangle positions at this time. Our estimated cost was $2.40 and we're planning to sell if either side of our strangle rises to $3.90. The options in our suggested strangle are the January $45 call (JWU-AI) and the January $35 put (JWU-MG).

Picked on October 29 at $ 38.92
Change since picked: - 2.65
Earnings Date 10/30/06 (confirmed)
Average Daily Volume = 226 thousand
 

Dropped Calls

Gilead Sciences - GILD - close: 66.55 chg: -0.96 stop: 66.75

GILD has continued to show relative weakness following its failed rally at resistance near $70.00 on Monday. Today's session witnessed GILD breaking down under technical support at its rising 50-dma. We're going to drop GILD as a bullish candidate. It has been our plan to buy calls on a breakout over $70.00 with a trigger at $70.25 but the stock has failed to hit our trigger.

Picked on November xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 01/17/07 (unconfirmed)
Average Daily Volume = 3.7 million
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

My 'Sentiment' Indicator

After my Trader's Corner article last week that discussed the jump in bullishness as indicated or suggested by my CALL/PUT INDICATOR at the end of last week, I received several Subscriber e-mails asking how I constructed it, was it available on any charting application(s) and what has been the history of trader 1-day (or multiple) extremes in bullishness or bearishness predicting trend reversals?

Since we get new Subscribers all the time, OR long-time readers happen to notice something for the first time that I've written on my indicator and/or on the subject of trader 'sentiment' as a contrary indicator, I should go over this again.

As seen in your saved e-mail; or, online by clicking here.

I posed the question in my Wednesday Trader's Corner column of last week (11/15):

"DO TRADERS 'BELIEVE' THE TREND?
This is major. In the nothing new under the sun department, Charles Dow long ago talked about how MAJOR trends don't die/reverse until there are a LOT of 'believers'. The way I measure this is by a 'sentiment' indicator using a simple equities call to put daily trading volume ratio plotted on a graph, as seen in this first chart. Some of the strongest moves come with less than obvious consensus on the outlook for EARNINGS in the coming 6 months to a year.

When there is disbelief or just caution in the staying power of a powerful move, the tendency is for that move to be longer, to go further and with fewer CORRECTIONS than traders especially anticipate. As traders we are used to trading less powerfully trending markets. Non-trending or 'trading range' markets (70% of the time) are more common than strongly trending markets (30% of the time).

If my sentiment indicator doesn't jump to an extreme, it's a good sign for the market trend continuing. This doesnt address the question of how high it can go on the next price swing or ultimately, but it's a good indicator or good indication to stay in the market."

Well, we did see an extreme on a 1-day basis in the call to put volume ratio on the CBOE for all equities options, which hasn't continued this week. Nevertheless, there is a good record of market corrections within 1-5 trading days after any 1-day extreme. That leaves us until Monday of next (11/27), so stay tuned with me!

I'm going to write an explanation on construction, use and rationale in a moment, but first let me go back to the idea of a top or bottom tending to occur within 1-5 days AFTER extremes in this indicator, or levels above 2.1 and below 1.2 as seen on the bottom of the S&P 100 (OEX) chart below. I am going to have to modify this rule of thumb slightly. I am talking mostly about TREND CHANGES. A 'trend change' can be a trend REVERSAL or it can be a notable acceleration of the previous trend:

Example #1: Two days after the early-August dip in the Equities options call to put daily volume ratio, such that daily call volume was nearly EQUAL to daily equities put volume, the market finished it's sideways to lower dip and reached it's lowest low during that time frame; after that low, the market took off in a strong upside extension of the bullish trend.

Example #2: The DAY AFTER the same type call to put reading seen in example 1 in early-October, OEX had a major up day and began another rally of a few weeks before there was even a minor pullback.

Example #3: The way this unfolds remains to be seen; e.g., the start of a (downside) correction, which would be suggested by a daily close below 650; or a reversal/correction after a peak around 660, which I figure may offer some resistance. Stay tuned on that!

To talk about 'sentiment' type indicators involves looking at the concept of 'contrary opinion' in the market.

CONTRARY OPINION
To understand why extreme levels of bullishness or bearishness tend to lead to a result of an OPPOSITE move ahead in the market, relates to the well-known concept or theory of 'contrary opinion'. This idea really goes back to Charles Dow's observations on market behavior. Dow was always as much a student of investor psychology as anything. He didn't call what he was talking about in this regard as a 'theory' or talk about 'contrary opinion'. Dow simply observed over many years and in different markets that when the mass of investors got extremely sure that stocks were going to keep going up, or keep going down, as 'far as the eye could see', this type of mass conviction was part of what happened near the END of bull, or bear, markets. Why?

The explanation for this is part of what it means to say that a market is 'over'bought or 'over'sold. In the case of a bear market or a bearish (down) swing, most traders or investors who are going to or are prone to sell, have done it already. This dynamic is what 'makes' a bottom so to speak. There are few investors left to sell. Therefore it doesn't take much buying to lift the market.

Of course, for a sustained bull market to begin there has to a change in the conditions relating to companies ability to start to make money or increase their profits. But, usually in a shift from a bear to bull market, individual traders remain bearish or just uninterested in stocks for some time, even if the major indices lift 10, 15 or 20 per cent off their bottoms.

In a bull market it's more common to take time to 'build' a top. The chart pattern tends to be different in bear markets. The final waves of selling tends to be more of a once or twice decision and come more in big surges of selling volume, when traders get really convinced that the market has no hope of advancing. In RISING market trends there is a lot piecemeal buying however. At tops, the mass of investors tend to keep buying, whereas more sophisticated professionals are selling, as they see that stocks have hit PE multiples that are 'over' done; there's that 'over' word again!

In terms of (technical/chart) patterns, this difference in tops versus bottoms explains why there are more 'broadening' or rounding tops, versus more 'spike' lows at bottoms. These two different pattern types tend to be the case whether we're assessing an hourly, daily or weekly chart.
There is a lot more about this subject in my book (Essential Technical Analysis) or in other guides to technical analysis. Mine is no longer being printed by J. Wiley & Sons, although it's still available via Amazon.com, both new and used; although why anyone would sell such a 'gem' is beyond me; but, the (book) 'market' has spoken on this...!

The reasons that market swings tend to be preceded by a build up or jump in bullishness is also part of the nature of mass/mob psychology to go from one extreme to another. What makes 'cycles' in markets is the pendulum like tendency to go from one extreme, then to start to swing back the other way, then all the way. Individuals as part of large groups have a tendency to be unrealistic in their expectations, somewhat less true of market professionals. When you work all the time with something, you know considerably more than average investor for whom market analysis is a part-time or occasional thing.

The point to make relative to my next chart of the S&P 100 (OEX) is that the market really wasn't able to break out to the upside in a new up 'leg', given the overbought-heavily bullish outlook suggested by my call to put readings 1, 2 and 3, where all registered extremes above 2.1 (and, in one instance, example 3, a LOT higher than 2.1).

Within a few days of the peaks seen at 1, 2 and 3 on the lower portion of the OEX chart below, a minor pullback began of 10-15 points in OEX. Ok, back to the Subscriber questions on how I construct this particular indictor.

CALCULATION OF MY SENTIMENT INDICATOR
Very simple, and similar to the common 'Put-Call' Indicator EXCEPT for two key things:

1.) Not SO key to the grand scheme of things, but I like to use whole numbers and read 'oversold' as the BOTTOM extreme and 'overbought' as the TOPmost extreme, just like the RSI and Stochastics and any of the 'overbought/oversold' indicators. To get this result, simply daily Call volume by daily Put Volume (almost always half or less). AND ... there's one other very key aspect:

2.) I use only CBOE daily EQUITIES Volume and take out the STOCK INDEX volumes. (The CBOE is enough of a representative sample that I don't need to use the totals from all options exchanges.) Since there is a lot of hedging activity that goes on in Index options, I get a more accurate reflection of bullishness or bearishness by just looking at the activity in individual equities' calls versus equities' puts.

It's of course also true that there is always some amount of Covered Call writing going on, and selling of puts as a bullish play (or attempt to get put the stock at a cheaper than current price). At times due to some big event in a big stock (e.g., payment of a special dividend), there will be significant related option activity. However, on balance, plotting the ratio of daily CBOE equities call to put volume, results in the most useful 'sentiment' indicator showing the bullish or bearish outlook and the occasional extremes of bullishness or bearishness.

The quirk about using my formula is that you can ONLY chart it yourself; or, write down the daily ratio and track it. You can sign up for an end of the day e-mail that will give you the number as part of the "CBOE Daily Market Summary". Also, a check can be made of the CBOE web site sooner and just after the Close; the final hourly summary will allow a close to exact ratio.

Fellow TradeStation users wrote me and thought that they might have overlooked my "CPRATIO" indicator. Not so, it's just that the TradeStation charting application allows me to create a 'custom' data item by giving this fictitious instrument a name and inputting a closing value each day. The application then charts it like it would any other instrument such as a stock or an index.

GOOD TRADING SUCCESS and HAPPY THANKSGIVING!

** E-MAIL QUESTIONS/COMMENTS **
Please send any technical and Index-related questions for answer in Trader's Corner articles to Click here to email Leigh Stevens Support [at] OptionInvestor.com with 'Leigh Stevens' in the Subject line.
 

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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