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Daily Newsletter, Wednesday, 12/27/2006

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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

Bulls Find More Treats in Toe of Holiday Stocking

Bulls found more treats in the bottom of their holiday stocking on Wednesday, where a stronger-than-expected rise in new home sales for the month of November had most market participants reaffirming their belief in Santa Claus and the "Santa Claus Rally."

After a 1.1% decline last week, it looked as if Santa Claus might be carrying lumps of coal in his sleigh, but the broader S&P 500 Index (SPX.X) has recouped all of last week's losses to come within fractions of its most recent multi-year high.

Small caps depicted by the Russell 2000 Index (RUT.X) 797.73 +1.21% grabbed today's bullish spotlight. With just two days left in the calendar year, the small caps battle 30 of the mega caps in the Dow Industrials (INDU) 12,510.57 +0.82% and the very broad list of 1, 2 and 3-lettered stock symbols for the NYSE Composite (NYA.X) 9,179.40 +0.84% and AMEX Composite (XAX.X) 2,056.31 +0.83% (+18.17% year-over-year) for this year's "U.S. Market Winner!"

Meanwhile the very broad NASDAQ Composite (COMPX) 2,431.22 +0.73% and its narrower brethren in the NASDAQ-100 Index (NDX.X) 1,763.41 and NASDAQ-100 Trust (QQQQ) $43.33 +0.51% bought up the rear as they have for much of 2006.

Closing U.S. Market Watch - 12/27/06

Homebuilders as depicted by the Dow Jones Home Construction Index (DJUSHB) 733.14 +1.86% found gains on mixed housing reports and with just 2-days left in the calendar year (see YrNet% above) are the only equity-based index in my U.S. Market Watch to show a negative return for 2006.

This morning's Mortgage Banker's Assoc. (MBA) report looked negative, but I do think a realization set in that buying a house the week of major holidays probably wasn't at the top of a "last minute shopper's list."

The MBA's seasonally adjusted mortgage applications composite index fell 14.2% from the prior week as the purchases index fell 10.6% to 390.2, but remained above the recent trough low measures of 375.5 from late September and late October. The refinance index fell 18.5% from the prior week as the average rate for a 30-year fixed-rate mortgage rose to 6.12% after dipping below the 6.0% level for the week ended 12/01/06. Other MBA indices, which comprise the composite, had the conventional index falling 14.3, while the government index fell 12.39%.

With a light holiday volume trade, it is difficult to tell if buyers showed up, or sellers vanished after the Commerce Department said sales of new homes in the U.S. rose by 3.4% to an annual sales pace of 1.047 million. The increase was well ahead of economists' prediction for a more modest 1.6% gain. The data also showed that homebuilders were working off some of their inventory as inventories fell 1.4%. While the median price of a new home is up 5.8% from a year earlier, the Commerce Department noted that sales are still down 15% from November 2005. November's year-on-year increase in the median house price was the most in five months.

Treasury yields rose notably from the time the housing figures were released with bond traders saying last week's jump in housing starts and today's Commerce Department report suggest the industry downturn that helped slow economic growth this year might not have the same impact in 2007.

Fed Chairman Ben Bernanke and other Fed officials have said that housing and energy prices are two primary areas of focus on the inflation front.

Economic reports scheduled for release tomorrow (in order of what traders/investors will focus on) is the 10:00 AM EST December Chicago PMI (forecast 50.0 vs. prior 49.9) where readings above, or below 50.0 signal expansion/contraction. Some economic data providers list this key report being released on Friday, but it will be a closely monitored figure. Today, the Fed Bank of Chicago said manufacturing activity in the Midwest rose 0.3% in November, compared to October, with machinery, resource and auto sectors all posting monthly gains.

Also due out at 10:00 AM EST is November Existing Home Sales (forecast 6.20M annual rate vs. 6.24M annual rate) and 10:00 AM EST December Consumer Confidence (forecast 101.0 vs. prior 102.9). Weekly jobless claims for the week ended 12/23 are slated to be released at 08:30 AM EST (forecast 315K vs. prior 315K).

Energy prices were weak again today, with February Crude Oil futures (cl07g) falling for a fourth-straight session. The February contract settled at its lowest level of the month, down 76 cents, or -1.24% at $60.34. Due to the Christmas holiday, the EIA delayed its weekly crude oil inventory report until tomorrow morning at 10:30 AM EST. Natural gas inventories will be reported on Friday at 10:30 AM EST.

Heading into settlement for January delivery, Natural Gas futures were weak as market participants have been reluctant to take physical delivery in the downward trend. February Nat. Gas futures (ng07g), which traded as high as $9.00 in late November, settled down 19.1 cents, or -3.02% at $6.142 per mmBtu.

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There a lot of company-specific news today.

One of today's top stories did have Apple Computer (AAPL) $81.52 +0.01% carving out a fractional gain after trading as low as $76.77 this morning! Shares of AAPL were atop today's list of most actives on a report that federal investigators are examining stock-option documents that were allegedly falsified by company officials to maximize potential executive gains. The report, citing anonymous "people with knowledge of Apple's situation," claims that criminal charges are being considered by prosecutors and that CEO Steve Jobs has decided to hire an attorney to defend against forthcoming Justice Department and SEC actions. Mr. Jobs previously relied upon the company's outside counsel. This Friday's delayed 10-k filing by Apple may contain further information on the options investigation, including the possibility of further earnings restatements.

Seeing the strength is easy, but what about weakness?

From a bull's perspective, it is GREAT to see the major indices pushing the envelope to new highs as we end the year, but let's remember that many traders won't return until after the New Year and volumes this week are running about 1/2 what they have been in recent weeks.

While holding one (1), or a partial put position on the Dow Diamonds (AMEX:DIA) $124.93 +0.77%, from a 12/01/06 entry point of DIA $121.93, I'm not about to pound my fist on the table and tell you there's major signs of weakness yet, or "still" to come.

However, some of the weakening signs I noted in last week's Market Wrap (Monday, 12/18/06) do look to be spilling over to other market internals.

In Friday evening's Market Monitor, I made the statement that I was turning more "neutral" from a mid-September "bullish" posture, and I'd like to review with you, some of the reasons why.

When you, or I review PRICE action in the above U.S. Market Watch, I want you to look at not just the 5-day Net% change for the major indices, but also the 20-day Net% and YrNet%.

Let's take the two major broad markets and the NYSE Composite ($NYA.X) and NASDAQ Composite (COMPX). Step back for a moment, take in a BIG picture and the YrNet%. The NYSE is up nearly double what the NASDAQ Composite has done year to date.

If just comparing these two markets, one can make several assumptions, or make statements as to "why" such a disparity exists (+18.17% vs. +9.17%).

But this is where I want to try and build on some of last Monday's commentary and "Have bears cried wolf one-too-many times?"

Again today, I see "valuation" as a bear's word of caution. That word of caution was used in September, October and November.

After this afternoon's close, I saw a Dow Jones news headline regarding S&P 500 earnings after 486 companies have now reported their Q3 earnings. Of the 486 companies that have reported, 208, or 43% have surprised on the upside. Twenty-eight percent, or 138 have issued positive reports. Ten percent, or 48 companies were on target with First Call estimates. Nine percent, or 46 companies issued negative reports, while 9%, or 46 companies revealed negative surprises.

**(Positive and negative surprises include companies that deviated from expectations by at least 5%, with adjustments when the numbers are near 0 and the percentage difference becomes meaningless. Positive and negative reports are from companies that deviated by less than 5%).

While some may view economists and fundamental analysts as "dart throwers" or those that have number-crunching models so complex that even they can't ascertain what the future holds, one should probably understand that a large portion of an analyst's estimate (reported and tabulated by First Call) is derived from the executives that actually run the companies!

What I want to focus on, and perhaps you may want to also stay focused, or aware of, is what you and I actually SEE.

It has been my experience that STRENGTH from one market can lead to STRENGTH in another. It has also been my observation that WEAKNESS in one market can lead to WEAKNESS in another.

As you review the BIG picture and the YrNet%, you can OBSERVE the PRICE differential. You and I might also make the observation that the "weakness" or the lag in the NASDAQ Composite has had NO effect on the NYSE Composite.

But there are signs that that this may be having an effect.

Last Monday (12/18/06) I reviewed the NASDAQ Summation Index ($NASI) on a 20-point box. While today's advance/decline line (see top table) was a very strong 2,175/900 and follows a very strong Tuesday a/d line of 1,878/1,156, I am OBSERVING a somewhat NEGATIVE, weakening NYSE Summation Index ($NYSI) begin to develop.

It's as if the NASDAQ is "pulling," or at least weighing on the NYSE.

Here's a quick update of the NASDAQ Summation Index ($NASI) where for vertical chart limitations, I'm going to once again show this chart on a point and figure 20-point box size. Then we'll look at the NYSE Summation Index ($NYSI).

NASDAQ Summation Index ($NASI) - 20-point box

The main observation is that since Monday, 12/18/06, the NASDAQ's a/d line has deteriorated from a +120 measure to +20. I tend to "think" of zero (0) as a point of equilibrium, but that "sell signal" at +200 still remains a warning sign of internal damage, where all the troops aren't advancing.

Now let's take a look at the NYSE Summation Index ($NYSI), which measures the a/d line of the NYSE. Here is where I start to see some of the "NASDAQ pulling/weighing on the NYSE" internals.

NYSE Summation Index ($NYSI) - 20-point box

Now, it may seem "crazy" that STRENGTH in one market can become STRENGTH for another, and that WEAKNESS in one becomes an alert for WEAKNESS in another. However, do you see the "buy signals" on the NYSE Summation ($NYSI) on 07/11 and 07/26? Those would have been well before the "buy signal" for the NASDAQ Summation at -580.

That was then, what about now? On the above 20-point box, the NYSE Summation ($NYSI) would have given its first "sell signal" on Tuesday at the +900 measure.

This is one sign of some internal weakening for the NYSE Composite ($NYA.X) 9,179.40 +0.84%, even as it closes at an all-time high this evening!

OK! That's two ways to VISUALLY look at some internals of two VERY BROAD indices. Roughly more than 6,000 stocks (3,000 NASDAQ and 3,000 NYSE).

What do you think about the NASDAQ-100 (NDX.X) YrNet% gain of roughly 5.6%? That's better than a kick in the mouth, but is it playing "catch up" to strength? Or is it a sign that WEAKNESS (relative to other major indices, say the 100 stocks in the S&P 100).

In today's Market Monitor, I provided a bit of a test for PRICE action with a day trade long for the QQQQ. Even a futures trader that may have traded the NQ on that signal may have been less than impressed with the NQ showing any attempt to play "catch up."

Now, let's take a look at another, yet different measure of internals strength/weakness, and the narrow (only 100 stocks) NASDAQ-100 Bullish % ($BPNDX). What we're doing here is simply looking at the percentage of stocks that comprise the NASDAQ-100 (the LARGE CAPS of the NASDAQ) that currently show a "buy signal" still intact with their point and figure chart. This indicator, or measure of internals gives us an observation of not only STRENGTH and WEAKNESS, but also RISK. I basic terms, HIGHER BULL RISK LEVELS are found at 70% and above, while LOWER BULL RISK LEVELS are found at 30% and lower.

NASDAQ-100 Bullish % ($BPNDX) - 2% box scale

While the NASDAQ Summation ($NASI) is exhibiting some signs of broader weakness in its advance/decline line, on Friday, 12/22/06 the narrower NASDAQ-100 Bullish % ($BPNDX) reversed to "bear alert" status at 66%. In early December (red C) 72% of the NASDAQ-100 stocks were showing a "buy signal" on their point and figure (supply/demand) charts, but now 66% show point and figure "buy signal" still intact, with 34% (or 34 of 100) now showing point and figure "sell signals" on their charts.

Now let's quickly review some PRICE action, and since it does appear that some WEAKNESS is leading WEAKNESS from the internals, I want to update a QQQQ chart shown previously in the 12/11/06 Market Wrap, where I had been "benchmarking" a Friday high close from 11/24/06 and various option expiration closes.

Since 11/24/06 (this would be just prior to early December) the QQQQ has NOT been able to see a Friday close above $44.65, and this past Friday (12/22/06) closed a penny (once cent) below $42.94. That's not a "big deal" on the surface, but it was a LEVEL, based on fibonacci retracement, I said I would use as an alert to PRICE weakness.

NASDAQ-100 Trust (QQQQ) - Daily Intervals

If I could describe yesterday's, and even today's PRICE action in the QQQQ, it would be "sympathy rally" with the other major indices. That is, their STRENGTH helped the QQQQ, but I wasn't that impressed and commented on it during today's session.

The table of today's internals should also warrant a quick discussion. I'm running very late on my editors deadline, and won't get a chance to show the NYSE, or NASDAQ New High/New Low ratio charts, but the NASDAQ NH/NL ratio chart has also given "sell signals" or "bullish leadership" as depicted by the number of New Highs compared to the number of New Lows as weakening.

In summary, several of the NASDAQ internals measures are signaling weakness, and flashing some warning signs to bulls. I have mentioned in prior Market Wraps that ACCOUNT MANAGEMENT should have traders/investors OFF of long MARGIN. That is, an investor that ONLY TRADES/INVESTS bullish, should NOT be on margin, and I would think 50% exposure on the LONG side for any major index (DIA/SPY/QQQQ) would be adequate.

A comparative Bullish % chart that I would have also liked to have shown in tonight wrap would be the S&P 100 Bullish % ($BPOEX), which like the NASDAQ-100, would be some of the LARGE Cap measures of the S&P. There are some stocks that comprise the S&P 100, that also comprise the NASDAQ-100, but there are differences too. Traders and investors can view that chart for FREE at www.stockcharts.com and its symbol is $BPOEX. StockCharts.com still shows it in a column of "X" to 84%, but as of tonight's reading is now 80%.

My thoughts as to WEAKNESS leading to WEAKNESS can be tested in the future too, should the $BPOEX begin to REVERSE lower.
 


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

Lockheed Martin - LMT - close: 92.95 change: +0.60 stop: 88.99

Wednesday was another bullish day in the market and our long play in LMT benefited. We're a little concerned about the light volume push higher and see the possibility for this stock to top out just above $94 but we'll reevaluate if and when LMT reaches that level whether or not we want to take profits a little early. Because it's reaching overbought and showing some bearish divergences at new highs we don't suggest any new plays at this time. A pullback to its uptrend line from June and its 50-dma, both located near $89.10, would provide a good opportunity for a new entry. If that support doesn't hold then we have our stop in the correct place. We have two upside targets--our conservative target is the $94.85-95.00 range; our more aggressive target is in the $99-100 range.

Picked on November 29 at $ 90.62
Change since picked: + 2.33
Earnings Date 01/23/07 (unconfirmed)
Average Daily Volume = 2.1 million
 

Put Updates

Intuitive Surgical- ISRG - close: 96.99 chg: +0.53stop: 104.05

ISRG broke its 10-day (with a minor bump up in the middle of that) losing streak with a small gain on Wednesday. While ISRG is oversold, which says it should be ready for at least a bounce, today's bounce looked more like a bear flag so we expect this to drop a little lower. Our downside target has been the $96.00-95.00 range and we're almost there. We do not want to hold over the early February earnings report. With the stock oversold and price nearing an uptrend line from August, currently at $95.70, we're suggesting taking profits and exiting the play if $95.80 is tagged. There is a gap up on November 20, 2006 that would be closed at $95.79. We can always look for another entry on a bounce.

Picked on December 18 at $102.05
Change since picked: - 5.06
Earnings Date 02/01/07 (unconfirmed)
Average Daily Volume = 938 thousand

---

Mohawk Industries - MHK - close: 75.38 chg: +0.42 stop: 79.01

Volume continues to drop during the bounce from Friday's sell off. Normally that's a bearish sign but during this low-volume week it's hard to say if it's meaningful. Watch for potential support at its uptrend line from July, currently near $73.30. MHK bounced up near its 10-dma at $75.58 and made for another short entry on this stock. A bounce back up to its 20-dma at $76.54 would not be out of the ordinary and could make for another entry point for a short play. A break below its uptrend line would also be a good entry. In the meantime we'll keep our stop above the December highs in case we see a bounce to relieve its oversold conditions. Our downside target is the $70.75-70.00 range, near November's low.

Picked on December 17 at $ 76.02
Change since picked: - 0.64
Earnings Date 02/22/07 (unconfirmed)
Average Daily Volume = 600 thousand

---

3M Co. - MMM - close: 78.47 change: +0.44 stop: 80.01

After dropping from its November highs MMM has been consolidating during December in what appears to be a sideways coil. This should be a continuation pattern for another leg down so our short play continues to look good here. We are suggesting puts for the more aggressive traders with the stock under $79.00 while more conservative traders can look for a decline under $78.00 or the 200-dma near $77.53. We consider this to be an aggressive, higher-risk play because MMM does have support at its 200-dma (where it found support today at $77.55) and is holding above its October gap up (top of the gap is near $77.35). It takes a break below $76.40 to enable bears to breathe a little easier. Our target is going to be the $72.50-70.00 range. The P&F chart is more bearish with a $47 target.

Picked on December 17 at $ 78.31
Change since picked: + 0.16
Earnings Date 01/19/07 (unconfirmed)
Average Daily Volume = 2.8 million

---

NewMarket - NEU - close: 58.69 change: +0.18 stop: 62.01

NEU dropped sharply first thing this morning but then recovered and closed slightly higher on the day. It is being held down by its downtrend line from the end of November and 10-dma, both near today's high of $58.75. A little higher, at $59.07, it would face resistance at its 100-dma which has acted as support and resistance for the past six months. The bounce off the December 19th low continues to look like a bear flag. NEU has a longer term uptrend line from October 2005 where price bounced on 12/19, currently at $56.79. A break of that support would be another opportunity to enter a short play. Our stop level is above the 20-dma ($60.08) which makes it a good place to keep it for now although more aggressive traders can consider lowering it to $61.01. Our downside target is the $54.00-53.50 range. FYI: The P&F chart points to a $51 target. Plus, short-interest is about 7% of the 14.8 million-share float, which is probably enough to raise the risk of a short squeeze if NEU abruptly turns higher.

Picked on December 14 at $ 59.11
Change since picked: - 0.42
Earnings Date 01/29/07 (unconfirmed)
Average Daily Volume = 275 thousand

---

Sears Holding - SHLD - close: 168.41 chg: +1.78 stop: 173.05

A trend line along the consolidation lows since October and the uptrend line from July are both near $169.50 and should continue to be resistance now that they have been broken. Our downside target is the $162.00-160.00 range. Aggressive traders can look for a further pullback to near $157 which is the October low and will be near the uptrend line from March 2006 by the time it gets there. Keep an eye on the simple 100-dma near $162.69 which might offer some support. If you missed the entry, any retest of the $169.50 area should offer another opportunity for an entry.

Picked on December 22 at $167.90
Change since picked: + 0.51
Earnings Date 01/16/07 (unconfirmed)
Average Daily Volume = 29.3 million

---

Yahoo! Inc. - YHOO - close: 25.75 chg: +0.30 stop: 27.05

YHOO got a bounce with the rest of the market today but wasn't able to get back up to its 10-dma at $26.00. If it can bounce a little higher it should find layered resistance at its 50-dma ($26.22), 20-dma ($26.44) and downtrend line from November ($26.45). This shows an area that could be another entry for a short play. The stop at $27.05 is above the resistance levels identified above. Our downside target is the $22.65 level near the October low. More aggressive traders may want to aim lower. FYI: It might be worth noting that short interest is about 6.9% of YHOO's 1.2 billion share float.

Picked on December 20 at $ 25.85
Change since picked: - 0.10
Earnings Date 01/16/07 (unconfirmed)
Average Daily Volume = 29.3 million

---

YUM Brands - YUM - close: 59.19 change: +0.45 stop: 60.26

Price continues to consolidate in a bear flag since our play was triggered. It's consolidating on top of what could be a neckline (at $57.80) for a developing H&S pattern since October. YUM climbed slightly above the 10-dma ($59.06) and might continue a little higher to its 20 and 50-dma's near $60. Our stop is at the right place just above the 50-dma. The 20-dma has crossed down through the 50-dma which should help our bearish play. A break below the neckline at $57.80 would offer an additional opportunity for a short play. Our downside target is the $55.75-55.00 range, which is near the top of the gap up on October 12, 2006. Closing the gap at $54.57 makes for another downside target.

Picked on December 12 at $ 58.49
Change since picked: + 0.70
Earnings Date 02/07/07 (unconfirmed)
Average Daily Volume = 1.6 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.)

---

Blue Nile - NILE - close: 36.37 chg: +0.12 stop: n/a

NILE has been struggling to bounce off its December low and while the bounce is not making much progress it is unfortunately just chewing up time. The bounce continued today but again stopped short of its 50% retracement ($36.52) of the decline from October. With it being overbought here we could see the bounce top out here. Our problem is time and we don't know if we'll see enough of a move before January expiration. 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), which is only $0.10, and the January $35 put (JWU-MG), which is bid at $0.65. Our best guess is that this stock is ready for a drop which would obviously help the put side of this trade. There's not much value left in the call side. A drop through $34.25 could see some acceleration lower but it will still need to get through its 200-dma at $33.71. For January expiration we'll need a closing price of $32.60 or less in order to cover our cost. There is still a reasonable chance that will happen if the broader market starts to sell off so use that as your guide as to whether or not you want to limit your loss and exit earlier. We'll continue to monitor this play into January expiration or an exit at $3.90 for either side, whichever comes first.

Picked on October 29 at $ 38.92
Change since picked: - 2.55
Earnings Date 10/30/06 (confirmed)
Average Daily Volume = 226 thousand
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

When Indicators 'Lead' Price

When I was a young sprout on the Street of Dreams, my trading mentor used to say quite often that 'volume precedes price'. Meaning that when a stock or index has reached an area of buying or selling interest, especially for professional traders and money managers, there is usually at least some pick up in volume (buying or selling) before an actual trend shift or turn up or down that's seen with a final top or low; or by a trendline(s) being pierced.

When a stock is under accumulation (being 'accumulated'/bought) or distribution (being sold/'distributed'), acute observation of volume trends can alert savvy market observers BEFORE an actual trend reversal or an acceleration of the trend. This 'heads up' may only be a day or two, but if a trend has been down, down, down, those interested in finding the inevitable bottom, at least in the case of a quality company, will be alert to the stirrings of buying interest. The same is true of a top; even the best companies will see their stock get overvalued and some institution will start to unload a few blocks of it, before there's any appreciable change in trend.

ON BALANCE VOLUME:
The normal way of displaying volume is by selecting "Volume" as an Indicator on charting applications - volume is displayed as a histogram or as vertical bars that show the volume total for that day on the right hand numerical volume scale.

On Balance Volume or OBV is also a type of volume indicator or volume-related technical formula; i.e., a mathematical calculation that is calculated and graphed with a financial instruments price and/or volume information.

OBV is an indicator that constructs a running total of volume that ADDS all the day's volume number when the close is higher than the day before and deducts ALL the day's volume when the close is lower than the prior trading session.

OBV CONSTRUCTION:
Assume that we start with a stock that traded a million shares on day 1 and assume this day is our starting point; we have to start somewhere. If the stock closes higher the next day and trades 750,000 shares, day 2s volume figure is added to the first day and assigned a positive number because our running total is a positive number; OBV is now a +1,750,000.

[NOTE: OBV would be a negative number if our example stock closed lower on day 2, on 1,500,000 shares: OBV would be 500,000.]

Going back to the example. Assume that on day 3 the stock closed lower on 500,000 shares and that days volume is subtracted from the cumulative OBV total: day 3, OBV equals +1,250,000. The stock is unchanged in price on day 4 and OBV is also then unchanged and remains +1,250,000.

This calculation process continues on into the future. If we graph the points, the resulting line will start moving upward or downward following the direction of the price trend of the stock for which OBV is being calculated.

Using the OBV Indicator with daily volume BARS:
I often display the OBV indicator on TOP of the daily volume bars per the GE chart below. If your own charting application or one on a web site only allows OBV use as a separate study, you can put it above or below the volume indicator:

General Electric (GE) had an interesting pattern of lower relative highs and higher lows, making a symmetrical triangle formation, as outlined below on its daily chart; a pattern that suggests that buying and selling forces are more or less in balance. A break out above or below this kind of triangle pattern usually suggests a strong move in the direction of the breakout. TRENDLINES applied to the On Balance Volume (OBV) line show the same up and down direction swings as price.

The OBV line in GE started up in early-September as seen above and the OBV line was quite consistently trending higher, even as the stock had an initial price dip back to the prior low. OBV here was showing the beginning of accumulation of the stock and helping reinforce a buying decision such as in calls or selling puts.

When the OBV downtrend line shown on the OBV graph above was pierced to the upside early in December, this was just ahead of the bounce and rally off the GE up trendline on the price chart. It was certainly reinforcing for what price action was doing. The recent pullback in prices has accompanied an OBV line that is trending higher, suggesting that the recent consolidation in bellwether GE will lead to another surge higher. This prospect also bodes well for a continued move higher in the S&P indices.

Certainly, SPX held 1410 and OEX above 655, the key supports suggested in my weekend Index Trader column, which can be seen online by clicking here.

OBV DIRECTION IS THE KEY:
With the OBV indicator, we are not concerned about whether volume is greater than or less than another day, and are looking at the direction of the LINE; i.e., it the OBV line trending higher with an up trend or lower with a down trend (volume is 'confirming' the price trend)?

Conversely is the OBV line trending down while prices continue higher; or, lower while prices trend higher; i.e., volume is 'diverging' from the price trend and suggests that the trend may be technically weak.

If the direction is up, the OBV line is bullish, as there is more volume on up days than on days when the stock price is down. A falling on-balance volume line is bearish, as more stock is being traded on down days than on up days. If both price and OBV are moving up together, it is a bullish sign portending higher prices. If both price and OBV are moving down together, this is a bearish indication for still lower prices ahead.

If prices move higher during a period of time when OBV lags or moves lower, this is a bearish divergence indicating diminishing buying activity and warns of a possible top or trend reversal. Conversely, of course, if prices are moving lower but OBV is trending higher, this is bullish divergence. This is not unlike other divergences such as when prices are trending lower, but with rising RSI lows; and, vice versa for a bearish divergence ith prices moving higher without a corresponding new high in the RSI oscillator.

BLAH, BLAH, BLAH
Enough with the words, on with the charts with On Balance Volume (OBV) markings on some key or bellwether stock charts relative to the S&P and Nasdaq indexes:

Intel Corp. (INTC) is of course a bellwether for the key semiconductor index, which is turn is a bellwether sector index in terms of the Nasdaq's prospects. INTC made an approximate double bottom low in the May to July period. However, traders didn't have to wait necessarily for that confirming sign of a bottom if they were also watching the OBV trend.

In terms of what a trendline highlighted with the OBV line above, OBV was trending higher AHEAD of the July double bottom intraday low in INTC. This is good example of volume trends, preceding price trends.

Google (GOOG) sure has been an interesting company, with its dynamic search engine and business model. The stock has been a great 'trading' stock also. On Balance Volume has shown some useful patterns that has reinforced clues to bullish or bearish price action; sometimes OBV has been slightly 'clearer' or ahead of the clues provided by the chart patterns.

Like a commodity chart (or a high-beta stock!), GOOG had some fast-paced bull flag formations over the course of its strong bull move of the fall. Trends in the OBV were insightful also.

The OBV trend was up clearly in GOOG, during the sideways move of the 1st. bull 'flag' pattern outlined above, suggesting reinforcement to the idea that strong accumulation of the stock was going on for a continued move higher. The 'breakout' noted at the OBV line above reinforced the idea of a bullish surge after bull flag #2 formed. The 'breakdown' suggested by the OBV trendline was a tip off for price weakness ahead earlier this month.

Microsoft (MSFT) has been a very consistent performer in the strong bull move in the market since this past summer. The sideways price consolidation (bull flag) of August highlighted on the MSFT daily chart below was accompanied by an OBV line that was consistently trending higher; if you didn't spot the bull flag pattern (a strong upswing followed by a sideways move; or, minor pullback dip as in GOOG above) but were watching the OBV line trending higher, it was apparent that the stock was being accumulated.


LOVE THOSE I-PODS, UNTIL WE DON'T
Apple Computer (AAPL), the maker of the trust MAC, which many California friends swear by, but which I never quite know how to use relative to my PC, has had a terrific run up fueled by the success of the new ubiquitous I-POD accessory in the X or pre-X generation.

I loved the stock until the recent breakdown and pullback; which may have ended today. I exited some calls on the stock when AAPL not only gave some signs of 'churning' and sideways wide-ranging intraday price swings indicative of a top, but when my OBV trendline got pierced as seen below.

The aforementioned OBV trendline 'break' (the line fell under its up trendline) with the close of 11/29, whereas the stock didn't start breaking below the low end of its price range until 12/6. An early Holiday present was had by profit-takers in AAPL calls bought a few weeks prior who exited based on the OBV trend action.

Again, because OBV is a directional line, it's easier to see the direction of the volume trend, in order to match it to the price trend. It is not the holy grail of indicators, but On Balance Volume is useful, especially at those times when daily volume jumps around; you need only glance at OBV to confirm the dominant trend in trading activity. It's even more useful when OBV turns up or down ahead of key (price) reversals.

GOOD TRADING SUCCESS!

** E-MAIL QUESTIONS/COMMENTS **
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Today's Newsletter Notes: Market Wrap by Jeff Bailey, Trader's Corner by Leigh Stevens, and all other plays and content by the Option Investor staff.

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