The Wednesday FOMC announcement suggested further rate hikes in our distant future but bulls ignored the news and charged higher. It was a Goldilocks week for economics with a mixture of slow growth indications and weakening inflation numbers. What is a bear to do when all the signs point to an early spring rally? Evidently they cover their shorts and move to the sidelines to avoid being trampled. New highs are becoming commonplace once again and still no correction in sight.
Dow Chart - Daily
Nasdaq Chart - Daily
The biggest economic report on Friday was the non-farm payrolls with a headline number showing a gain of +111,000 jobs in January while the unemployment rate rose to 4.6%. This was well below the consensus estimates for a gain of +150,000 but just right for Goldilocks. Adding to the positive spin was an upward revision of December by +30,000 to 206,000 jobs and November by +42,000 to 196,000 jobs. Warmer than expected weather was credited with some of the employment gains in the construction sector. The January employment report also contained the annual revision for all of 2006 and that showed another gain of +752,000. This pushed the average monthly average for 2006 from 153,000 to 187,000 jobs. This was a very nice report and suggests that the economy is stronger than previously expected but is not growing at an inflationary pace. This was the perfect Goldilocks scenario except for the continued drop in manufacturing employment of -16,000 jobs in January stretching the loss to -129,000 manufacturing jobs since June. This is consistent with a six-month decline in the ISM manufacturing index. The weakness in manufacturing and the continued tame increase in monthly job creation support the Fed's decision to remain on the sidelines. Once jobs begin to spike that decision will be much tougher.
The final reading of January Consumer Sentiment came in at 96.9, down from the initial reading of 98.0 but still well above Decembers reading of 91.7. The slight downtick late in the month could have been due to the arrival of the holiday bills. Gasoline prices are holding at their lows and the markets remain at their highs. Job creation is strong and wages are rising. There was nothing in the headlines to depress sentiment leaving analysts to suspect the arrival of holiday bills as the culprit. Even at the slightly lower level this was still the biggest one-month jump since Dec-2004. The expectations component posted the biggest gain of +6.4 points.
The final economic report on Friday showed that Factory Orders rose +2.4% in December following an upwardly revised gain of +1.2% in November. The headline number was well above the consensus estimates for a rise if +1.9%. Durable goods orders rose +2.9%. Nondurable goods orders rose +1.8% and the largest increase since May-2006. This bounce in orders shows the economy picked up slightly late in Q4 and is consistent with the Goldilocks slow growth scenario. Even with this unexpected rise in December the orders for the entire fourth quarter were the lowest since Q3-2001 when we were well into the recession. Inventory levels have begun to moderate and manufacturers will continue to manage them as we move further into 2007. In the ISM we saw a sharp drop in the inventory component that was the largest drop since the early 1980s and the lowest level since 2001.
Last week was a very busy week economically and the outcome basically confirmed the Goldilocks scenario and the Fed's decision to remain on hold. To recap the week's events puts this into perspective.
New Home Sales 1,120,000 versus estimates of 1,055,000
The majority of the reports were slow growth positive with only the PMI and ISM showing slight declines into contraction territory. Those declines were driven by the decline in the manufacturing sector and that is actually positive for inflation watchers. More weakness in manufacturing reduces the chances of inflationary prices. For the bulls it was the perfect economic storm. The overall cloudy conditions remain but faint rays sunshine are peaking through in many places suggesting better weather ahead.
The Fed added to the expectations for sunshine with their surprising comments on the economy. The statement was almost bullish in tone considering it came from a bunch of career bankers and economists.
"Recent indicators have suggested somewhat firmer economic growth, and some tentative signs of stabilization have appeared in the housing market. Overall, the economy seems likely to expand at a moderate pace over coming quarters. Readings on core inflation have improved modestly in recent months, and inflation pressures seem likely to moderate over time."
What is not to like about that statement. There is no sign of a more hawkish Fed and one that wants to talk up interest rates. They did maintain their tightening bias but it remains bland and data dependent. All that Fed worry and it turns out they were on our side. The bears were definitely blindsided by that one.
Punxsutawney Phil came out of his burrow on Friday and did not see his shadow. That is supposed to mean spring is just ahead and we have been spared six more weeks of winter. Ben Bernanke and company came out of their burrows this week and saw a stronger economy and falling inflation. They quickly proclaimed the possibility of stable growth and retired to their burrows for six more weeks until March 20th when they will emerge again looking for sunlight to pierce the economic gloom.
For next week it will be a holiday if sorts from the heavy schedule we saw last week. There are very few reports and only one of any consequence. That would be the ISM non-Manufacturing on Monday. Analysts are expecting a small gain but the number is really not material unless there is a major move in either direction. The US economy has become a services economy but the markets tend to ignore the ISM services number. It would have to fall near or under 50 into contraction mode before traders would become concerned. There is a much better chance for an upside surprise rather than a material dip. As investors we just want it to remain relatively flat to avoid any major changes in economic visibility. The rest of the reports are filler and should be ignored unless there is a major change.
The earnings parade will begin to wind down next week with 62% of the S&P already reported. It will take six more weeks for the remaining 38% to confess as the smaller company reports trickle in. Of the 62% already reported 64% beat estimates, 20% missed and 16% reported inline. Earnings projections for Q4 have risen back into double digits at +10.4% with the help of several outstanding reports late last week. If this trend holds it would be the 14th consecutive quarter of double-digit earnings. It would require a major miracle for that streak to continue next quarter. As of Jan-1st the projection for Q1 was S&P earnings of +8.7%. According to Thomson Financial that number has dropped to earnings growth of only +5.1%. There was a very bad series of lowered guidance reports early in the week that spiked the ratio of negative to positive guidance to 1.8 to 1 and nearly double the historical average. The earnings late in the week reversed that trend with numerous positive results that knocked that ratio back down to only .8 to 1 and back into normal territory. Still, without some additional strong positive guidance the earnings for Q1 will fail to impress at +5.1% and end that streak at 14 months.
Earnings late in the week included Amazon, which reported profits that fell -50% on a +34% rise in sales. That sounds terrible but there were charges of $91 million in taxes for the quarter compared to a tax benefit of $38 million in the comparable 2005 period. Analysts were only expecting 21 cents and Amazon reported profits of 23 cents so even with the tax problem they beat the street. The stock was beaten to a -$1.31 loss on the news.
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In another headline shocker Wendy's earnings fell -90% due to losses from its recently sold Baja Fresh Mexican Grill chain. Net income was 3 cents compared to 25 cents in the comparable quarter of 2006. Excluding charges Wendy's earned 6 cents compared to Wall Street estimates of 21 cents. You would have thought WEN stock would have been grilled on the news but it only fell -73 cents or -2%. Investors read between the headlines to see that same store sales rose +3.1% and future profits were expected to rise now that Wendy's is free of the Baja Fresh and Tim Horton brands.
Homebuilders soared again after builder Standard Pacific (SPF) gave guidance for Q1 that exceeded analyst expectations. SPF gained +1.95 even after posting a net loss for Q4 of -1.53 and a $290.7 million write off for inventory impairments and land deposit write-offs during the quarter. It appears if you write everything off then you will eventually make a profit. Other builders riding the Pacific wave were KBH +1.09, TOL +1.22, CTX +1.34, LEN +1.09, DHI +0.96 and NVR +20.50.
Nabors (NBR) spiked nearly $3 intraday on talk of a leveraged buyout deal in the works. We get one of these rumors nearly every quarter. Nabors has more than 1500 drilling rigs including both land and offshore. With a market cap of only $9 billion they have been rumored as a target by GE, DO and several European companies. Nabors spokesman, Dennis Smith, said, "it is our policy not to comment on rumors." Over 60,000 calls and 11,125 puts traded on Friday on more than eight times normal volume. Nabors will report earnings Tuesday after the close. Nabors has already warned that earnings will fall short of estimates due to lower demand for gas drilling rigs in the U.S. Nabors lowered its earnings forecast to 95 cents to a dollar. Analysts are now expecting $1.01. Major analysts downplayed the buyout rumor saying the cyclical nature of drilling produced too large a swing in revenue to tempt LBO firms. They need strong guaranteed income to payoff their acquisition debt.
March Crude Oil Chart - 90 min
Energy traders were in a buying mood again on Friday with oil spiking +1.72 to close at $59.02. That equates to an 18% rebound since February crude hit a low of $49.90 back on Jan-18th. Even as bullish as I am about oil long term I was very surprised to see this strong of a bounce. All the normal factors were blamed again and this time there were no expiring futures contracts to create an artificial move. The Nigerian oil workers union is threatening to strike on Monday due to a lack of security and the increased number of attacks on oil facilities. If they strike this could further crimp output of light crude from Nigeria. OPEC is thought to have actually begun cutting production again on Thursday despite the rise in prices. We will not know that for sure for several more weeks. Russia and Iran are said to be considering formation of an OPEC like group for gas producers. How this would impact world markets remains to be seen. Russia has 26.6% of the global supply of gas followed by Iran at 14.9% and Qatar at 14.3%. Considering we are going to be importing significantly larger amounts of LNG from these three countries in the very near future it is not likely to be at favorable prices. Venezuela was also quoted as a problem for oil with Chavez rewriting laws by presidential decree. Chevron said it lost 90,000 bpd in production in Venezuela when Chavez cancelled their prior agreements and nationalized the facilities. Analysts believe this will slow production wherever nationalism is practiced. Russia is also quietly kicking international companies out of Russian oil fields and turning operations over to their national oil companies. The potential for a military conflict with Iran appears to be growing daily with the announcement they are installing 3,000 enrichment centrifuges at the underground complex at Natanz. The eventual goal is to have 54,000 active centrifuges in order to accelerate the program. The U.S. said the announcement proved Iran was not moving to comply with the UN mandate for a halt in the process. Whatever the real reason for the spike in oil prices those of us invested in energy are not complaining.
Dell and Intel were back in the news and the news was not good. A class action lawsuit on behalf of investors was filed against Dell saying Dell had hidden $1 billion a year in rebates from Intel. Dell evidently received huge amounts of money from Intel to keep it an Intel only computer maker. These payments have been known for sometime as they were mentioned in an AMD suit a year ago. AMD claimed they were secret illegal rebates used to protect market share. Intel insists the payments were legal and were part of a discount pricing arrangement. The current suit does not claim they were illegal rebates but were simply not disclosed properly by Dell and gave investors the wrong impression about Dell's profitability. Dell claims the payments of $250 million per quarter were marketing fees paid to Dell to feature the Intel logo on Dell computers and advertising. Payments for advertising are not broken out on Dell's financial statements and according to the suit they inflated profitability assumptions on PC sales. Another suit claims Dell insiders propped up the stock price from 2003-2005 with improper accounting and disclosures enabling insiders to sell $3.5 billion in stock. Since 2005 Dell stock has fallen -44%. Dell also announced that CEO Kevin Rollins had resigned, Michael Dell was returning as his replacement and that Dell profits would be less than expected for Q4. It was not a good week for Dell. There are also some benchmark tests making the rounds on the web showing that in tests of identical class PCs between Dell and HP the HP computers are sometimes up to 50% faster than the Dell model. This could be another reason why HP is taking back market share by leaps and bounds against the former PC leader.
Global chip sales are expected to rise about 10% in 2007 to $273.8 billion after a similar +8.9% rise in 2006. The Semiconductor Industry Association said sales of chips were benefiting from the inclusion of chips in almost every electrical product made including the explosion of music devices, cell phones and large screen TVs. The semiconductor index has not benefited from this explosion in chips and fell -13% over the past year. Recent performance has been volatile with many chip companies warning about future profits. For an industry with 10% growth you would think the chip stocks could find a bid. The SOX has been trending sideways for the last five months.
Dow Transport Chart - Daily
Dow Transport Chart - Weekly
The Dow Transports (+6%) had no problem finding a bid last week after dropping back to test initial support at 4700 on Friday Jan-26th. The rebound off that support was dramatic with a vertical sprint to close at a new historic high at 5006. Twice before in 2006 that 5000 level had been tested followed by sudden declines. Is the third time the charm? The rebound was prompted by monster moves in FedEx (FDX) from $108.50 to $115 in three days and UPS +4 in four days. The railroads like BNI, UNP and CSX were also strong gainers while the airlines were stuck on the taxiway. Transports up to a new historic high while oil rebounded +18% from its lows? What's up with that? It is the Goldilocks stealth growth economy starting to gain speed. It is a rebound to 3.5% GDP in Q4 and the potential for an even higher number in Q1 that has sparked the sector.
140-Year Temperature Chart
Coal also found a bid with colder weather upon us. Arch Coal reported earnings on Friday of $79.5 million compared to a loss of $1 million in the comparable quarter. For all 2006 Arch profits soared +1,058% to $260.6 million compared to $22.5 million in 2005. Arch and Peabody (BTU) have said they are going to reduce production targets for 2007 given the current surplus of coal. Winter consumption trends have been shattered by warm weather over the last decade. The top seven warmest years on record in the U.S. since 1850 from the top down are 2006, 2005, 1998, 2002, 2003, 2004. In the Netherlands January was the warmest January in the last 300 years. It was the 5th warmest in England in 350 years. According to a UN organized group of scientists the top 11 hottest years globally occurred in the last 12 years. Think about this. These are huge statistics! There is no doubt that global warming has accelerated but that is a topic for a different time. The Arch Coal CEO said there were plans to build 96 gigawatts of coal fired electric plants in the U.S. over the next decade, 156 GW by 2030. Each 15 GW requires 16 million tons of coal per year. Once all 96 GW are built that will require an additional 102 million tons of coal per year or nearly 900,000 rail cars or 9,000 trainloads, 25 per day, of coal. To put that into perspective Arch only sold 127 MT (million tons) in all of 2006. The new plants currently scheduled would nearly double the current output of Arch Coal. Obviously they are not the only coal company with Peabody (247 MT worldwide), Massey (39.1 MT) and Consol Energy (68.9 MT) the other majors. Using the 2006 numbers listed here those new plants will increase coal demand in the U.S. by more than 10% not taking into account the coal used for other than power generation. The EIA said that U.S. coal demand in 2007 would increase by 20 MT but production would decrease by 30 MT. With the huge increase in demand in our future you would expect coal stocks to be rising. However, they were hit by the warm weather and are trading significantly off their highs. I would consider coal a buy here with Peabody my favorite. They have increased exposure to Asian markets through their recent acquisition or Excel Energy in Australia. Prices are rising to Asia as is demand. The sector is ripe for further consolidation with Peabody the eventual survivor. However, with coal the energy of the future there has been speculation that a larger energy company like Exxon could start acquiring coal assets for the eventual coal to liquid (CTL) shift as oil prices eventually move over $100. CTL needs oil to be over $50 to be commercially practical in any real quantity.
Wilshire-5000 Chart - Weekly
Wilshire-5000 Chart - Daily
What do we do now? With the S&P-500, NYSE Composite, Russell-2000, Wilshire-5000 and Dow Transports all at new historic highs do we continue to go long? That is a tough question but nothing attracts money faster than new highs. Eventually this streak will end badly but there is nothing on the horizon to suggest it will be soon. We spent weeks wandering sideways in 2007 as we consolidated the gains from the last half of 2006. The markets had plenty of chances to roll over and crash back to earth in an expected correction. Despite six individual days of sharp declines in 2007 none have stuck and the bulls bought every dip. Until that pattern changes we should continue to buy the dips. Eventually we will be wrong and it will be painful. Historically when the correction eventually appears investors will buy the first dip and lose money. They will buy it again lower and again lose money. We are creatures of habit and it normally takes several consecutive days of losses before we get the message. I don't see a dip on the horizon but the real ones are rarely expected. According to Ned Davis Research the Dow has gone 138 trading days as of Friday without a -2% retracement. The Dow has also gone 981 trading days without a -10% correction. We came close in May 2006 but close does not count in statistics. This is the longest streak for the Dow without a correction since 1958. Kind of makes you question the wisdom of going long doesn't it? This is probably what is keeping everyone else out of the market and costing the shorts lots of money. Everyone is betting on what they think will happen rather than what is happening. The trend is your friend and right now the trend is up.
Russell-2000 Chart - Weekly
The Dow closed at 12656 and just shy of Thursday's new high. Based on the recent series of new highs and higher lows it appears 12700 is the next target and that could easily happen soon. 12500 is current support and the 30-day moving average. It would take a dip to 12400 to qualify as a -2% retracement and 11400 for a -10% correction. I could easily see 12400 but I can't imagine 12000 much less anything below that without a significant change in market sentiment.
The Nasdaq closed at 2475 on Friday and a very slight breakout over the 2400-2475 range it has been stuck in since Nov-13th. We had that three-day buy program spike back on Jan-11th that took the Nasdaq to 2508 before dropping nearly 90 points and back into the range in the three days that followed. Without that spike it would have been three months of pure boredom.
The S&P finally broke out of its 1430 resistance ceiling with a monster spike after the Fed announcement. That spike triggered significant short covering and added nearly 10 points for the day. On Thursday the bears tried to sell the opening bounce but were rewarded with another new high close. Friday the index closed within a point of 1450 but could not make the connection despite nearly a full day of trying. Friday's close was a 6.5-year high and I am sure there are plenty of shorts that still need to cover. Once over the psychological 1450 barrier the next material resistance is 1530. I know that sounds unreal at this point but we are in breakout mode with very few plot points above us.
The Wilshire 5000, the broadest of all U.S. indexes is also in breakout mode with a new historic high on Friday at 14642. This shows a broad participation of all sectors in the rally. Even more bullish is the breakout on the Russell-2000 past the very strong resistance at 800 to close at a new historic high of 809 on Friday. This shows that fund managers have committed to the rally and are buying small caps. This is a critical sentiment indicator and suggests the bullish sentiment is rising. The NYSE Composite closed right at Thursday's historic high and continues to be a broad based sentiment indicator covering everything from small caps to the largest blue chips listed on the NYSE.
There are simply no bearish indications to be found and that in itself is scary. When there are no bears to be found it usually means their trap is about to be sprung. It is worry about the potential downside that keeps most traders from participating in the upside. It is easy to buy a corrective dip like the $50 bottom in oil. The risk is minimal and there is plenty of proven upside potential. Buying a breakout is much tougher on the brain since there is nothing to measure it against. Every hiccup appears to be the start of the next correction and sends traders scurrying to the sidelines only to watch a sudden rebound occur without them. We have to realize that there are hundreds of thousands of investors with cash in hand waiting for a pullback to buy. Some may be waiting a long time for a significant dip while others may bite the bullet and jump in on any future pause. I admit I am very skeptical about buying breakouts after finding out I bought the peak more times than I care to admit. I was talking to the person in charge of the option plays about what to pick this weekend. Do we buy the breakout with option premiums on the edge of extreme or do we buy puts on the chance of a failure at this level. If we bought calls then what sector? Those that have a good story are already up strongly. Same with puts. Do we buy puts on the winners or on those few bouncing along the bottom? This is a tough weekend for stock pickers.
SPX Chart - Daily
Officially we need to remain long as long as the market continues higher. I know that is easy to say and tough to do. The S&P is far enough over 1430 that we need to choose a new pivot point for our market direction indicator. I use the term loosely this weekend since all indicators appear to be pointing higher. I am going to be buying the dips to 1440. Under 1440 I plan on reversing to a short bias with a target of 1420. Over 1450 I am just going to close my eyes and hang on. I know if I watch it closely I will see an impending sell off in every hiccup. We are in a precarious period on the calendar. Q4 earnings are winding down and Q1 guidance has been less than exciting. 5.1% earnings growth for the quarter could begin to sour investors on the whole rally concept. When is the question? We also have the refunding in the bond market next week with $28 billion up for auction. That could extract a few bucks out of the market with yields around 4.8% on the ten-year note. Those institutions with profits in equities may need to rebalance their portfolio to spread the risk. We also have the typical post Fed slump to deal with only based on the Fed's bullish statement there should not be any reason to slump. There are no material economics ahead and nothing on the news calendar. It is the perfect scenario for Goldilocks and the three markets. The rally appears to be just right, not too fast and not too slow with bears in sight. Just to be safe keep those stops keyed to SPX 1440 in case lightning does strike out of a blue sky.
Play Editor's note: We hope everyone read the market wrap this Sunday. This is a challenging time to pick stocks. Why? Because the market is so overbought and veteran traders know that nothing goes up forever. Eventually this market will see a correction and the selling will likely be sharp and painful. It is essential that traders, no matter what direction you play, use a stop loss to try and limit your risk. The market's trend is up so we are sticking with the trend and adding more bullish than bearish candidates. However, we suggest readers consider new positions very cautiously and keep one foot pointed toward the exit door.
Bear Stearns - BSC - cls: 166.35 chg: +1.07 stop: 161.49
Why We Like It:
BUY CALL MAR 165 BSC-CM open interest=497 current ask $6.80
Picked on February 04 at $166.35
Garmin - GRMN - close: 51.15 change: +1.45 stop: 48.79
Why We Like It:
BUY CALL MAR 50.00 GQR-CJ open interest=1776 current ask $3.30
Picked on February 04 at $ 51.15
Research In Motion - RIMM - cls: 132.82 chg: +5.44 stop: 124.95
Why We Like It:
BUY CALL MAR 125 RUP-CG open interest=2576 current ask $12.30
Picked on February 04 at $132.82
Ryland Group - RYL - close: 59.29 chg: +2.19 stop: 54.99
Why We Like It:
BUY CALL MAR 55.00 RYL-CK open interest=1223 current ask $5.70
Picked on February 04 at $ 59.29
Ventana Medical - VMSI - cls: 40.14 chg: -2.15 stop: 42.05
Why We Like It:
BUY PUT MAR 45.00 UMI-OI open interest= 15 current ask $5.20
Picked on February xx at $ xx.xx <-- see TRIGGER
Burlington Nor.SantaFe - BNI - cls: 81.42 chg: -0.05 stop: 77.99
The Dow Transportation average touched a new all-time high at 5032 and closed at a new high at 5006 on Friday. While this is great news the $TRAN average only rose 0.16% on the session. The rally in the railroad index also took a rest and the transports look short-term overbought and due for a dip after last week's big surge. Shares of BNI traded near Thursday's high again before slipped lower throughout the remainder of the session. This looks like a possible short-term top and we would expect a consolidation back towards $80.00 and/or its simple 10-dma currently near $79.16. A dip or bounce in the $79.00-80.00 region can be used as a new bullish entry point on BNI. We would prefer to buy a dip but if we don't see a dip consider buying calls on a breakout past $82.60. Our target is the $87.00-87.50 range. The Point & Figure chart points to $100 and BNI's inverse H&S pattern also suggests a $100 target. FYI: We continue to read positive analysis of the railroads and how they will benefit from rising demand for coal and ethanol. Of course these are going to be long-term influences for the railroad industry and may not act as short-term drivers.
BUY CALL MAR 80.00 BNI-CP open interest=4243 current ask $3.70
Picked on February 1 at $ 82.01
Macerich - MAC - close: 96.60 change: +0.32 stop: 91.95
MAC continues to rally but it looks like the air is getting harder to breathe at this altitude at least without a rest. The stock is up eight days in a row so it's probably time for a dip. We would expect a dip towards $95.00 or lower towards the simple 10-dma near $93.75. MAC is relatively close to our target in the $98.00-100.00 range so we're not suggesting new positions although readers might want to consider jumping in on a bounce near the 10-dma. This remains an aggressive, higher-risk play. We do not want to hold over the February 13th earnings report.
Picked on January 28 at $ 93.46
OM Group - OMG - close: 49.66 change: -0.48 stop: 45.75
The past couple of weeks have been relatively strong for OMG. In spite of rising crude oil, which is usually a big cost for chemical producers, shares of OMG have broken out from their early January consolidation and the bearish trendline of lower highs. Right now the stock looks ready to dip back towards the 10-dma and 100-dma near $48.00. We would use a dip or a bounce near $48 as a new entry point to buy calls. If you study the chart OMG might have some resistance in the $51.50-52.00 region but the P&F chart points to a $57 target. We are aiming for the $54.00-55.00 range. We do not want to hold over the early March earnings.
BUY CALL MAR 45.00 OMG-CI open interest=2590 current ask $6.60
Picked on January 25 at $ 48.05
RTI Int. - RTI - close: 82.56 change: -1.23 stop: 76.75
It looks like most of the steel-related stocks all spiked lower at the open on Friday. Most of these stocks saw traders buy the dip within the first thirty minutes. We remain bullish on RTI and would consider new positions right here. However, if you have any patience then consider waiting for another dip closer to the $80.00 level, which as broken resistance should now act as new support. This past week was very bullish for RTI with a significant breakout past the $80 level. The P&F chart points to a $105 target. Our target is the $88.00-90.00 range.
BUY CALL MAR 80.00 RTI-CP open interest=926 current ask $7.00
Picked on January 31 at $ 81.75
Teleflex - TFX - close: 67.79 chg: +0.19 stop: 64.75
Last week was bullish for TFX. The stock bounced from support near $65 and its 50-dma to post a 3.9% gain for the week. Short-term technicals are turning bullish again. Unfortunately, we remain concerned by the lack of volume on the move, which suggests a lack of real conviction. We suspect that TFX is poised to dip back toward $66.50-67.00. If you're looking for a new bullish entry point wait and watch for a dip or a bounce above $66.00. Our target is the $71.00-72.00 range. The P&F chart points to an $81 target. We plan to exit ahead of the mid February earnings report. FYI: We cannot find a confirmed earnings date and it looks like TFX is due to report in the February 14th-27th range. More conservative traders may not want to open plays with a potential earnings announcement just seven trading days away.
Picked on January 14 at $ 67.11
F5 Networks - FFIV - close: 71.81 change: +0.40 stop: 76.25
It is challenging to find a good put candidate with the major market indices hitting new highs. Fortunately, thus far, FFIV has been showing relative weakness. That could change on Tuesday. Networking giant Cisco Systems (CSCO) is due to report earnings on February 6th after the closing bell. CSCO's results and guidance could have a big influence on shares of FFIV. More conservative traders may want to tighten their stops ahead of CSCO's report. If you look at the chart for FFIV you can see how the simple 10-dma continues to act as short-term overhead resistance, which is a positive for the bears. We are not suggesting new positions at this time unless FFIV can breakdown under $70.00. A 38.2% Fibonacci retracement of the August-January run would be very close to $65.00 so we are aiming for the $66.00-65.00 range. Traders should be aware that the rising 100-dma near $67 might offer some support. FYI: The Point & Figure chart has produced a triple-bottom breakdown sell signal with a $63 target. Plus, the company recently announced an analyst meeting for February 7th in New York.
Picked on January 28 at $ 72.70
Whole Foods - WFMI - close: 44.67 chg: +0.70 stop: 45.51
After six weeks of declines the bulls are making a comeback in WFMI. The stock rebounded 5% for the week and has broken out past short-term technical resistance at the 10-dma and is now challenging resistance near $45.00 and its six-week trendline of resistance (lower highs). More conservative traders may want to tighten their stops more closely toward the $45.00 level. At this point we'd wait for a decline under Friday's low near $43.85 before considering new positions. Our target is the $40.25-40.00 range compared to the P&F chart, which points to a $26 target. FYI: There appears to be some confusion over WFMI's upcoming earnings announcement date. We checked two different sources and one says WFMI will report on February 13th after the market's close. The other source says WFMI will report on February 21st after the market's close. Both sources have labeled this a confirmed earnings date. Obviously someone is wrong or it's a typo. We are going to play off the February 13th date and plan to exit on February 12th assuming WFMI doesn't stop us out or hit our target.
Picked on January 19 at $ 44.85
(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.)
Google - GOOG - cls: 481.50 change: -0.25 stop: n/a
GOOG's lack of follow through lower after Thursday's big sell-off and bearish reversal candlestick is not the greatest sign for the bears or our strangle play. The stock barely moved as it oscillated on either side of $480. Technically the trend is bearish with the double-top and the recent breakdown. More conservative traders may want to exit early right now. We're going to stick it out for a couple of more days and re-evaluate. We are not suggesting new strangle positions. In our original play description we suggested two different potential strangle strategies. One involved the February $530 call (GOP-BW) and the February $470 put (GOP-NG). This strategy had an estimated cost of $17.40 and we want to exit if either option rises to $29.00 or more. The second strangle strategy involved the February $550 call (GOP-BY) and the February $450 put (GOP-NJ). This second strategy had an estimated cost of $8.70 and we want to sell if either option rises to $16.00 or more.
Picked on January 28 at $495.84
United Parcel Srv. - UPS - cls: 74.17 chg: +0.53 stop: n/a
UPS investors continue to ignore the company's bearish earnings report from last week and the transport stocks continue to ignore the rising price of crude oil. Instead traders are choosing to focus on the optimistic outlook for the growing economy, which should be fundamentally bullish for UPS. Shares of UPS are at a pivotal spot where we should see a bullish breakout over resistance or a failed rally. We are not suggesting new strangle positions at this time. February options expire in two weeks and considering UPS' failure to move on its earnings report more conservative traders may want to adjust their targets to break even. Our estimated cost was $1.65. We suggested the February $75 call (UPS-BO) and the February $70 put (UPS-NN).
Picked on January 28 at $ 72.49
Did you ever find a big hole in your education as a trader? I recently did. What I found may prove useful to those whose main trading strategies include directional options, futures or stock trades. This would include buying calls or puts or buying or shorting stocks or futures, for example.
I stick to credit spreads these days, but I use the monthly average true range (ATR) indicator when I'm getting into those spreads, and this new information relates to the ATR. This indicator helps me ensure that I've placed my spreads far enough away from the action that they're not likely to get clipped if the underlying just moseys through its current typical range for a month. I found out that some traders employ the ATR in a specific way for setting stops and not determining entries, however, and that method is what this article will address.
First, a little background might prove helpful to newer traders. According to the Stock Charts' Chart School, Average True Range or ATR was developed by J. Welles Wilder. Its calculation requires several steps, although most charting programs perform these calculations for you automatically. Still, understanding how an indicator is calculated helps in understanding how to best use it. First, those making the calculations find the true range. This is defined as the greatest of three differences: the current high less the current low, the absolute value of the current high less the previous close or the absolute value of the current low less the previous close.
If the SPX has one of its occasional big-range days such as the one on January 25 when its day's range was more than 18 points, then it's likely that the day's high minus the day's low will be the greatest of the three. If the SPX has instead produced an inside-day situation in which one day's candle is inside the previous day's range, then one of the other two calculations is going to be greater and will be used as the true range for that day.
As the name implies, the average true range is then calculated by taking an average of the true range over a certain period of time or number of bars on the chart. The default calculation on my chart provider is 14 periods, but I have substituted 20 on my charts. For example, if I'm looking at a daily chart, the true ranges will be averaged over the previous 20 days.
This indicator speaks to the volatility of prices rather than their likely direction. If prices become more volatile, the ATR rises because all those true ranges that make up the average expand. If prices are rising quickly or even dropping quickly, ATR will rise. Direction of prices doesn't matter: only the width of the calculated true ranges does. If prices become less volatile, ATR declines. Over the last several years, the SPX's monthly ATR has been falling.
Annotated Monthly Chart of the SPX:
In fact, I place the sold strikes of my credit spreads much further than one ATR on the SPX, especially for the bear call spread above the SPX. If a market has been trending as the SPX has been, I would try to get my short strike much further than one monthly ATR away from the current price in the direction of the trend. In other words, at the time this chart was snapped early last week, I wouldn't have wanted to place March bear call credit spreads only 55.80 points away from the then-current SPX price of 1426.61. I would have wanted to be much higher with my sold call.
I'm also lengthening the period over which the true ranges are averaged to 20 periods rather than the default 14 from my charting service because ATR has been trending lower. I want to capture the lengthier period in the averages so that the ATR doesn't get too narrow and I don't inadvertently get too close to the action. This is particularly true because a low ATR can be a sign that a market is topping out.
Think about it. When markets climb, they soar higher and then frequently go through a period when a mushroom or rounding-over-type top is made. While that top is forming, the volatility diminishes as ranges contract. I'm not certain that's happening now, but it remains a possibility. If that should be true, the SPX could plunge faster than it's been climbing. In a falling-ATR environment, I want some of those earlier, higher true ranges averaged in to keep me as far out of danger with my spreads as possible. If and when the SPX plunges lower, I'll shorten the number of periods used in the ATR's calculation so that it will react as quickly as possible to the increasing volatility.
After using the ATR all this time to design my credit spread entries, I happened across an article by Sharon Yamanaka in the November 2006 issue of STOCKS & COMMODITIES describing chandelier exits, a type of exit that employs the ATR in a way that I've never imagined using it. After bullish entries, such as buying a stock or a call, the exit or stop is set by subtracting a multiple of the ATR from the highest high or highest close during the period being considered. In effect, the exit hangs from that highest high or highest close, giving the exit its name. The opposite is done with a bearish entry, with the exit or stop hung from the lowest low or lowest close.
Why would traders want to do that? One benefit of the chandelier exit is that it expands or contracts with the changes in volatility. Yamanaka notes that while she always sets a hard stop upon entering a trade, stops "can do more harm than good" when a too-tight stop takes traders out of a trade too soon or a too-wide one keeps them in a bad trade too long. She believes that this type of exit helps protect against being whipsawed out of what will ultimately turn out to be profitable trades because the exit is wider during volatile periods, when ATR rises. This exit would also tighten when volatility contracts, so that profits are better protected than they would be with an exit that is too wide for the current conditions. The exit or stop can be recalculated at the end of each day so that volatility changes will widen or contract the exit.
Another important aspect of this type of exit, Yamanaka notes, is that it's unlikely to be placed at the same place as the majority of stops might be placed. Stops may be less likely to be overrun in a typical stop-running move meant to take out as many stops as possible.
Sound interesting? It did to me, too. Yamanaka had mentioned that she hadn't been familiar with the chandelier exit, so I wasn't feeling too chagrined at having missed information about this type of exit the whole time I was trading those purely bullish or bearish plays, when I most could have used information about them. However, imagine my surprise when I went looking for other articles on the topic and discovered that a few traders have been advocating chandelier exits for almost a decade. In TRADE YOUR WAY TO FINANCIAL FREEDOM, a book copyrighted in 1999, Dr. Van K. Tharp discussed the methodology, although I'm not certain he employed the term "chandelier exits" when discussing the terminology.
According to Chuck Le Beau and Terence Tan, writing for The Traderclub Forum (December 3, 1999), Tharp hung his exits three ATRs' distance from the highest or lowest close, calculating the ATR with a ten-day exponential moving average. Chuck Le Beau has also written about the chandelier exit in his System Traders Club. In their earlier article, he and Tan advocate an ATR calculated with a 20-period exponential moving average, the same one I use. They suggested keeping the exit wider at the beginning of a trade, perhaps 2.5 to 4 multiples of the ATR, and narrowing it as the trade becomes profitable, perhaps as narrow as one or one-half multiples of the ATR.
Yamanaka sticks with Tharp's ATR using a 10-period average and sets the stop three ATRs away from the highest high on long plays or lowest low on bearish ones. She allows for some adjustment depending on conditions such as trading style, chart formations, time frame and risk tolerance.
All--Yamanaka, Le Beau and Tan--tout the flexibility of these exits and their usefulness in any type of market, whether one is trading the forex markets, corn futures or the QQQQs. An important point to note is that in bullish entries, the chandelier exit will never move lower than the original stop because it's hung from the highest high or highest close, which will change only if there's a new, higher high or close. In a bearish entry, the chandelier exit or stop will never move higher because it's hung on the lowest low or close, and the only way that will change will be if there's an even lower low or close.
Le Beau and Tan note that changing the moving average of the ATR will make the stop at the chandelier exit more or less reactive to current trading conditions. A shorter-term moving average of the ATR will result in stops that react more quickly to changing market conditions. They will sometimes calculate two ATRs, one using their typical twenty-bar calculation and another using a shorter length, perhaps as short as four bars. They'll then use the widest of the two exits calculated using the two methods as their stop. This allows the exit to quickly adjust to expanding volatility without resulting in too many whipsaws when volatility contracts for only a few days before expanding again, a case in which the four-bar calculation might result in a too-tight stop.
Yamanaka also advocates some flexibility. She would study chart patterns and support and resistance levels in conjunction with the calculated chandelier exit or stop. In one example in her article, she calculated a chandelier exit at 3 ATRs from the highest high, putting that calculated exit at $9.77 for her bullish play in her chosen stock. She noted strong historical support at $10.00, so the $9.77 exit made sense to her. One can imagine, though, that if the calculated chandelier exit had been just above strong support rather than just below it, she might have widened her exit so that she wouldn't be taken out just ahead of strong support.
She also cautions that account considerations should be an important part of any consideration of where stops should be. If the calculated chandelier exit is wide, for example, so that the loss would represent too large a percentage of a trader's account, then a smaller number of stock shares or options contracts might be entered than had been originally anticipated. She, like many others, advocates knowing where the stop will be before the trade is entered.
How would this work in practice? An example might be seen on the Russell 2000's daily chart, with this chart captured at the end of the day January 30, when I first began roughing out this article.
Annotated Daily Chart of the RUT:
Note that the stop would also roughly correspond to a retest of the rising trendline that was former support for the RUT as it climbed off the summer lows, so should some extra leeway be given to allow for a complete test of that trendline? What about for the expected volatility that might come after the FOMC decision? Would adding another point or so to that stop be a good idea to allow for that trendline test, especially given the likely post-FOMC-decision volatility? Or would be it better to stick to the 4 times ATR stop or maybe even narrow it further inside their advocated 2.5-4.0 times ATR range?
That would be up to the individual trader and that trader's account and risk tolerance. Some might even have stuck with Yamanaka's tighter three-times-the-ATR stop, although Yamanaka does use chart formations, too, to help her set stops. What would you have decided? Think about it in the context of your trading style and your account size before glancing at the chart below.
Annotated Daily Chart of the RUT:
What decision would you have made? As I type this Friday morning, the RUT is still testing that trendline without a clear result. Because the trendline is rising, Friday's trendline test means that the trendline has moved higher than at Thursday-morning's level. The RUT has been as high as 809.58 this morning, but is at 808 as I type. Perhaps it will print a doji at that resistance today and perhaps it will fall back, but perhaps it will just continue to climb the underside of that trendline.
So was this test a failure? It's possible that those who might have taken a chandelier exit and been stopped would have stood by to watch that play ultimately be profitable for someone else. That doesn't mean that this type of exit is a failure, though. In addition, Yamanaka, Le Beau and Tan all advocate learning the ATR multiple that best works with your preferred trading vehicle, so some experimentation is necessary. There's another possibility, too.
Remember that some advocate basing the chandelier exit not on the highest high or lowest low on the period being considered, but rather on the highest close or lowest close. At the close on 1/30, the date that the first RUT chart was snapped, the lowest low over the last 20 periods had been 774.55, considerably higher than the lowest intraday low. When a chandelier exit or stop is calculated at 4 ATRs' distance from that lowest close, the exit or stop would have been at 812.55, not 806.68. That would have been a wide, wide stop, but it would have allowed for a thorough testing of the rising trendline.
So which stop would have been appropriate? Would one have kept traders from being whipsawed out of a trade that would ultimately be profitable? Would one have protected traders from a bigger loss if the RUT continues zooming higher? That's ultimately still to be proven, and the reason that if you decide that you're interested in these exits, you must experiment.
LeBeau and Tan note that Dr. Tharp conducted a study that employed chandelier exits after random entries were made. According to LeBeau and Tan, Tharp's study concluded that the results were likely to be profitable, even with the random entries. It's of course a study that I have not replicated and can not defend.
I'm not trading the types of trades in which these chandelier stops would be used, either, so I can't tell you about my personal experience with this just-discovered type of trading. I haven't back-tested it. However, I do think it's interesting enough that it's worthy of investigation if you're entering directional plays.
I would suggest that those interested in this type of stop or exit first back test or at least paper test the exit before relying on it for actually setting stops. Most charting services now calculate ATR and most allow you to input the period over which the true ranges will be averaged. If yours doesn't, Yamanaka lists Prophet.net's "Analyze" tab as one source for this indicator's value for your preferred trading vehicle. Terence Tan has written code that allows TradeStation users to code the chandelier exit, with that code available at the www.traderclub.com website.
While I can't guarantee that the chandelier exit measures up to all the claims that have been made about its usefulness, it perhaps warrants a look.
Today's Newsletter Notes: Market Wrap by Jim Brown, Trader's Corner by Linda Piazza, and all other plays and content by the Option Investor staff.
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