Just when things appeared to be going so well some cautious comments out of Micron caused an immediate tech reaction to the downside. This brings back memories of numerous tech corrections in the past that occurred because of a sudden change of outlook for chips. Add in worries about the impact of sub prime loans to the banking system, new guidance challenges from the homebuilders and some hawkish Fed comments and you have a recipe for profit taking on a lazy Friday afternoon. There were plenty of bulls out singing the "Don't worry, be happy" jingle to themselves since support held and proclaiming it as just another buying opportunity. We should know by Monday's close if they were right.
Dow Chart - Daily
Nasdaq Chart - Daily
There were no economic reports on Friday so the markets were left to fret over the slowing earnings guidance and comments from various Fed officials. It was a slow week for economics in general but that will change next week. They will start to increase in intensity as the January reports begin to appear. The major reports are the manufacturing surveys on Thursday and the Producer Price Index (PPI) on Friday. These manufacturing reports will show if the decline in the ISM into contraction status last week was an anomaly or a prediction of things to come. The PPI will show if inflation is on the right track and decreasing as the Fed claims. There are numerous filler reports but those three headliners should be the only market movers. After Friday's chip decline the Semi Book-to-Bill may also have an impact but typically this number is so well managed that it takes several months for bad news to slip out.
Next Wednesday we will also have Ben Bernanke testifying before the Senate Banking Committee on Capitol Hill. On Thursday he will repeat the performance in front of the House Financial Services. The key as always will be any indications from Bernanke that we are heading for another series of rate hikes if the economy continues to strengthen.
Three Fed presidents made hawkish market moving comments on Friday. Dallas Fed President Richard Fisher said he was fairly comfortable with the inflation outlook but would "aggressively" argue for further rate hikes if needed. Currently he said he "was as comfortable with the inflationary outlook as a prudent central banker can be." He said the strong Q4 GDP would not hold and was likely to be revised down to about 3% growth. Cleveland Fed President Sandra Pinalto said she "was not convinced" the underlying trend in inflation had moved lower and suggested higher rates may still be needed. She said the inflation picture had been impacted by large swings in energy, commodities and housing prices. "As these markets normalize, we may see that inflation risks remain. In that case, some additional firming may be needed." St. Louis Fed President William Poole said inflation should moderate this year amid solid growth, BUT, if this failed to happen he would press for higher rates. "If core inflation seems to be settling in at a rate above 2% then such an outcome would be unacceptable to me." Also, "My commitment is to do what I can to promote policy adjustments that will yield an inflation outcome, on average over a period of several years, centered on 1.5% on the core PCE price index." The core PCE came in last week at +2.1% quarter over quarter and +2.3% year over year. These numbers are declining but not as quickly as the Fed would like. It could be a long time before Poole sees his 1.5% target. If we are seeing a strong recovery in the economy as evidenced by the +3.5% Q4 GDP then it is almost a certainty that we will see future rate hikes. I don't believe it was a coincidence that three Fed presidents gave nearly the same hawkish comments only three days before Bernanke is due to testify. I believe it is part of a plan to talk up bond rates and set the stage for his testimony. This flurry of hawkish comments helped turn Friday morning's low volume stroll into a nearly a -100 point Dow decline. The bulls bought the dip reversing that decline to only -56 points.
The Nasdaq imploded to a -35 point drop at 2:30 after Micron stunk up their analyst meeting with some bearish comments. Micron told analysts that prices for memory chips used in consumer electronics would fall -30% to -40% this quarter. Micron said the falling prices came after they boosted production of NAND memory chips amid an industry glut. The spokesman said Micron did not see any signs of strengthening demand and it was just bad timing for Micron to ramp up production as demand slowed. He also said that DRAM memory prices would fall another -15%. DRAM chips produce about 70% of Micron's revenue but only 20% of its profits. Micron fell off a cliff when the news hit the markets but with an already depressed $13 stock the loss was not material. The problem came from the impact of the news on the sector. Chip companies of every variety dropped sharply.
Chipmaker SanDisk (SNDK) had already warned about future expectations but the Micron news erased almost all of the gains made since that warning on the 31st. Silicon Image (SIMG) dropped -24% after warning that sales would be lower than expected for Q1. Six investment firms cut their ratings on SIMG. Gateway lost -10% after saying that revenue declined in Q4 and margins shrank to a miniscule 5.2%. Intel, AMD, NVLS, AMCC, NVDA and nearly every chip stock declined to some extent. The exception was Broadcom. BRCM said sales rose +12.5% and beat estimates. Brokers were upbeat on their guidance and BRCM finished fractionally in the green. The SOX just can't seem to find any traction amid the almost constant warnings and lowered guidance for the sector. As chips go, so goes the Nasdaq.
The Nasdaq is finding it difficult to make any forward progress carrying an 800-lb software giant on its back. Microsoft has stretched its losses to seven consecutive days with Friday's close at $28.94 a new two-month low. Microsoft has posted a loss for seven of the eight days since Vista was released to the public. Horror stories of conversion difficulties, massive overhead requirements and hardware incompatibility is keeping buyers away in droves. It is going to be an interesting quarter for Microsoft but they did shift over a billion dollars of revenue into Q1 from Q4 so maybe they won't warn. That would be a very bad omen for Microsoft to warn in the quarter they release their long awaited operating system. Microsoft will spend almost as much marketing Vista ($300 million) as their entire company sales in 1987.
Techs are also having trouble moving higher as cautions continue to appear regarding the future of tech sales. Stock buybacks are actually higher than capex spending by tech companies suggesting there are few new products in the pipeline and corporate buying patterns are not improving. When companies resort to buying back stock rather than investing in new products it suggests there is a lull in our future.
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Toll Brothers (TOL) fell -10% over the last three days after warning that Q1 revenue would fall by -19% and saying the housing market would likely remain weak in early 2007. They also said write downs would spike to between $60-$160 million or more for the quarter. In December Toll projected a $60 million write down for the entire year. That is a significant change in view in only 45 days. Contracts signed fell by -33% so far this quarter. The cancellation rate was 29.8% but better than the 36.9% in the prior quarter. This is still worse than the historical average by 7%. It amazes me that you can run a business even in good times with a 23% historical cancellation rate. Toll said the continued cancellations should shrink because most speculators buying the homes just to flip them had already canceled their orders. Robert Toll continues to be bullish because the American population is outpacing the rate at which new homes are built. "We are adding people at a clip that is much greater than the ability to add supply to the homebuilding stream." That may be true but few of those immigrants and young families just getting started can afford a luxury Toll Brothers home. Their success is truly a result of the ripple up effect. Successful people climb the ladder to prosperity while the new workers fight for a foothold on the bottom rung.
Subprime mortgage lenders continue to take heat as mortgage defaults continue to climb. HSBC Holdings (HBC) fell to a new 5-month low on Friday only two days after warning that it was raising its reserve for bad loans by +20% to $10.6 billion. New Century Financial (NEW) said it will have to restate results for the first three quarters of 2006 and now expects a loss for Q4. That knocked -$12 off the stock over the last two days. The company said it had to buy back loans it originated and sold to other investors. Several subprime lenders have closed over the last three months. Other subprime lenders IndyMac (NDE), Novastar (NFI), H&R Block (HRB) and Accredited Financial (LEND) took heavy losses for the week. Only Countrywide Financial (CFC) weathered the storm but still lost -8% over the last two days. Countrywide has been in the business for 40 years and is expected to survive the cycle. CFC saw its stock price soar in late January on rumors of a buyout and this week's losses still have not erased that spike.
MasterCard reported earnings of 31 cents that beat the street estimate of 17 cents by the proverbial mile. The stock dropped -$11 after the company told analysts that margin growth was likely to slow in 2007. CEO Robert Selander said that MasterCard's +3% margin growth in 2006 might be difficult to duplicate in 2007. Their operating margins of 19.5% were helped by higher fees for cross border charges in 2006. MasterCard does not expect any special items or price increases in 2007. The stock was hammered as investors took profits after the stock hit an all time high of $118 on the initial earnings news. That was nearly a +200% gain over its $40 low when it went public back in May. MA found some pretty strong buying support at $100 and managed to rebound +3.50 off its lows before the close.
Real Estate Investment Trusts (REIT) are also feeling the pressure of investors taking profits. The weakness in the housing sector is starting to bleed over into the REITs even though they are not related. More than likely investors are simply undecided if the housing weakness will eventually cause a recession and are just locking in profits on REITs many of which have been strong performers. Public Storage (PSA) for instance had risen +67% since May. That is a lot of profit at risk if the housing sector turns into a recession. Boston Property (BXP) was another big winner with a +61% gain since May. Both PSA and BXP hit new historic highs this week and then sold off hard on Thr/Fri along with the rest of the sector.
The public hedge fund business got off to a rousing start today with shares of Fortress Investment Group (FIG) soaring +67% in its IPO. Only 23% of the company was sold to the public with the founders and principals still holding 77% and voting control. The stock was priced at $18.50 and closed at $31 after a brief spike to $35. This values the entire company at $12 billion and much higher than previous estimates of $8 billion pre IPO. Ken Hebner said it best on CNBC. He said he would avoid jumping in the water because the initial IPO was just chumming for the sharks. Chumming is where fishermen throw chunks of cut up fish in the water hoping the scent will attract the much bigger fish like sharks. In this case the limited 23% in the IPO was designed to generate a highly oversold offering and push the stock price well over what some would consider a reasonable value. As retail investors fight for the limited shares it pushes the prices higher and allows the founders and principals to exit for a windfall profit when their lockup expires leaving the retail investor holding the bag. Nobody is saying that is what the Fortress insiders are doing but the winks and nods were making the rounds on Friday. Based on Friday's close FIG is trading at 36 times trailing earnings. According to Ted Gooden, a partner at Berkshire Capital, other U.S. asset managers trade at 20-30 times earnings. The most vocal critics suggested buying Goldman Sachs instead which is essentially a hedge fund as well and trades at only 11 times earnings with a market cap of $88 billion. In the Fortress IPO prospectus they planned to acquire some smaller hedge funds and branch into other areas of business. Let's hope they are as successful in their new businesses as they were in this IPO.
March Crude Oil Chart - Daily
The energy sector saw oil trade higher once again with only a last minute selling spree forcing a close back under $60 at $59.90. Oil reached an intraday high of $60.80 on continued cold weather and a temporary shutdown of a field on the West Coast. Geopolitical news was also driving prices with Nigeria declaring Force Majeure on deliveries for the rest of February and March. Nigeria said production would be down by 370,000 bpd for the rest of February and by 260,000 bpd in March. This is major news since Nigeria produces the light sweet crude refiners need for making gasoline.
Lloyd's Marine Intelligence Unit said OPEC production for January really did fall by another 200,000 bpd. This confirmation is coming from various sources and suggests OPEC is really getting serious about supporting prices. With another 500,000 bpd cut supposedly starting on Feb-1st this could get interesting very soon. According to the EIA they only expect about 60% (300,000 bpd) of that cut to actually occur due to cheating. Iran is also on the calendar with the Iranian President scheduled to make a big speech this Sunday on the 20th anniversary of the Islamic Revolution. In this speech he is reportedly going to make a major announcement about their nuclear project. I doubt they are canceling it. Supreme leader Ayatollah Khameni warned on Thursday that Iran would strike U.S. interests around the world if his country was attacked. Analysts wonder if his statement was a warning planned ahead of Ahmadinejad's speech due to some potentially explosive content. On Friday the International Atomic Energy Agency (IAEA) suspended 22 of its 55 technical aid programs to Iran. Iranian officials immediately condemned the suspensions. This is going to be an interesting weekend in the oil markets!
As we begin to test the air over $60 again we should not forget that rising oil prices are inflationary. All this reduced inflation talk we have had over the last three months has largely been due to falling oil prices. Should they continue to rise it would jeopardize the fragile inflationary balancing act the Fed is trying to manage. This fact is sure to come out in the various speeches next week.
Next week could be rocky for the markets. We have some major economic reports and a couple Bernanke appearances. Earnings are dwindling but guidance warnings appear to be increasing. Recent market leaders are showing signs of profit taking on stronger volume. Is it just another dip to buy or the start of something bigger? Obviously nobody knows for sure and it could be just position shuffling ahead of some high profile events. On a chart basis the Dow had two serious days of losses after setting another historic high on Wednesday at 12700. Despite those two days of major intraday drops the Dow only lost 72 points for the week. No harm, no foul and the long term bullish trend is still intact. 12450 is current support followed by 12350. Neither is out of range and neither would represent any material change in the trend. A dip to 12450 would almost hit that -2% retracement analysts have been expecting. A continued dip to 12350 would only be a -2.5% drop from the Dow's recent record close. That would be a great spot to launch a new rally with real legs BUT it might also be enough to sour investors on buying the dips.
We saw strong dip buying on Thursday that lifted the Dow +100 points off its lows. The Friday drop of -125 points from that Thursday rebound high had to hurt sentiment and there was far less buying interest Friday afternoon. The rebound only managed +35 points from the day's lows. Since it was a Friday ahead of a heavy reporting week that could have influenced buyers to stay on the sidelines.
The Nasdaq may have fallen -35 points intraday but that dip to 2455 was only to initial support. That is the same support that produced a nice rebound on Tuesday with follow through on Wednesday to a new four week high. Friday's rebound was only 5 points from that same support. With tech warnings increasing I am becoming doubtful that this rebound trend will continue. The next material support is 2425 followed by 2400. With Microsoft and several of the other tech giants bleeding points it could be difficult for buyers to push the indexes higher even if individual stocks can post some gains.
S&P-500 Chart - Daily
The S&P-500 lost -10 points for the week and that was the largest weekly loss in the last eight weeks. The S&P struggled to break resistance at 1450 all week and could not produce a breakout. This failure was a defining moment for some analysts that indicates a tired market with bullish sentiment waning. That is a very big leap of faith to think the bulls are just going to roll over because resistance at 1450 held. If that is the case we may not know it for a couple more days. There is strong support at 1420 and again at 1400. There is massive support even lower at 1385. The bulls may be tired but they have a lot of places to rest and regain their strength on any continued decline.
With the big three indexes giving us mixed views we need to look elsewhere to see if bullish sentiment is fading. The Russell-2000 retreated from Thursday's record high close at 816 to close at 806. A -10 point drop on the Russell is a big move (1.13%) but there was a dead stop at support at 804. There was not even a hint of a breakdown below that support. Like the other indexes there is monster support lurking just a tad bit lower. It would be very surprising if the Russell breaks the various support levels between 780-800 and while there may be some softness ahead it would take a major change in sentiment to break that 780 level. As long as the dips are being bought in the small caps the market is not going significantly lower. Watch the Russell and you will see the real market sentiment.
Russell-2000 Chart - Daily
Wilshire-5000 Chart - Daily
The broadest market index the Wilshire 5000 collapsed from the morning's historic high at 14705 to 14505 intraday for a -200 point move. The rebound was also muted but managed +50 points off the bottom. The Wilshire did NOT breakdown along with the Dow on Wed/Thr. Traders were still buying stock until the sell programs began firing at noon on Friday. That is another sentiment indicator that the broadest market indicator was still showing bullish indications up until noon on Friday. Real support on the Wilshire is 14300 and I would expect that level to hold on anything but a complete reversal of sentiment. That 14300 level would be only a -2.7% decline from the highs and I would view that as a strong buying opportunity.
I think everyone should realize there is a decent bout of profit taking in our future. We just never know when. As I have reported before Ned Davis research said that as of Friday it has been 143 trading days since the Dow had a very minor -2% dip. That would be roughly 12412 on a closing basis and something we could easily hit very quickly if fund managers pulled their bids. Friday's drop was not a retail drop. It was pure sell program inspired drop from 12:30 to 2:30. We saw that same sell program activity late Wednesday and early Thursday. A few strong programs combined to push the markets lower. This is a departure from our recent norm. Sell programs have been almost nonexistent. Their return could suggest that institutional sentiment is changing.
For us as retail traders we just need to follow a few simple guidelines to stay
on the right side of the trend. When the S&P fell below 1440 that was our
switch to a short bias with a target of 1420. Last week our plan was to run with
the bulls and remain long over 1440. I am going to change that recommendation
this week. We want to remain short under 1440 but should a rebound appear I want
to be flat over 1440 and reenter a short position with another failure at 1450.
I don't think we are going to see that level tested again early in the week but
Robert Craig "Evil" Knievel thought he could jump the Snake River Canyon
What I think does not matter. What matters is how we react to what the market
gives us. If it gives us another rebound to 1450 I am going to short it ahead of
Bernanke's testimony. After his testimony conditions could change if he says the
right thing. Be prepared to change your plan if he blesses the markets with some
form of no hike language. I am actually hoping for that -2% dip to appear so
people will quit worrying about it. Maybe Bernanke can provide us with the
power to do it. We were Greenspamed many times in the past but as yet
never seriously Bernanked.
Play Editor's note: We looked at hundreds of stocks this weekend and it was a struggle to find an attractive candidate for either bullish or bearish strategies. The market action lately suggests we could see more profit taking but the market is technically still in its bullish trend and has yet to break any significant levels of support. We are going to add a few bearish candidates to the newsletter but readers may want to wait for more follow through lower in the major market averages before considering new positions!
Harley Davidson - HOG - cls: 67.80 chg: -1.56 stop: 70.11
Why We Like It:
BUY PUT MAR 70.00 HOG-ON open interest=7347 current ask $3.30
Picked on February 11 at $ 67.80
MarineMax - HZO - close: 22.59 change: -1.49 stop: 24.25
Why We Like It:
BUY PUT MAR 25.00 HZO-OE open interest= 2 current ask $2.70
Picked on February 11 at $ 22.59
Meritage - MTH - close: 41.99 change: -1.75 stop: 45.26
Why We Like It:
BUY PUT MAR 45.00 MTH-OI open interest=906 current ask $3.80
Picked on February 11 at $ 41.99
Sealed Air - SEE - close: 64.08 chg: -0.66 stop: 65.26
Why We Like It:
BUY PUT MAR 65.00 SEE-OM open interest=240 current ask $2.00
Picked on February xx at $ xx.xx <-- see TRIGGER
Garmin - GRMN - close: 52.26 change: -0.89 stop: 49.95 *new*
Shares of GRMN could not escape the market-wide profit taking on Friday. The stock pulled back 1.6% and dipped toward short-term technical support near its 50-dma and the $52.00 level. More conservative traders may want to exit early on Monday morning to avoid or limit any losses. We are already planning to exit on Tuesday at the closing bell to avoid GRMN's earnings report on Wednesday. We're inching up our stop loss to $49.95.
Picked on February 04 at $ 51.15
J.C.Penney - JCP - close: 82.85 chg: -0.60 stop: 81.99
Warning! The retail stocks may be in trouble. Market action was bearish across the board on Friday and the RLX retail index produced a new failed rally/bearish reversal with Friday's session. Shares of JCP has failed to rebound and dipped again toward the $82.00 level. We are not suggesting new bullish positions at this time and if JCP doesn't bounce soon we'll drop it as a bullish candidate. Meanwhile in the news it was announced that JCP's CEO will present at a retail conference on February 13th.
Picked on February 06 at $ 85.51
Nike - NKE - close: 103.60 change: +0.21 stop: 99.49 *new*
NKE ignored the market's weakness on Friday and continued to push higher. NKE has hit a succession of new all-time highs this past week with the breakout past $101. Volume has been above average for the last three days, which tends to be a bullish signal. Yet even NKE, with all its strength, may struggle to hit new highs if the market turns lower. We would hesitate to open new plays although we'll be watching for a dip toward $102.00-101.50, which could be used as a new entry point to buy calls. Please note that we're adjusting our stop loss to $99.49. Our target is the $107.50-110.00 range.
Picked on February 06 at $101.17
OM Group - OMG - close: 50.30 change: -0.52 stop: 47.75 *new*
The rally in OMG ran into trouble with market weakness on Thursday and Friday. Volume dried up as the stock consolidated sideways in the $50-52 region. Lower volume is what bulls want to see during a consolidation in a stock's rising trend. However, we're concerned that the markets may be in for a deeper correction. Therefore we would not suggest new bullish positions at this time but we'll be watching for a bounce near $48.00 just in case as a potential bullish entry point. Please note that we are adjusting the stop loss to $47.75. We are aiming for the $54.00-55.00 range. We do not want to hold over the early March earnings.
Picked on January 25 at $ 48.05
RTI Int. - RTI - close: 81.19 change: -2.02 stop: 79.75 *new*
The action in steel stocks on Friday was dictated by U.S.Steel (X). After a big rally in the last two weeks, shares of X lost 4.3% following news that two analyst firms issued downgrades for the stock on Friday. These downgrades and the market-wide profit taking influenced trading in RTI. Shares of RTI lost 2.4% and slipped toward broken resistance and what should be support near $80.00. The low on Friday was $80.30. RTI was beginning to bounce from the $80 level on Friday afternoon but we would be careful about opening new bullish positions given the market's vulnerable condition. We did note that RTI's low on Friday pierced the bottom of its four-week rising channel but the stock's afternoon rebound put it back into the channel. Aggressive traders might want to consider new positions on a bounce back above $82.50 but readers should note that we're raising the stop loss to $79.75. The P&F chart points to a $105 target. Our target is the $88.00-90.00 range.
Picked on January 31 at $ 81.75
(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: 461.89 change: - 9.14 stop: n/a
Interest rate concerns sparked profit taking in the growth stock sectors and tech was hit pretty hard. Shares of GOOG another 1.9% and broke down under technical support at its simple 100-dma. We are not suggesting new positions. Don't forget that February options expire in five trading days. 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 are adjusting our target to $24.50. 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 are adjusting our target to $9.00.
Picked on January 28 at $495.84
United Parcel Srv. - UPS - cls: 73.56 chg: +0.23 stop: n/a
Surprisingly, UPS continues to resistance any post-earnings warning selling and the stock is resisting the rise in crude oil, which puts pressure on fuel costs. Maybe investors are hesitant to let go of UPS following FDX's bullish breakout a week ago. Whatever the case shares of UPS are not moving and that is a worst-case scenario for our strangle play. We have five days left for February options. We are adjusting our target to breakeven at $1.65. We suggested the February $75 call (UPS-BO) and the February $70 put (UPS-NN).
Picked on January
28 at $ 72.49
Burlington Nor.SantaFe - BNI - cls: 79.13 chg: -0.31 stop: 77.99
We are jumping out of the BNI play. Several sector indices and a number of market internals and technicals are turning bearish. While the railroad index (DJUSRR) looks like it could bounce from its six-week trendline of higher lows, shares of BNI have already broken that trendline of support. Furthermore volume is rising as BNI continues to slip lower and the technical picture on BNI has turned increasingly more bearish. We warned readers on Thursday that we were considering an early exit. If BNI breaks $78.50 nimble traders might want to try and scalp a drop toward $75.00.
on February 1 at $ 82.01
Bear Stearns - BSC - cls: 159.73 chg: -4.02 stop: 161.49
We have been stopped out of BSC at $161.49. Renewed concerns about rising interest rates sent shockwaves through the financial stocks. The broker-dealers really took a beating with the XBD index slipping 1.7%. Shares of BSC under performed its peers with a 2.4% loss. Friday's breakdown looks pretty bearish with a technical breakdown below the bottom of its channel and its 50-dma on big volume. A failed rally under $162 might just be a new entry point to buy puts.
Picked on February 04 at $166.35
Research In Motion - RIMM - cls: 134.21 chg: -4.19 stop: 127.75
It was close but not close enough. RIMM rallied to $139.74 on Friday morning and then promptly dropped. Our target was the $140.00-142.00 range. In hindsight we should have set the target starting at $139.50 give or take a quarter. Tech stocks endured most of the profit taking on Friday and RIMM was no exception with a 3% decline. Friday's performance looks like a clearly defined failed rally under resistance and almost a bearish engulfing candlestick. We're suggesting an early exit now to avoid or narrow future losses. We would keep an eye on RIMM as the $130 level might offer some support.
Picked on February 04 at $132.82
Ryland Group - RYL - close: 54.27 chg: -1.69 stop: 54.99
We have been stopped out of RYL at $54.99. The homebuilders continued to sink and the bullish breakout a week ago now looks like a bull trap. Technicals have turned bearish.
on February 04 at $ 59.29
Teleflex - TFX - close: 66.19 chg: -0.81 stop: 64.75
Another decline in TFX, this time a bearish engulfing candlestick, combined with widespread market weakness looks like a good sign to bail out of any bullish positions. TFX might still have support near $65.00 and its 50-dma but we don't want to find out.
Picked on January 14 at $ 67.11
We all know how to draw trendlines, but how do we know that they're valid? What are prices likely to do when the trendline is approached next?
In my years writing about technical analysis, I've addressed trendlines previously, of course, but we accumulate new subscribers. In addition, if seasoned traders hang on through the basics addressed in the first part of this article, they'll find some information about combining volume studies with trendline approaches that will help them make decisions about whether the trendline support or resistance will hold.
For newbies, most technical analysts consider a trendline established only if it has three points of contact. Two can be used to establish a tentative trendline. Sometimes, those tentative trendlines turn out not to be the best ones. Sometimes, drawing trendlines also requires judgments to be made.
Note: My articles are often drafted a week or two before they're submitted, so charts are not current, as is true of this article.
Tentative MMM Trendline Drawn Off Two Points:
If that trendline were extended, however, it does not explain the downturn that occurred at the apparent resistance near 80 in January.
Extension of Tentative MMM Trendline:
That illustrates the fallacy of making trendline decisions when you have only two points. That other tip already mentioned is also illustrated: traders must make decisions about where the true trendline lies.
For example, all traders have seen instances when prices pierce an established trendline but then close back below that trendline. Sometimes, before a trendline is even established, prices pierce the resistance zone that's still forming and close lower, effectively piercing and then closing below the trendline that has yet to form. This is also true of rising trendlines: prices sometimes pierce a support zone that is still forming but then close above it.
I can hear the "Huh?" exclamations out there. Maybe a chart explains better.
The best-fit trendline drawn here appears to be more valid than one that began as an extension of a short line section that ran along the two November tops. Sometimes traders have to decide whether to draw a best-fit trendline or one that skims the tops or bottoms of each day's candle, depending on whether it's a descending or ascending trendline.
Traders can sometimes validate the decisions made when they've drawn a best-fit trendline. Combining the action of an oscillator such as the RSI with the action of prices near trendline tests sometimes works. I purposely did not handpick the chart or the trendline I would discuss, but focused on the first chart that I pulled, so let's see if we can corroborate this trendline using RSI.
of the Trendline's Validity:
An RSI descending trendline can be drawn off the November and January RSI highs, although it's a tentative trendline with only two points. Because of the similar RSI action at each of the price trendline tests, I would consider the price trendline valid, although it didn't have as strong a corroboration from the RSI as I had expected to see. Of course, there's some corroboration in what price action has since done, but when traders were first drawing trendlines on their charts or having a charting program do it for them, they wouldn't have had the benefit of that hindsight.
Or would they? A study of the volume compared to the shape of the days' candles as that trendline is tested might have given them a clue. Although I've always been interested in watching volume--reporting on volume considerations was one of my first inputs to the live Market Monitor portion of our site many years ago--I owe some of current conclusions from my study of Tom Williams' MASTER THE MARKETS. I won't blame him for my mistakes, however, if I should make them when describing what I'm seeing. Any mistakes are mine alone.
Again, remember that I didn't handpick this chart so that it would illustrate what I wanted it to illustrate, but rather am discovering what it shows as I write. Let's see what volume considerations show us as that trendline was tested, and what traders might look for the next time it is.
MMM's Daily Chart with Volume:
As the trendline test continued in January, there were numerous days that produced what Williams calls "no demand" bars. These occur on low-volume up moves that produce narrow spreads (when compared to the bars preceding them). This is not the way big money's participation would be observed if big money were bullish about prices at this level.
Big money can, however, choose light-volume periods to run stops and trap retail traders, however. Consider again that November 30 candle that pierced that best-fit trendline, with prices falling back by the close. November 30 came during the week after Thanksgiving, a time when it might have been easy to run some stops and distribute some stock to retail traders buying the breakout or shorts covering at the breakout.
What would traders see if a stock in a downtrend might be gaining strength, the downtrend nearing its end? See that huge-volume down day at the end of January? Strangely enough, that could be a sign of accumulation beginning, although it's certainly not a sign that retail traders should begin accumulating just yet.
Here's what I mean. I chose another chart at random, scrolling through until I found another chart with a huge-volume down day, with prices bouncing off their lows that day. Why did they bounce?
Annotated Daily Chart of BNI:
So, while traders haven't seen proof that it's time to buy MMM again, bearish traders are at least forewarned that the huge volume seen at the end of January could have been signs that big money was beginning an accumulation of the stock. While a big-volume drop is normally a bad sign, huge volume on a punch to a new recent low, especially if there's a big bounce by day's end, can be a sign that big money has decided to step in and accumulate.
Big money can be wrong, but, more importantly for us retail traders, they can begin accumulating and hold on while momentum propels a stock's price lower, while we retail traders don't have the funds to tie up to do that. So, I'm not counseling that traders should buy MMM right now.
What would traders see on trendline tests in a bullish stock, if that trendline were to hold? They want to see some of the same characteristics pointed out in that last arrow on BNI. They want low-volume small-range tests of the rising trendline with prices bouncing by the end of the day and with prices climbing the next day. They don't want to see volume increasing as prices drop toward that supporting trendline, especially not if that volume is producing big-range candles that close on the lows of the day.
Drawing trendlines requires art, but fortunately we traders have some tools such
as corroboration by oscillators to help us gauge when we've gotten them right.
We also have volume and price action comparisons to help us gauge whether the
trendline is likely to hold or not
on the next test.
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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