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Daily Newsletter, Wednesday, 08/22/2007

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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

The Slippery Slope

They say bear market rallies are a bull's worst enemy. It continues to offer hope to bulls in long positions waiting for a better price to get out of their positions. Hence the name "slippery slope of hope". I don't know for sure if we've started a more serious decline although that's the way I'm leaning. Therefore the rally off last Thursday's low may be just another false hope for the bulls. These bounces of course do a number on the bears as well. Bear market rallies are often very sharp but short-lived. They spike just high enough to stop the bears out of their positions but not high enough to let the bulls out of their long positions. And then both end up chasing the market lower again and the selloffs can be very strong following the strong spike up.

Whether or not that's what's setting up here can't be known but I'll show a couple of ideas as to what could be playing out in the charts. To say we've got some volatility in the market would be a gross understatement. I think both sides are having a tough time not getting whipsawed out of their trades. The latest rally spike can be attributed to a little help from our friends in the Fed. But even with today's nice rally you can see in the table above that the new 52-week lows beat out the new highs. There's buying but it's not broad based and probably has more to do with short covering and buying in the big caps than anything else. It's also thanks to the Fed's actions as of late. I was going to title tonight's report "Bernanke Blinked".

There are lots of opinions about whether we should see a lowering of the federal funds rate from the current 5.25%. Even though Bernanke only lowered the discount rate (the rate charged by the Fed for short term loans to banks) he basically made what many are referring to as a rookie mistake. He blinked. He was determined not to be pressured by the financial community (the cry babies like Jim Cramer) and stay vigilant in his fight against inflation. But he blinked. The day before Bernanke lowered the discount rate, St. Louis Federal Reserve President William Poole said the central banks would not need to intervene in the stock market unless there was a real crisis. I guess billionaires losing their jobs constitutes a crisis.

That's said of course somewhat tongue-in-cheek since the banking system was clearly having difficulty meeting cash requirements (withdrawals from accounts). But there are many who think Bernanke did a 180 degree turn and went against everything he has been saying since he's been in the job (fighting inflation is job #1). In other words his actions in the past week have caused him to lose a lot of credibility and that's not what the financial community needs.

Bernanke had been trying to convince the market that he was not going to follow Greenspan's example of caving into pressure from the financial community. Greenspan always provided immediate assistance in times of stock market declines and that's where the "Greenspan put" came from. I guess now we'll have to call it the "Bernanke put" or maybe the "Bernanke Bounce" to give him his own recognition.

The stock market rally from last Thursday's low is very likely more a result of short-covering and false expectations by people who don't study history. It could continue for another week, especially if the Fed comes out with a fed funds rate decrease. But that should worry anyone who is a student of the market (explained in more depth below with my discussion about the 13-week T-Bills). Certainly the problem that caused Bernanke to panic has not disappeared (the collapse of credit as a result of fear that was sparked from the crash in the values of mortgage-backed securities and all their derivatives). In fact the revaluation of all that paper has just begun--Bloomberg reported yesterday that $550B of commercial paper, or nearly half of the total, is coming due in the next 90 days and all of that will likely be repriced to reflect market values.

Bernanke panicked and he probably did the wrong thing. Inflation is still a problem and is expected to get worse in the next six months. Due to the drop in inflation the last half of last year, the year-over-year comparisons the last half of this year are expected to show an increase in inflation and not a continuation of the gradual decrease. By lowering the discount rate, flooding the market with $120B in added liquidity and especially if they lower the federal funds rate, the inflationary problem will only get worse. Reflating the economy now is not what it needs (that's what got us here in the first place).

The knee-jerk response from Bernanke will now put the Fed behind the power curve when it comes to inflation. I've mentioned several times that I think there's a good chance the stock market will follow a pattern similar to the 1970s (if not worse) which means another trip down to the October 2002 lows. It may also mean a period of stagflation similar to the 1970s that Paul Volcker finally broke by drying up liquidity which forced interest rates very high and our economy into a deep recession. This is a deadly combo for the stock market. Bernanke's mistake has put us on that path and it's because he succumbed to pressure from Wall Street instead of sticking to his guns, using a little intestinal fortitude and maintaining his battle on inflation. He continues the job that Greenspan started in painting himself into a tighter corner.

As a student of the market you should be studying periods of time prior to 1982 which was the start of the greatest bull market ever experienced. Most analysts refer to market patterns since 1982 and most use comparisons only to the 1990s. This is wrong if the bull market has ended. That is of course debatable (if the bull market has ended) but it behooves us to review the previous bear markets to see if there are similar patterns. And that's why I mentioned above the need to study what happened during the 1970s since there's a good chance we may see something similar this decade especially if inflation rears its ugly head while the economy continues to slow.

Speaking of comparisons though, and this one is much closer to current times, we need to look at what interest rates are doing on the short end of the curve, specifically the 13-week Treasury Bills. There's been a strong desire to own this paper and it requires our attention.

Last week I had made a comment that you should carefully research the money market accounts in which you have funds. Not all money market accounts are considered equal and some are much riskier than others, especially if they have much of their money in the higher-risk mortgage-backed securities, or in risky commercial paper. The safest place is in a fund that is invested primarily in U.S. government securities. The run on short term U.S. treasuries the past week caused the 13-week T-Bill to spike higher in price (yield dropped) as funds rushed to snap up the safer paper. What's disturbing for the market, or certainly should be, is that yield on the 13-week Bills (IRX.X) has dropped so hard so fast. The yield got a big bounce on Tuesday so it needs to be watched closely here. The last time the IRX saw a rapid decline was in 2001:

SPX vs. 13-week Treasury Bill (IRX), Monthly, 1999-2007

The top chart is SPX and the bottom chart is the 13-week T-Bill (IRX). Notice that when IRX last dropped hard (meaning strong buying) was in 2001. The stock market also sold off hard during this period. Buying the shorter term maturities in ultra-safe government securities is a sign of fear in the market. When market participants are fearful they shun risk and that means stocks.

On the SPX chart I added a couple of notes showing where Fed interest rates were changed. The significance is that the stock market dropped hard in 2001-2002 even while the Fed was aggressively lowering rates. This clearly demonstrates why I insist that the Fed follows the market up and down and does not lead the market with their interest rate policies. So the fact that the market rallies on news that the Fed is lowering interest rates is just plain wrong. The current buzz about expectations that the Fed will lower rates by the end of this month and why that's bullish is completely and utterly backwards. If the market rallies subsequent to a Fed rate cut you should be looking to short it. Listening to the bozos on CNBC about this will get you into trouble.

Investors are showing they're willing to forego the possibility of a higher return (and its higher the risk) for the guarantee of a relatively poor but safer return. This is when the return OF capital becomes more important than the return ON capital. It says investors are worried and fearful.

T-Bill yields fell for five straight days into Monday as money market funds dumped asset-backed commercial paper and rolled into the shortest-maturity government debt. The 3-month T-Bill yields made their biggest drop since the stock market crash of 1987, and more than after the September 11, 2001 terror attacks. Funds were basically getting rid of investments that might be linked to weakening mortgage and commercial markets. "The market is totally, absolutely, completely in fear mode," said John Jansen, who sells Treasuries at Castle Oak Securities in New York.

I've mentioned many times in the past that the stock market runs on emotions and not on fundamentals (fundamentals follow the stock market, not the other way around). So when investors become fearful they become bearish. Hence when you see the yield dropping fast on 13-week T-Bills (meaning a rush to buy them which drives their prices higher and yields lower) it tells you people are becoming more bearish on equities. And that's exactly what happened in 2001, as shown in the above chart, and I'm thinking will happen again within the next year.

And that brings us back to money market accounts and why you need to do your due diligence about where your money is parked. A story is making the rounds about Raymond Przybilinski, a regular hard-working guy who managed to stuff away $521K from a lifetime effort of saving his pennies. He thought it was safe in bank CDs. Only because the bank deposits were covered by FDIC and he and his wife were joint owners did he manage to get $200K back otherwise it might all be gone. Money market accounts are Not insured by FDIC.

On August 14th there was a headline in USA Today that read "Sentinel Freezes Assets of $1.5B Fund". Most thought it was just another hedge fund that went tango uniform (TU for, um, belly up). But it was another money market fund and not a hedge fund. But this MM fund was more exposed to the mortgage-backed assets including all the derivatives. If your bank CD or MM account are offering above-market rates then it probably would be in your best interest to find out why.

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Sentinel thought they knew the value of their paper. They sent out a letter to their clients telling them they were frozen out of their accounts until the market improved. Management stated "We have never experienced a situation quite like this one. Liquidity has dried up all over the Street." I've been saying we'll see the credit bubble collapse mind-numbingly fast and it's upon us now. Moody's, Fitch and the S&P ratings agencies have all been caught flat-footed, as well as the number of quant models used by big hedge funds.

And now these funds are denying requests for withdrawals because they don't want to be forced to sell securities at a deep discount to "fair value". This of course begs the question what is fair value. Is it the value the fund manager thinks it is (according to their expensive computer model) or is it what the market thinks it is? The answer of course is obvious. Bear Stearns locked their investors out of their two busted hedge funds back in January while they waited for the market to recognize their fair value. At that time investors could have gotten 70% of their money back. By waiting for fair value BSC caused their investors to get a big goose egg. It's that same slippery slope of hope at play.

And now Bloomberg is reporting $550B of commercial paper that's coming due in the next 90 days. If that paper can't find new buyers then hundreds of hedge funds, home-loan companies and more money market accounts will be forced to sell their paper for pennies on the dollar. This is why money market managers are making a run on the 13-week T-Bills. They know they're in trouble and they're trying to liquidate their riskier holdings as fast as they can.

All of this is not stock market friendly and it's why you should look at rallies in the stock market as opportunities to lighten up your positions and even look for opportunities to add some short positions. A 600-point rally in the DOW does not make the credit crisis go away. Many are sticking their heads in the sand in hopes their butts won't get whacked. The Fed doesn't have enough shields to protect your butt (they're handing them out to the billionaires first) so do something to protect yourself.

Economic reports
There was only one report today--crude inventories. This week is a very light week for economic reports.

Crude Inventories
Crude supplies rose for the first time in 7 weeks, up 1.9M barrels to 337.1M. But gasoline supplies fell -5.7M barrels to 196.2M, making it the largest decline this year. Half of that decline can be attributed to lower imports because refiners felt confident that they would be able to meet demand. But refinery utilization rate fell to 91.6% from 91.8%. Gasoline inventories are -6.5% below their year-ago levels. Distillate stocks were up 1.3M barrels to 129.0M.

And now to the charts. While I'm bearish the stock market, for what I think are good reasons, I'll show both immediately bearish scenarios as well as the possibility for a pullback and more rally into the end of the month or beginning of September. Just because we have many bearish things afoot here, never underestimate the power of short covering or bullish hopes. With just about every pundit on TV pounding the table about what a great buying opportunity this is, and with the long term trends still in play, it's easy to see why so many continue to buy the dips.

DOW chart, Daily

The pattern of the decline, from an EW (Elliott Wave) perspective leaves open several possibilities as far as the wave count goes. It needs to develop further before the larger pattern clears up from here. The sharp rebound off last Thursday's low leaves a clear 3-wave decline from the July high. First thought is that means the uptrend is not finished yet. An impulsive 5-wave move followed by a corrective 3-wave move means the larger impulsive trend is still in play. That has many people, Elliotticians included, thinking that the market is headed to new highs from here. That's not what I'm showing on my charts, including the DOW's chart above.

Based on the longer term wave count from October 2002 I believe the rally is finished. That would mean the 3-wave decline to last week finished a larger degree wave-A and we're now into a wave-B correction of that decline. This is my interpretation and obviously I could be wrong but until proven otherwise I'm looking for opportunities in this bounce to get short. The question tonight is whether the current bounce could be finishing up that correction or is only part of a larger upward correction. I show two possibilities--one calls for a pullback to be followed by another rally into the beginning of September (dark red) while the other calls for a significant decline to start next. Both cases could see a little higher in the market before it pulls back/starts declining.

DOW chart, 60-min

I'm showing a pullback starting right away on Thursday morning. As I write this report the futures are up strong so if that carries through into the cash open then we could see the 50% retracement of the decline, or even 62%, get tagged before price pulls back. I show with the SPX why I felt the end of the day today was a good short setup.

SPX chart, Daily

I'm using the SPX daily chart to show how price could play out the rest of this year if it follows a typical price path that's similar to the way the market declined in 2000. It may be full of 3-wave moves as part of a very large corrective pattern that takes the market back down over the next year or so. It's why I don't believe a 3-wave pullback from July is necessarily bullish. These corrections are very difficult to figure out real time so I take it one leg at a time and watch key levels to help determine what's likely to play out next.

SPX chart, 60-min

Like the DOW I'm showing a pullback starting tomorrow. Whether it pulls back right away or after moving higher first is the question tonight as futures are up. And then it will be a question whether it will be just a pullback and then another rally leg into the end of the month/beginning of September (dark red) or if the decline will keep going and make new lows.

The 30-min chart shows the setup as I showed it on the Market Monitor at the end of the day and why I felt it was a good time to try a short play.

SPX chart, 30-min

The ascending wedge pattern, with bearish divergences, over the past 3 days looks like a good setup for a short play. It looks like a nice a-b-c bounce with an ending diagonal (ascending wedge) for wave-c which is very common. At the same time price is about to run into the downtrend line from July 19th. If SPX jumps up over the downtrend line tomorrow morning and then finds it to be support on a pullback then long will be the right place since it will be a break of resistance and a rally out the top of an ascending wedge which is usually accompanied by a strong rally. Otherwise a brief poke above the pattern (often news related) followed by a collapse back inside would create the first sell signal so either way we should get a trade signal early tomorrow.

Nasdaq-100 (NDX) chart, Daily

NDX shows the same potential as shown for the DOW and SPX. Price jumped up and over the 100-dma today so if it gets a little higher tomorrow watch for possible resistance at its 50-dma at 1956.

Russell-2000 (RUT) chart, Daily

The RUT is having trouble with its 200 moving averages and the 50% retracement of its decline. It's had a very volatile August and the volatility may not be over. If it can press a little higher then watch 62% at 813. Otherwise if this starts back down in what appears to be a 3rd wave setting up then the selling could get intense at times.

NYSE (NYA) chart, Daily

The NYSE has been trading its trend lines very well and that's what caught my eye today on its chart. It stopped at resistance at its broken uptrend line from July 2006 and its downtrend line from this July, and with a slight throw-over above its 200-dma. Any drop back down from here will look like a kiss goodbye against broken support and will be stuck in its new downtrend. It will have to gap above this resistance tomorrow otherwise I think it will be tough to rally above it.

BIX banking index, Daily chart

Banks have been very volatile this month as traders duke it out over where banks stocks should be trading. Two equal legs up from the August low is at 380 and that's where price has been struggling the past 4 days. The July-Aug downtrend line is right there as well. The wave count I have on this chart is very bearish as it's setting up a very strong decline in a 3rd of a 3rd wave down. These are the screamer waves so if it unfolds that way I suspect the broader market will be following.

U.S. Home Construction Index chart, DJUSHB, Daily

The housing index is still well entrenched in a down trend and the faster moving averages have crossed below the slower averages. This all defines a down trend and until there's better evidence of bottoming I wouldn't be thinking long this index.

Oil chart, December contract (CL07Z), Daily

Oil made a 3-wave bounce off the January low with the 2nd wave up achieving 62% of the 1st wave (a common relationship) before rolling over and breaking its uptrend. I believe oil's rally is finished and we'll now see oil head for sub-55. A slowing economy will be "blamed" for the drop in oil's price.

Oil Index chart, Daily

Oil stocks, which led the decline in the commodity (very typical) look like they have a little more bounce left before they're ready for another leg down. A rally back up to the 750 area would be a typical place for the bounce to fail--top of its parallel up-channel that it's back inside, its bounce would have two equal legs up (753) and it would be at its previous 4th wave. If you're long any oil stocks and looking to lighten up or hedge your position that could be your last best place to do it.

Transportation Index chart, TRAN, Daily

Like the banks I see the possibility that the Transports are setting up a very bearish wave pattern. The current bounce may find resistance at or below its 200-dma and the next leg down could be a 3rd of a 3rd wave down and consequently see some very strong selling.

U.S. Dollar chart, Daily

As expected, the US dollar has pulled back from its downtrend line and appears to be correcting the bounce off its August low. Two equal legs down in its pullback would have it dropping down to the 80.70 area which would also be a 62% retracement. If the dollar has bottomed then that pullback should be followed by some strong buying as the dollar breaks its downtrend.

Gold chart, December contract (GC07Z), Daily

Even with a hard sell off in the stock market from July into August, gold was not able to rally. In fact it sold off with the market. This has many gold bugs scratching their heads in wonderment since gold is almost always a safe haven in times of distress for the stock market. This is in keeping with what I've been saying about what will happen once the credit bubble collapses. All asset classes will suffer just as they've all benefitted from the creation of credit and all the liquidity that's been sloshing around the globe. Just as money was created out of thin air, so too will it disappear just as easily. People will be forced to sell anything of value (gold, stocks) in order to cover those things with no value (mortgage-backed securities, commercial paper) and to meet their margin calls. Gold is setting up for a very strong decline.

Results of today's economic reports and tomorrow's reports include the following:

Tomorrow is a big day for economic reports--there are two of them. Don't hold your breath for a big move in the market because of them. Friday's reports might have a little more impact but only if the number is a real surprise.

SPX chart, Weekly

I'm showing an impulsive wave count to the downside (it's still very early to tell) whereas the daily chart shown earlier calls for a corrective (A-B-C) move down. Once the larger pattern becomes clearer I'll update this chart if need be. The important level is last week's low since a break of it will also be a break of its long term up-channel (in place since the October 2002 low). By this channel the trend is still up and one would have to say stick with the trend and stay long until it's broken. But I'm comfortable calling a top to the bull market and am therefore looking to short the rallies ahead of time. But it does take a break below 1370 to put us officially in a down trend.

As I mentioned earlier, equity futures are up strong this evening so we'll see if that carries over into the cash opening tomorrow. There was a good setup to get short at the close on Wednesday and therefore watch for the possibility of a gap up and then crap out first thing Thursday morning. If the market starts a pullback on Thursday then we should get at least a 50% retracement of the rally off last Thursday's low. More bearishly we'll start another leg down to new lows.

On the other hand if the market gaps up Thursday morning, pulls back to test support at Wednesday's closing prices and then proceeds to rally then you'll want to be long the market since that should be a bullish move. Just keep an eye on the resistance levels above that I identified on the various charts.

Longer term I believe the stock market is in trouble. There's a wall of worry to climb and then there's a brick wall. The market has run into a brick wall and the collapse of the credit bubble, which we're just beginning to see evidence of, will cause a lot more selling in the very near future. There's a whole lot more pain that the holders of bad paper are going to have to endure before this is over. Even the majority of mortgage resets doesn't hit us until later this year and the first half of next. So look for opportunities to lighten your long positions, get some protection and/or add some short positions.

Good luck and I'll be back here on Monday as I fill in for Jeff. Hopefully we'll be a couple of steps closer to identifying what the larger term price pattern will be. See you then.
 


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

Amazon.com - AMZN - cls: 78.50 chg: 1.01 stop: 72.45*new*

AMZN rose again on Wednesday and shares came within one cent of our target. The intraday high was $79.49 and our initial target is the $79.50-80.00 range. The $80.00 level looks like short-term resistance so traders may want to lock in some gains now or on another rise toward $80.00. We do have an aggressive target in the $84.00-85.00 range. Please note that we're raising the stop loss to $72.45. We would not suggest new positions at this time.

Picked on August 19 at $ 75.02
Change since picked: 3.48
Earnings Date 10/23/07 (unconfirmed)
Average Daily Volume = 10.1 million

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L.B.Foster Co. - FSTR - cls: 36.96 chg: -0.03 stop: 34.59

The good news with FSTR is that the stock didn't change much from yesterday. The bad news is that FSTR hasn't changed much from yesterday. Lack of follow through lower on yesterday's bearish reversal is encouraging but FSTR displayed relative weakness again with a decline on a day where most of the market was higher. We would still expect a dip toward $36.00 at a minimum and probably the $35 region. We're not suggesting new positions at this time. We're not exiting early because FSTR still has a bullish pattern of higher lows. We have two targets. Our first target is the $39.90-40.00 range. Our second target is the $42.00-42.50 zone. Please note that this remains an aggressive, higher-risk play.

Picked on August 14 at $ 37.33
Change since picked: - 0.37
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume = 148 thousand

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Goldman Sachs - GS - cls: 177.89 chg: 2.41 stop: 167.45

GS continues to bounce. The stock rose 1.3%. The failed rally at $180 this morning is a concern but we would still consider new bullish positions at this time. More conservative traders may want to wait for another rise over $180 or $181 to initiate positions. Overall we don't see any big changes from our weekend comments. We have two targets. Our first target is the $184.75-185.00 range. Our second target is the $194.00-195.00 range. One of our biggest risks is the intraday swings that could easily stop us out.

Picked on August 19 at $175.00
Change since picked: 2.89
Earnings Date 09/12/07 (unconfirmed)
Average Daily Volume = 11.6 million

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DJ Transports iShares - IYT - cls: 88.22 chg: 1.87 stop: 83.99*new*

Another drop in crude oil futures helped the transports rally. The IYT ishares rose 2.1% and cleared short-term resistance at the 10-dma. More conservative traders may want to exit in the $88.85-89.00 range because the 200-dma near $88.90 could be technical resistance. We continue to target the $89.75-90.00 range. Please note that we're adjusting the stop loss to $83.99.

Picked on August 19 at $ 85.43
Change since picked: 2.79
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 600 thousand

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Sears - SHLD - cls: 143.63 chg: 2.38 stop: 134.85

Retail stocks did well with the RLX rising 1.79%. Shares of SHLD tried to keep pace with a 1.68% gain. SHLD has a strong short-term trend of higher lows. We would still consider new positions here or on a dip near $140. We have two targets. Our first target is the $149.50-150.00 range. Our more aggressive target is the $157.00-160.00 zone. We do not want to hold over the very late August earnings report (unconfirmed date). The only information we found was a press release saying SHLD plans to report earnings on or before August 30th.

Picked on August 21 at $141.50
Change since picked: 2.13
Earnings Date 08/30/07 (unconfirmed)
Average Daily Volume = 2.1 million
 

Put Updates

None
 

Strangle Updates

None
 

Dropped Calls

Freeport McMoran - FCX - cls: 85.59 chg: 4.30 stop: 74.45

Target exceeded. FCX rallied again. The stock gapped open at $83.20 and closed near its highs for the session above potential resistance at the $85.00 level. The stock looks poised to challenge the 50-dma near $87.00 soon. Our target was the $83.50-85.00 range.

Picked on August 19 at $ 76.90
Change since picked: 8.69
Earnings Date 10/17/07 (unconfirmed)
Average Daily Volume = 10.3 million
 

Dropped Puts

None
 

Dropped Strangles

None
 


Trader's Corner

Completing a Correction: Ways to Measure

This article is a natural closing article in a series I've written recently, mostly about the ins and outs of fibonacci retracements. Now that our big downside correction appears to have run it's course, for now, I'll take a final look at what retracements occurred at the recent top, and the last bottom. After that, I'll move on to one way of viewing the common chart formation for bull market corrections or interruptions, that of a Down-Up-Down pattern called an A-B-C pattern in Wave terms.

As discussed last time I wrote this column, its common to see 38, 50 and 62 percent retracements of a prior move, part of the so-called Fibonacci number series. WD Gann, a legendary stock speculator (mid 1900s), found it significant for retracements between a major low to high or, high to low, of 1/4, 1/2 and 3/4ths; i.e., 25, 50 and 75%. Gann also found significance in the 1/3 and 2/3rd retracement levels; I have learned to look closely for rally or downswing failures in the area of the 66% retracement point when a move has slipped past the fibonacci 62% retracement.

In so-called 'A-B-C' corrections, having a big decline, a short rebound and another long down segment. The two down 'legs' in a DOWN-side correction will of course be the longest. What's more, the two down-legs tend to be either EQUAL in length (a 'measured move') OR downswing 'C' is 1.25 to 1.62 times longer than 'A'. It's common in stocks to see a second downswing that is a fibonacci 1.62 times the first downswing.

SPX, as seen in the daily bar chart below, had a first decline of 129 points from peak (1556) to trough (1427), comprising price swing 'A'. The second decline from peak (1504) to trough (1370) carried 134 points, making price downswings 'A' and 'C' nearly equal. If you assume equal length price swings as a factor in covering puts that is not a bad call for the lead index in this market cycle. As long as you accept that a equal 'measured' move tends to be a 'minimum' for how far the second downswing will carry; and, the second leg down (C) might carry significantly lower still, as was seen in the Dow just recently.

The above is not to suggest that there will not be a lower low than already seen at 1370 at some point. But the close above the 21-day average is a bullish positive. I attempt to identify trading swings that are both substantial and predictable. How to get predictable? If you get a big downside correction, especially after a long rally, DON'T assume that the FIRST rebound is anything more than a pause in the two-part downswing comprising an A-B-C correction.

Rebound 'B' couldn't exceed more than 62% of the first decline, making it all the more likely that another good-sized decline of at least equal length was coming. What a trading useful thing to know from pattern recognition!

In terms of this thing I talk about all the time as 'pattern recognition', it's interesting to place the recent 1370 SPX low in context of its broader weekly chart. Suppose I was wondering (I was!) if the second leg down in the S&P was going to EQUAL the first decline OR was maybe was going to carry farther; e.g., another 50% further. However, if a low was ALSO coming down to support implied by the low end of a well-defined long-term weekly chart uptrend channel, this weekly chart factor would suggest the 'equal' moves outcome provided the trendline held.

I had this weekly chart pattern outlines drawn for some time; only the price fill is unpredictable. You can project straight lines as in my weekly chart markings below, but it doesn't mean that a decline will STOP right at support implied by its long-term up trendline. WRONG! The recent upside reversal came from a low, at 1370, right at technical support implied by this long-established trendline. I've seen it unfold this way in market cycles so much as for it to no longer seem kind of 'uncanny'.

The Dow, consisting of just 30 stocks and not being capitalization weighted to boot, can get more volatile in its price swings, particularly in a mini-panic environment. While the second part ('C') of its two-part decline was 1.25 times the first, the shape of the A-B-C is the same basically, is the exact fibonacci retracement of 62% of the first down leg before a sharp part-2 decline kicks in.

The A-B-C decline seen in the Nasdaq 100 (NDX) was very similar to INDU in that the second downswing of 189 points (C) was 1.27 times the 148 point decline (A) from 2060 to 1912. If you were 'keying' off the S&P 500 dominant index, NDX was a buy when it got down near 1800.

With the Nas 100, the retracement at the end of rebound 'B' was just 50%. The index couldn't get more traction than that. The 'natural' resistance levels are 38%, 50%, and 62-66%. That another downside correction was 'due' so to speak was being 'announced'.

Technical indicators are great when they can 'confirm' or not confirm what is being suggested by other market measures; e.g., the bottoming-reversal suggested by:
1.) the equal leg decline in SPX and
2.) the rebound from a major SPX up trendline.

My important 'sentiment' indicator can be yours too. Whenever total CBOE equities put volume equals or exceeds total daily call volume (a 1:1 ratio, or less) my rule of thumb is to look for a major trend turnaround to the upside within 1-5 trading days. [Conversely, when call volume is twice equities put volume (CBOE), that's often a precursor to a top.]

In the market activity there were two days registering such a put to call 'imbalance' relative what happens most of the time and is seen below. Within 2-days where my call-put ratio dipped into 'oversold-extreme bearishness' territory I also label as 'BULLISH'. Contrary as it is, a certain level of bullishness is associated with tops and a certain level of bearishness, with bottoms and these can be pretty precisely measured. Sure worked here, so far. Stay tuned!


GOOD TRADING SUCCESS!

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Today's Newsletter Notes: Market Wrap by Keene H. Little, Trader's Corner by Leigh Stevens, and all other plays and content by the Option Investor staff.

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