Analysts have talked a lot about the so-called "Greenspan Put" that underpinned the equity markets for the last decade. Analysts felt that Bernanke did not want to fall into that same trap and be known for rushing to the market's aid every time it caught cold. On Friday Bernanke tried to stress that the Fed was not going to come to the aid of the financial sector because of bad credit decisions. But, if those decisions were impacting the overall economy the Fed would come to the rescue. Regardless of how you phrase it the new Bernanke put is definitely taking shape.
Dow Chart - Weekly
Nasdaq Chart - Daily
There was a flurry of economic reports on Friday with mixed results. The first was Personal Income for July and the headline gain of +0.5% was above the consensus of +0.3%. It was a four-month high. Spending rose +0.4% compared to +0.2% the prior month. The PCE deflator rose only +0.1% and the slowest rate since last November bringing the headline inflation rate down to +2.1%. The core PCE deflator rose only +0.1% for the fourth month out of the last four and held the core inflation rate at 1.9%. That is just barely into the Fed's target range but not enough to press them to cut rates based on the inflation rate alone. On the flipside real disposable income jumped +0.5% in July and the fastest rate since February. Spending rose only +0.3%. The obvious dislocation between those numbers meant the savings rate to +0.7% and the highest rate since March. This means consumers are putting more money back for future bills and being less frivolous in their spending. With home equities shrinking and much harder to tap given the mortgage problem many consumers are reeling in their discretionary desires in order to keep within their budget.
The NAPM-NY report showed business conditions fell again in New York and well below the April high. The six-month outlook fell from 62.5 to 60.0 but the current conditions component spiked higher to 47.3 from 39.7. That current conditions spike kept the index from showing an even bigger drop in August. The conditions in New York are directly impacted from the current credit crunch. Money becomes tighter, layoffs are prevalent and bonuses are expected to be minimal.
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Moving to Illinois the Chicago Purchasing Manager report moved slightly higher to 53.8 from July's 53.4. The amount of the move was not important after last months sharp drop to 53.4 from 60.2. Any positive movement was appreciated. Without going into the boring details, only two components rose while four declined, the biggest moves were in the employment and inventory components. Employment fell sharply to 53.7 from 61.6 and inventories dropped to 44.6 from 55.1. The drop in employment suggests confidence is dropping and businesses are not as willing to add workers and take on new expenses. The drop in inventory could be due to shipments leaving for the holidays ahead as well as a lack of confidence in future demand.
Factory Orders were one of the bullish reports for the day rising +3.7% for the July period. This compares to an average gain of only +0.3% for the prior three months. Shipments jumped +2.6% after losing -0.5% in June. Durable goods spiked +6% and posted the second month of gains since the -2.4% drop in May. This report was largely ignored since it is a trailing indicator.
Lastly the final Consumer Sentiment Survey for August closed at 83.4 and -7 points from the 90.4 in July. Expectations fell -8 points and present conditions -6 points for the month. The continued debt wreck and the weakness in the equity markets overshadowed the decline in gasoline prices over the last two weeks. Another survey found that gasoline prices were a bigger factor in consumer sentiment than falling equity in their homes but that did not appear to carry forward into this months report.
Next week we have two major reports and the release of the Fed Beige Book. On Tuesday the Institute of Supply Management (ISM) report will tell us if last month's sharp drop after three months of gains was an anomaly or the beginning of another down trend heading into a Q4 recession. That may sound dire but that is the forecast by many analysts for the country to enter a recession in Q4 or Q1 of next year. A continued drop in the ISM would be a leading indicator. Estimates are for a flat report with a 53.8 headline number. The Beige Book on Wednesday will give investors a detailed look into the conditions in each of the Fed regions. It is also a report the Fed will use the following week to determine how seriously the mortgage/credit problem is contaminating the rest of the economy.
The biggest report for the week will be the Non-Farm Payrolls on Friday. Last month we saw job creation fall to only 92,000 jobs and well under the 135,000 consensus estimate. 92K is about as low as analysts think the market can stand. If job creation falls much under the 75k-85K level the recession fears will ratchet up sharply. This will be a key number for the Fed's rate decision the following week. Something in the range of 150,000 jobs need to be created each month to absorb the new workers moving into the job market from immigrants and graduates. A negative number next week would be a disaster for the markets and almost a guarantee the Fed would cut rates aggressively.
Everyone has been waiting for three weeks for Bernanke to speak on Friday. Now that the speech is history the reactions have been pretty much as expected. However, most praised him for being uncharacteristically blunt regarding the current conditions. He stressed that the Fed would not bail out firms that made bad credit decisions and bad business decisions. However, if the result of those decisions did spread out into the broader economy the Fed would be forced to act to support the economy. The wording of his statements changed slightly and was taken as a clue that a rate cut was coming. Bernanke said the Fed "will act as needed to limit the adverse effects on the broader economy." The change to "will" act instead of might or could act was seen as a clue. In a separate paragraph he said the impact of the credit crisis was spreading to the broader economy. This is a case where 1+1 does equal 2 and a cleverly worded indication of his plans. He also mentioned the dramatic change in conditions just since the August 7th meeting. At that meeting the primary concern was inflation. A little over a week later the Fed said there was a dramatic shift in market conditions and now economic worries were the top priority. By referencing that dramatic shift again and the shifting focus to the economy rather than inflation he also telegraphed a potential rate cut. He said the new risk adverse attitude by the financial community was causing undue market stress and the Fed would continue to act to provide liquidity. This suggests there will be another rate cut at the discount window. He stressed repeatedly that the Fed was not responsible for the consequences of actions by the financial community but was responsible for the consequences to the overall financial system. He said the outlook uncertainty was far greater than normal and the Fed would take into account not only normal indicators but also anecdotal evidence from banks and businesses. That evidence should not be too hard to acquire since nearly every CEO interviewed in the last two weeks is screaming for a rate cut to avoid an impending recession. In one series of sound bites on CNBC on Thursday they put together comments from more than a dozen high profile CEOs interviewed over the last two weeks. All of them were pleading for a rate cut to stave off impending doom. Nearly every sector was represented and follow on comments have even seemed harsher. One Countrywide official said late last week that the country was plunging into a recession at breakneck speed. That was not the exact quote because I got the info second hand but it conveys the urgency Countrywide is feeling. To sum up the Bernanke speech it was a blunt assessment of deteriorating conditions and the Fed will act but there was no commitment to specific actions. As Paul McCauley from Pimco said, "it was the best confirmation Bernanke could give that a rate cut was coming without actually saying he was going to cut rates." Bernanke does not want to appear pressured or panicked and that is why they are waiting for the meeting on Sept-18th.
The market did not know how to take the back-to-back speeches by Bush and Bernanke. It continued to wander all over the place on very light volume. It was as though traders got the message but did not believe it. Theoretically the confirmation of a pending rate cut should have put wings under the market. Unfortunately analysts started to second-guess themselves and tried to find holes in their assumptions. They also began to focus on those three critical reports next week that could confirm the current economic assumptions, prove them worse or disprove them completely. If the ISM, Beige Book and Jobs suddenly took a turn for the better then the Fed would likely provide a cautionary statement and pass on changing rates. That would be negative for the markets and produce additional weeks of wandering until the Fed's Halloween meeting in October. If the conditions proved worse than expected the analysts would begin wringing their hands over the crash and start blaming the Fed for waiting too long and begin putting out doomsday scenarios. That would also be bad for the market. That means we are right back to wishing for Goldilocks to return and find economic conditions next week as comfortably lukewarm and deserving of a rate cut to provide a gentle nudge higher.
I have started to see some light at the end of the tunnel in the various individual reports. Some areas of the country are actually seeing a slight improvement in home sales and a rise in home prices. Insiders at the builders were net buyers of stock in four of the last ten days according to TrimTabs. Since insider transactions are normally 10:1 in favor of sellers even in normal conditions the news that insiders are buying building stocks is clearly positive.
Several financial companies have also reported a loosening of the corporate paper market with several debt sales proceeding at regular rates. The key for next week will be the First Data (FDC) and Texas Utilities (TXU) deals. As of Friday the stocks were improving and values returning towards the sales price in anticipation of the deals being closed. If those two giant deals can close soon it would go a long way towards reassuring banks that business was returning to normal. Reportedly over $200 billion in corporate paper debt sales have not closed in the last four weeks. This are loans that failed to be placed and had to be eaten by the originating lender called "hung bridges." That will put a severe crimp in future deals until those loans are eventually sold. At the current rate of hung bridges at about $45 billion per week it would not take long before defaults would begin to occur as debt piled up on originator balance sheets. These would not be credit defaults but defaults on commitments to fund future deals due to lack of funds. The calendar for the corporate paper world cycles about every 45 days. While this current cycle has been avoided as though it was contaminated spinach the next cycle may get better reviews. If anything the credit profile should be better since the current change in lender appetites is to prime cuts rather than ground meat.
There are also rumors of some giant layoffs ahead in the structured finance areas. Reportedly Lehman, Bear Stearns and Goldman Sachs are preparing some monster layoffs since even a return to normalcy in the credit markets will not mean a return to subprime loans. Reportedly layoffs could exceed 20%. Those hundreds of billions in subprime originations and CDOs are over. Whatever the new lending paradigm brings with it will have to be structured as it happens. Clearly the global appetite for subprime debt has disappeared along with the loans. Bonuses for those lucky enough to retain their jobs are expected to decline by -10% to -15%. Given the massive loses some of these firms are going to take I am surprised they will get bonuses at all. Don't forget, the financial sector begins reporting earnings for the last quarter with Lehman and Bear Stearns leading off on Sept-13th. If they report massive losses it could get ugly in the markets. If they report manageable losses along with restructurings (layoffs) and provide tolerable guidance the street will probably forgive them and a bottom will form.
The Bin Laden Trade I mentioned on Tuesday has now gotten press around the world. With the glare of the spotlight some players have been discovered and more is known about the trade. Reportedly Dan Perper, a partner at Peak 6 (www.Peak6.com), one of the largest option market makers and proprietary trading firms, said Peak 6 was a counterparty to a good portion of that SPX trade. He described it as a box spread loan and a form of alternative financing. A box spread in this instance would be a short in the SPX 700 calls, 1700 puts and long the 1700 calls and 700 puts. In theory there is no risk in the trade since each option leg offsets another. Like I surmised on Tuesday it produces a giant loan on the market to whoever owns the spreads. Basically you receive large amounts of money from those options you sold and the money spent for the out of the money legs is minimal. The spread holder receives the premium in their account for the duration of the trade. Obviously as option traders we all know that the premium from selling short options or stocks must in theory remain in the account until the trade ends so how does that help the spread writer? Let's assume you had a very large stock and bond portfolio but some of the securities were underwater or illiquid. Say you owned millions of shares of Countrywide at $40 and for some reason did not sell them when they started falling or maybe some subprime bonds you can't sell. You are faced with margin calls as the values continue to drop. You can short something else, say an SPX box spread, to produce premium income. That cash sitting in your account is an offset to your margin requirements in other issues. The big question obviously on everyone's mind is what happens if the bleeding continues and the cash goes back to the market at expiration? They would then have to liquidate other positions to cover their margin requirements OR roll the spread over to the next month in hopes for a rebound in whatever it is they can't or won't sell. Perper already said this trade would probably be rolled over into December options. That market loan (off balance sheet financing) grew by 3000 contracts since Tuesday for an additional $300 million in premiums. Obviously this is a cause for concern since somebody being short $6 billion in SPX options is an expensive loan and that suggests they are in trouble and could not get the money elsewhere. It also suggests they are a credible company since you and I would not qualify for the same treatment. Should we be worried about the potential outcome? I am not as worried about a single company with financial problems taking out a loan on the market as I would be worrying that a terrorist event was headed our way. This explanation on the SPX trade does not explain why there are massive out of the money put positions being accumulated on nearly every index around the globe for the September contract. There is still an underlying cause for worry and time will tell if it is just a cautionary move by some big players.
What a week in the markets. At Tuesday's close it appeared the bears were in control and we were headed back to a retest of the August lows. Resistance had held and the bears were piling on every dip. Friday's high was nearly +400 points off Tuesday's lows and Tuesday's -260 drop was matched by Wednesday's +250 rebound. Volatility was increased by an extremely low volume week. The daily volume was nearly two billion shares below normal and five billion per day below the record volumes over 10 billion shares per day back in mid August. Note the alternating sentiment for the last four days. Welcome to whipsaw trading!
The Dow dipped almost to 13000 and rebounded right back to test resistance at 13400 and the 100-day average at 13375. I thought we were going to see an end of day short covering rally but instead there was a -80 point drop at the close. That surprised me given the steady progression higher from Tuesday's lows. In scanning some stock charts after the close there were some serious red candles right at the close in quite a few and many were the recent leaders. Evidently a fund with a large portfolio was expecting more of a Bernanke boost and exited when it did not appear. There was also a -15 point drop in the S&P futures in the last several minutes of trading. A move up from here faces strong resistance at 13700.
The Nasdaq has been a veritable pillar of strength with a close just below 2600. Since tech stocks should be immune to the mortgage problem they have been benefiting from sector rotation. Network stocks held up well and Hewlett Packard and IBM, while not Nasdaq stocks, moved back to their highs and supported the entire tech sector. Apple gained ground despite a contract cancellation by NBC for its video downloads in 2008. NBC supplied 30% to 40% of the video downloads on the iTunes site. Vivendi also declined to sign a contract for 2008 and may be looking for a better deal elsewhere. Amazon may be set to launch its new music service on Sept-17th to compete with Apple. Reportedly Amazon will have over one million tracks when they launch and they will offer them in MP3 format. Since Amazon believes in selling some things cheap to draw traffic let's hope songs are going to be highly discounted. The Nasdaq faces decent resistance at 2625 so next week could see a critical test of any move higher. Support remains 2500 and then 2400.
The S&P-500 has already returned to a critical level with a retest of the Aug-24th high at 1480. That level was tested at 12:30 and again at 3:30 on Friday and both tests were hit with a sharp increase in selling. If we can break that level on Monday the next test would be the 100-day average at 1495 followed by resistance from the June highs at 1540.
S&P-500 Chart - Daily
Russell 2000 Chart - Daily
The key for me is still the Russell-2000 and the strong resistance at 800. That level has held since it first broke on July 26th. Until the Russell moves over that level the fund managers are not comfortable with the market. If you look at the winners from the last week or two it is the big caps and a few favorite momentum stocks. The broader market has not been moving other than by the rise and fall of the overall tide. The real winners have been the highly liquid big caps. Until the Russell shows enough buyer interest to break over 800 in volume we are still in a confused market. It is good for nimble traders able to change directions twice a day but for normal traders with a job it is a tough environment. Be patient, a directional market will eventually return.
S&P-500 Chart - Weekly 2003-2007
It may not return in September or at least history suggests that is not a good bet. Historically September is the worst month in the market but you could not tell that from the trend in 2006. July 18th was the low and it was straight up from there until Feb-22nd. October was the Q4 low in 2005 and again in 2004. You have to go back to 2002 to see a normal Aug-Oct trend where we saw an average September drop. You just can't count on any particular historical trend reappearing each year. The historical averages are just that, averages over many decades. I view the rest of 2007 as dependent on the economy. Not the fed, not the subprime mess and not the yen carry trade, bonds or rates. However, we already have a rate cut on Sept-18th built into the market and it could be a problem if it does not occur. I believe the market always wants to go higher and today the road ahead is pretty clear. The Fed will probably cut rates and that will be one more reason not to sell stocks. The credit crunch will ease once the financials report earnings in September assuming there is not a smoking crater where earnings used to be. Once deep pocket lenders believe that there are no skeletons in the closet of those looking to sell debt the debt markets will quickly return. For instance State Street disclosed last week they had exposure to $29 billion in subprime debt. Nobody knew that before and that is keeping lenders on the sidelines until the earnings cycle is over. There are already dozens of new funds forming to trade in the distressed debt currently plaguing the credit sector. Sharks can reportedly smell blood from a mile away and a hungry hedge fund manager can smell opportunity and act on it before the shark can even get up to speed. A short side note, WSJ reporter Charlie Gasparino, said rumors on the street have 60% of hedge funds down -40% for the year and 30% in danger of going under. That is another problem we will face later in the year if in fact it is true. Having a random hedge fund fail is not a challenge as long as it is not as big as Long Term Capital back in 1998. We have been seeing funds fail on almost a daily basis in August and it has not yet impacted the markets in a lasting way.
Just because I think the market has less to worry about now than a month ago
does not mean we are going straight up. Normally when there is a significant
decline in July/August the month of September is not that deadly. An event
generated crash in July or August tends to take the negativity out of September.
It just accelerates fund manager portfolio shuffling forward in the year.
However, some of that September negativity comes from earnings warnings for Q3
and we are still several
weeks away from that. September is going to be a
minefield but it is possible for traders to negotiate that field without getting
blown up. It all depends on the timing and severity of the events. For traders
we just need to follow the trend and keep our stops in place. That is always
easy to say and tough to do but to be a successful trader it requires effort. I
am going to maintain my long over Russell 800 guidance and try to maintain a
short bias under 790. Between 790-800 I am
neutral. That does not mean I am not
going to make any trades unless the market is moving in one direction or the
other. There are always individual stocks that break from the trend and go
strongly directional. If you see a play on one of those don't hesitate to take
it. Just keep your stops in place. A helium balloon may rise above the crowd but
in a down elevator it still goes down. By finding these standouts in a choppy
market we are prepared to profit handsomely once the market goes
Watch Russell 800 for a breakout, the ISM on Tuesday, Beige book on Wednesday
and NonFarm Payrolls on Friday. Some volume should return next week as most
traders return to work but it won't return entirely until the following week.
Play Editor's Note: It would appear that the market has found comfort in Bernanke's comments on Friday. However, this remains a very volatile market and September is traditionally the worst month of the year to be bullish on stocks. Considering the whipsaws we have seen in the past few weeks more conservative traders may want to just step back and not trade until we see more of a trend take form. We're going to try and capture any further upside with some bullish positions but they remain higher-risk. In the market wrap this weekend Jim suggests that traders wait for the Russell 2000 smallcap index to break out over resistance near 800 before considering new bullish positions. It is a good idea to wait for the Russell to confirm the trend but it is up to you if you want to wait and follow that strategy. FYI: A few stocks we considered as potential bullish candidates but chose to just watch for now are... TEX, AXE, CLF, ROK, RIMM, UIC, and UNP.
Amazon.com - AMZN - close: 79.91 change: +1.32 stop: 77.45
Why We Like It:
BUY CALL SEP 80.00 ZQN-IP open interest=25525 current ask $2.80
BUY CALL OCT 80.00 ZQN-JP open interest=18315 current ask $4.70
Picked on September xx at $ xx.xx <-- see TRIGGER
CanadianPacific Rail - CP - cls: 70.48 chg: 2.60 stop: 66.75
Why We Like It:
BUY CALL SEP 70.00 CP-IN open interest=473 current ask $2.40
BUY CALL OCT 70.00 CP-JN open interest=178 current ask $3.60
Picked on September 02 at $ 70.48
Ceradyne - CRDN - cls: 72.27 change: +2.08 stop: 68.49
Why We Like It:
BUY CALL SEP 70.00 AUE-IN open interest=2608 current ask $4.30
BUY CALL OCT 70.00 AUE-JN open interest= 93 current ask $6.00
Picked on September 02 at $ 72.27
Eaton Corp. - ETN - cls: 94.22 change: +1.43 stop: 91.99
Why We Like It:
BUY CALL SEP 90.00 ETN-IR open interest=159 current ask $5.60
BUY CALL OCT 95.00 ETN-JS open interest=1147 current ask $4.20
Picked on September xx at $ xx.xx <-- see TRIGGER
Millicom - MICC - cls: 84.33 change: +2.08 stop: 79.90
Why We Like It:
BUY CALL SEP 80.00 CQD-IP open interest=776 current ask $6.30
BUY CALL SEP 85.00 CQD-JQ open interest=565 current ask $5.20
Picked on September xx at $ xx.xx <-- see TRIGGER
Manitowoc - MTW - cls: 79.49 change: +1.90 stop: 73.99
Why We Like It:
BUY CALL SEP 75.00 MTW-IO open interest=1385 current ask $6.00
BUY CALL OCT 80.00 MTW-JP open interest=348 current ask $4.70
Picked on September xx at $ xx.xx <-- see TRIGGER
Riverbed Tech. - RVBD - cls: 44.40 chg: +0.15 stop: 41.95
Why We Like It:
BUY CALL SEP 40.00 UEX-IH open interest=2524 current ask $5.00
BUY CALL OCT 45.00 UEX-JI open interest= 954 current ask $3.20
Picked on September 02 at $ 44.40
Intl. Bus. Mach.- IBM - cls: 116.69 chg: +1.32 stop: 109.85
IBM continues to look healthy with another new five-week high on Friday. If there is anything to worry about it's that shares may be due for a dip considering the rally from its mid August lows. A pull back into the $115-114.00 zone could be used as a new bullish entry point but we'd probably look for signs of a bounce first before initiating new plays. At current levels we're not suggesting new positions. Our first target is the $118.00-120.00 range. Our second, more-aggressive target is the $124.00-125.00 zone. More conservative traders might want to consider adjusting the stop loss toward $111.50. FYI: The Point & Figure is very bullish with a $177 target.
Picked on August 26 at $113.24
Transocean - RIG - cls: 105.09 change: +2.86 stop: 99.50
Oil stocks did participate in the market's Friday rally and another rise in crude oil certainly doesn't hurt. Shares of RIG out performed most of its peers with a 2.7% gain. The stock hit an intraday high of $106.03 and broke through technical resistance at its 50-dma on an intraday basis. Our suggested trigger to buy calls was at $105.75 so the play is now open. However, we want to caution readers. Failure to hold the breakout over resistance is a concern. Plus, shares were sliding fast into the closing bell so RIG could see more profit taking on Tuesday. Next we want to remind readers that while oil will remain sensitive to any potential storm threats in the Gulf of Mexico we wouldn't be surprised if crude futures traded lower for the next couple of weeks. The trend in RIG is still short-term bullish but watch your stops and consider waiting a day or two before jumping into a new position. A bounce around $102.50 or a new relative high over $106 could be used as new entry points. Our target is the $114.00-115.00 range.
Picked on August 31 at $105.75
Acuity Brands - AYI - cls: 52.54 change: +0.16 stop: 56.01*new*
AYI posted another gain on Friday but the actual tone of the trading looks bearish. Looking at the intraday chart AYI never really participated in the market's rally and only closed up 0.3%. Shares remain in their bearish trend of lower highs. Readers can choose to open new put positions on a failed rally under $53.50 or a new decline under $52.00. We're adjusting our stop loss to $56.01. We have two targets. Our first target is the $47.75-47.50 range. Our second target is the $45.25-45.00 zone.
Picked on August 26 at $ 52.80
(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.)
Diamonds - DIA - cls: 133.40 chg: +0.83 stop: n/a
The market did see a pop on the Bernanke speech last Friday. Unfortunately, the move was not as big as expected. The DIA only rallied toward short-term resistance near $134. We are not suggesting new positions at this time. However, if the DIA dips back toward the $132 level readers could certainly use the move as a new entry to open strangle positions. It's possible that next Friday's jobs report could spark a bigger move in the major indices. Our strangle play suggested using the September $137 call (DAZ-IG) and the September $127 put (DAW-UW) with an estimated cost of $2.05. We want to sell if either option rises to $3.10 or more.
Picked on August 30 at $132.57
S&P 100 Index - OEX - cls: 687.47 chg: +7.01 stop: n/a
The OEX index produced a similar move to the DIA. It rallied higher but stalled near short-term resistance. We're not suggesting new positions but a pull back to the $680 level could definitely be used as a new entry point for strangles. Our strangle suggested using the September 700 call (OEZ-IT) and the September 660 put (OEY-UL) with an estimated cost of $14.30. We want to sell if either option rises to $21.45 or more. Considering these prices we probably need to see a move into the $705-710 range or the $655-650 zone to be profitable. This will probably be a multi-day trade. Don't expect it all in one day. FYI: With any strangle play the biggest risk is that the equity just consolidates sideways and doesn't move enough to make one side of our play profitable.
Picked on August 30 at $680.46
CNBC guests debate that question, and financial writers appear to do so, too. The titles of their articles appear to argue with each other. How would a trader who prefers technical analysis form an opinion?
Getting a broad overview appears to be the best place to start. Since we're talking about technical analysis, you might be surprised to find the first place I look: an economic release calendar. If I'm trying to determine where prices are likely headed on an equity's stock, I look at a schedule for earnings releases, analysts' presentations, and any other event that might impact the stock.
Technical analysis can be a great tool but don't stick your head in the sand, either. As a newbie trader, I was once surprised by an FOMC meeting that I didn't know was scheduled. That will never happen again!
Different traders use different technical analysis tools, but I begin with a look at a point-and-figure chart. That might surprise you, too, because I seldom post them. I am certainly no expert on these charts, but I can read a price objective that the charting service calculates for me. I suggest you do so, too.
I'm drawing examples from the NYSE for this article since fewer of us have preconceived notions of where the NYSE will go. Fewer of us have certain price levels embedded in our memories for the NYSE. It's easier that way to form unbiased judgments.
Point-and-figure charts can be found on Stockcharts.com. I believe QCharts may include them now, too, although I'm not certain of that because I switched charting providers some time ago.
For those of you unfamiliar with the development and uses of point-and-figure charts, StockChart.com's Chart School offers explanations. More in-depth explanations can be located in Thomas J. Dorsey's POINT & FIGURE CHARTING.
Because I haven't obtained permission from StockCharts to post their charts, I'll note some of the characteristics of the NYSE's P&F chart. Price is above what's known as the bullish support line, now at 8500. The overall tenor is bullish, then, although no trader currently holding bullish positions in NYSE stocks wants to see the NYSE decline to test that bullish support line.
In addition to being above the bullish support line, the NYSE's columns of X's have produced a bullish price objective of 11,150. Hmmm. So, the P&F evidence provides an overall bullish view of the NYSE.
If this weren't the NYSE, a broad-based index, my next steps might be to look at the P&F chart for the sector to which a stock belonged and then to compare the relative strength of this security to a broader one, including its sector and something like the SPX, Nasdaq or even NYSE. For example, if I were studying KLAC, a good idea would be to compare KLAC's strength to that of its sector, the semi-conductors, and then to a broader index such as the Nasdaq.
How is that done? Check your charting service to see whether or how the service allows that comparison. When using a chart from StockCharts.com, one would place a colon (:) between the two symbols. In the example noted above, comparing KLAC's strength relative to that of the SOX, one would use "KLAC:$SOX" in the symbol box.
Although I look at P&F charts to provide an overall outlook, I prefer candlestick charts for my own charting studies. They're as visually evocative as P&F charts. Although one might not know all the esoteric names of the most complicated of the patterns, it's easy to glance at a chart and determine whether one is seeing bullish action (predominantly tall green candles), bearish action (predominantly long red ones) or chop (either large- or small-bodied candles with red and green mixed).
When I'm studying a security for the first time, I start with a weekly chart. Because I also like nested Keltner charts, that's the setup I want on my charts.
Annotated Weekly Chart of the NYSE:
What can I tell about this chart? Several things. For periods over several years, the NYSE went into breakout mode, breaking out above the widest channel's resistance line (the purple channel). Those breakouts were so frequent and prolonged that they hauled other channel lines above what is normally the outer one.
That kind of action connotes strong momentum, but it also connotes momentum that must eventually run out of steam. It appeared to begin doing so in June and July, when price/RSI comparisons revealed bearish divergences (not shown). It was not until the week of July 23, however, that the NYSE's prices broke back inside that widest channel line again.
Notice that two of the channels--black and purple--still climb? Over the intermediate and long term, it appears that the bullish tenor hasn't yet been strongly impacted by recent market activity, despite what we all might have been feeling a few weeks ago. A slight note of warning sounds, though. The smallest channel turns down now. Bulls want to see that entire channel stay above the central basis line.
What's the central basis line? That's the aqua-colored line. It's the central basis line of the largest of the Keltner channels, a 120-ema. As long as the NYSE's weekly prices close above that basis line, it's in the bullish half of the channels.
This begins to sound reminiscent of the conclusions from studying the P&F chart, doesn't it? In both, the NYSE remains above a bullish/bearish benchmark, the bullish support line on the P&F chart and the central basis line on the weekly Keltner chart. That P&F bullish percent line had been at 8500. The weekly support shown here now lies near 8590, so they're not that far apart, given that they're derived using totally different methods. That concurrence provides a bit of extra confirmation of the importance of the 8500-8600 zone as delineating bullish versus bearish tenors.
No one holding bullish positions in equities wants to see the NYSE fall all that way, however. How vulnerable is the NYSE to doing that? Now we're getting down to what we all want to know.
The Keltner chart turns up some disturbing setups. Notice how the thin red line is now providing resistance on weekly closes? That is the basis line of the smallest channel, a 9-ema. The resistance at the declining 9-ema, the downturn that's beginning in the small channel, and the possible softening of that 45-ema support increase the likelihood that prices will descend to the bottom of the blue channel, and perhaps all the way down to the 8580-8700 support zone. They don't yet make that possibility into a probability, however.
Where are we now with our analysis? On this chart, the long-term tenor could be labeled bullish, but there's vulnerability to a retest of the summer's low. Given this information, I'm going to want to look at another weekly chart, a traditional one with a 10-ema and a 30-ema. Crossovers of the 30-ema by the 10-ema sometimes mark changes in trend. Has such a trend change begun?
Annotated Weekly Chart of the NYSE with 10- and 30-ema's:
As the notations point out, no bearish 10-ema/30-sma crossover has yet occurred. Yet, the 10-sma has dipped close to the 30-sma. We should be alerted to watch this chart for a crossover, remaining aware that such crossovers sometimes occur rather late in a movement. I use the -ema's because they tend to be a little more responsive on long-term charts than the -sma versions, but the payment for that responsiveness is more false signals. Use 10-sma and 30-sma crossovers as confirmation of an existing move or warning of an impending one but don't act solely on such a crossover.
On this traditional chart, I've also drawn a long-term rising trendline. This is not the trendline off the 2003 low, which would cross a little higher. Rather it's a trendline that began forming in 2004 as the NYSE broke above prior resistance, came back to see if it would hold as support, and then began trending higher. Notice that trendline's proximity to the support zone that's already been determined through other means.
What are the conclusions drawn from this chart? The NYSE maintains long-term support and wouldn't violate it until a weekly close beneath about 8650-8700. Some signs of potential weakness do show up, however, and should be watched.
So far, both weekly charts--Keltner and more traditional trendline/MA charts--concur rather well.
What does a daily chart suggest?
Annotated Daily Chart of the NYSE:
Friday, the NYSE retested Keltner and historical horizontal resistance, closing at or near both. This chart doesn't provide as much information as I would like, with the close not convincing me that the NYSE can pull free of that resistance. The NYSE's ability to sustain values above the central basis line hasn't been established, especially since the rally up to that resistance on a Friday before a Labor Day weekend must be somewhat suspect. About all I can conclude from this is that the NYSE appears to be undergoing an important test. How it will turn out is not apparent yet.
What is visible on this chart is the turning down of the black channel as well as of the central basis line on the widest channel. Unless the NYSE can sustain values above that basis line, the widest channel may turn down, too, heightening the possibility that prices will retest that support zone that's a benchmark for bullish and bearish activity on these various charts.
What can I conclude after studying all these charts? Both the P&F chart and the weekly Keltner chart would characterize the NYSE as still maintaining a bullish tenor but one that would be maintained all the way down to 8500-8580. Retesting that level would not be tops on a "to do" list for bulls, to say the least. A few signs on the weekly charts do demonstrate the NYSE's vulnerability to a retest of that zone while not yet calling for that test to be a probability rather than a possibility.
One of the reasons that I like the nested Keltner charts is that they allow me to form a scenario and determine levels that would either disprove it or prove it true. What would it take for the NYSE to lessen its vulnerability to a retest of the summer lows? The weekly nested Keltner chart suggests that it needs to produce consistent weekly closes above the weekly 45-ema. That's what's needed at a minimum to stabilize the channels. Then the NYSE needs to begin producing daily closes above the 9-ema again rather than finding resistance on that moving average as it's been doing for a number of weeks. The daily chart suggests that prices need to move into and stay in the bullish half of the chart. If these things don't happen, descending moving averages may pressure prices right back down to retest that support zone that delineates bullish versus bearish long-term action.
These studies didn't tell us where prices were going, but they did show us what vulnerabilities exist, where prices could go, and how to determine if they're likely to go there. For those of you who wondered why I didn't discuss upside targets, it was because of the resistance that's been holding, resistance pointed out on the Keltner weekly and daily charts. That resistance must be cleared on a consistent basis before new upside targets are set on these charts. The P&F chart has, of course, already set one.
A thorough study of where markets might go would also require a study of indicators of market breadth, too, such as bullish percent levels and those sorts of measures, as well as studies of how volume acts at certain price points. There isn't room enough to include all information in a single article, but I wanted you to see the general process I undergo.
The process seems onerous, doesn't it? This article's text, excluding charts, is five manuscript pages long and much longer with charts. This is truly one of those times when a picture is worth a thousand words, however. Calling up those charts and examining them requires only a few moments.
For those who would like to set up Keltner charts, I'll include my settings.
Blue channel: based on a 9-ema, with a multiplier of 1.4. Black channel: based
on a 45-ema with a 3.0 multiplier. Purple channel: based on a 120-ema with a 7.2
multiplier. Of course, feel free to color your channels however you wish. I know
that QuoteTracker and QCharts both allow the nesting of these channels. I'm not
sure about other charting services.
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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