This morning, several developments confirmed fears that a weakening economy could be impacting consumer spending habits; the subprime mess could be spilling over into the broader economy; and the ECB might not be on board to find a global solution to what is increasingly viewed as a global problem. Wal-Mart's same-store sales figures this morning were the first of those developments. The retailer's report confirmed fears that the weak jobs number would translate into weak consumer spending. Many retailers reported numbers that were worse than already dim expectations.
In addition, a U.S. company not related to the mortgage, finance or real estate industries confirmed fears that the subprime mess could impact companies outside those sectors. Exelon Corp.'s (EXC) 2007 SEC report detailed the company's exposure in some of the securities it holds in its investment trusts.
The European Central Bank also confirmed assumptions that it would not ease rates today. Many market participants want a global response to what they feel is a global problem as economies slow and credit woes continue. As expected, however, the European Central Bank left rates unchanged at 4 percent while the Bank of England lowered rates by a quarter of a point to 5.25 percent. The ECB remains more worried about inflation than other concerns.
Jean-Claude Trichet, the ECB's President, said in his statement that "[t]he firm anchoring of inflation expectations over the medium and long term is of the highest priority to the Governing Council." He mentioned "very vigorous money and credit growth" as risks to price stability, and stated that "the current short-term upward pressure on inflation must not spill over into the medium term." He did admit to "unusually high uncertainty" about the eventual impact of the risk reappraisal going on in the financial markets and confirmed that incoming data revealed downside risks to the economy in the euro area. Still, the ECB's focus on inflation remains clear.
Market participants who wanted a global response were likely disappointed by the BoE's quarter-point cut, too. Some had called for at least a half-point cut. In England, lenders have been raising rates, locking out some borrowers who had hoped to refinance their mortgages. The Bank of England's Monetary Policy Committee stressed that it remained worried about inflation. The committee pegged its easing on disruptions in global financial markets and deteriorating prospects for global output growth.
At first, the dollar's reaction to those central bank actions proved puzzling. The dollar strengthened against both the euro and the pound. Given that our Fed has eased and is perceived to be on a path to ease more, that strengthening seemed contrary to what would be expected. However, that reaction was perhaps clarified by a U.S. Treasury auction this afternoon. The participation by central banks was termed disappointing, as was the auction as a whole, with yields going up and treasuries declining as a result. Among currency traders and bond traders, at least, the concerns appear to be swinging back toward worries about inflation.
Despite having fears confirmed, however, most equity indices shook off worries and posted gains. On the SPX, for example, a slide that had initially punched beneath support that had held since 1/23 was stopped in its tracks by an across-the-board buy program. When equities dropped in the afternoon, they managed to hold support and gain into the close.
The SPX's daily candlestick was one that's sometimes indicative of a potential reversal. Such candlestick and other chart truisms often fall apart in the current market conditions, but let's take a look at what else we see. On the SPX, there's no clear next direction depicted.
Annotated Daily Chart of the SPX:
With the SPX daily candle hanging out in the middle of nowhere, between support and resistance, it's difficult to gauge what may happen next. Space doesn't allow me to post both traditional and Keltner daily and weekly charts, so I've stuck with the more traditional charting system, but perhaps the Keltner one will provide some benchmarks. I'll give you some numbers. The body of the daily candle is stuck between current Keltner resistance at 1337.80 on daily closes and support at 1316.30 on daily closes, so we would have to see daily closes outside those boundaries to make predictions. Until there are daily closes above about 1351, however, the SPX maintains some vulnerability to 1300 support.
Well, who are we kidding? In these market conditions, that vulnerability remains even if there's a close above 1351. However, a daily close above the benchmark 9-ema there would show that vulnerability to 1300 has lessened, at least temporarily.
Annotated Daily Chart of the Dow:
On a daily Keltner chart basis, the Dow looks better than the SPX, but it's easier to manipulate this index with a narrower base. The Dow is maintaining daily closes above the Keltner support at 12,191 currently, but it has potential resistance at 12,385-12,400 on daily closes. The Dow needs daily closes above that level to improve its tenor. Potential lower support is at 12,100 and then 11,835 on daily closes.
Annotated Daily Chart of the Nasdaq:
The Nasdaq's daily Keltner chart tells us what we already know: the Nasdaq needs to produce daily closes above 2300-2303 before it's even begun to improve its tenor. Then it faces potential resistance at about 2336, the approximate location of the daily 9-ema by the time the Nasdaq could rise to test it.
Annotated Daily Chart of the SOX:
Annotated Daily Chart of the RUT:
The RUT's daily Keltner chart shows the RUT rising today to challenge its daily 9-ema near 704, without yet being able to close above it. This information merely verifies what we already know from the traditional chart. Until the RUT begins producing daily closes above that red trendline, it looks vulnerable to a quick downturn toward 680 and maybe even 660. A push up through that resistance on a daily close doesn't mean that the RUT will erase all vulnerability to those lower levels, especially since it, like so many other indices, is chopping out a consolidation zone. It does, however, make the immediate likelihood a bit less.
Annotated Daily Chart of the TRAN:
Today's releases included January's Chain Store sales. Wal-Mart (WMT) was supposed to save the day for retailers and, therefore, for the economy. However, its 7:30 release disappointed. Industry watchers had expected sales to rise 2 percent; instead, they rose only 0.5 percent. Gift card redemptions fell below expectations, the company said, and bad weather contributed to the slow sales.
Target (TGT) also disappointed, but Costco (COST) beat estimates and Big Lots (BIG) matched them. J.C. Penney's (JCP) same-store sales dropped far less than the expected 6.3-percent decline, and Children's Place (PLCE) reported same-store sales that rose 6 percent from the previous year's comparable period. Ann Taylor (ANN) also beat expectations.
However, the weakness wasn't limited to stores such as WMT and competitor TGT or to their sector. Macy's (M) disappointed, as did Nordstrom Inc. (JWN) and West Seal (WTSLA).
Initial and continuing jobless claims have garnered more attention lately, and that was the next release on the slate for today. Market watchers anticipated that initial claims would pull back a little from last week's 375,000, to about 342,500. When the release came at 8:30 am ET, last week's 375,000 initial claims had been revised higher to 378,000. This week's claims did decline, but only by 22,000 to 356,000.
While that's the lowest number reported in two weeks, it did nothing to improve equity futures in the pre-market session. The Labor Department cautioned that there had been difficulties adjusting for the Martin Luther King Jr. holiday. The more reliable four-week moving average climbed 8,500 to 335,000.
Continuing claims added their own concerns. Continuing claims--representing those who have lost their jobs and are unable to find new ones--have been on a mostly upward trajectory. That continued this week, with the number rising to its highest level in more than two years. Those claims climbed 75,000 to 2.78 million, and the four-week moving average rose 24,250 to 2.73 million. The seasonally adjusted insured unemployment rate rose back to 2.1 percent.
December's Pending Home Sales index from the National Association of Realtors appeared at 10:00 am ET, confirming fears about continued weakness in home sales. Industry experts had predicted a decline of 1 percent, but the decline was a greater-than-expected 1.5 percent drop. November had shown a 3-percent decrease. The index declined 24.2 percent year over year.
Both the NAR and other economists predict that the housing market will remain soft at least through the first half of this year, with the weakness suggested by a deteriorating labor market. Some pointed to actions that may help, including raising loan limits for conventional mortgages, as long as such actions are enacted quickly. NAR believes that new home sales may decline 17.7 percent this year but may rise into the high single digits in 2009.
Congress confirmed that an attempt would be made to raise conforming loan limits for Freddie Mac and Fannie Mae in the economic stimulus package. Democrats favor the increase. They want these two companies to help those borrowers hurt by the subprime mess and the resultant credit crunch. While the director of the agency overseeing Freddie Mac and Fannie Mae asserts that these agencies have already been helping borrowers refinance, some say they haven't been doing enough. Republicans reportedly do not favor the lifting of the limit.
By late today, Dow Jones and other news sources were reporting that the Senate had voted in favor of a package that includes rebates up to $600 for workers and $300 for veterans or seniors living off Social Security benefits. Tax incentives for businesses are also included. As this report was prepared, information was not yet available on whether the plan included a lifting of those loan limits for Freddie Mac and Fannie Mae.
Freddie Mac reported on average mortgage rates for last week. Those rates for a 30-year fixed-rate mortgage inched lower to 5.67 percent, down from the previous week's 5.68 percent. Freddie Mac's chief economist noted that the rates were moving--or not moving--in concert with Treasury bond yields for the period.
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The Department of Energy released information on weekly natural gas storage at 10:30. The Energy Information Administration, the EIA, said that natural gas supplies dropped 200 billion cubic feet. Industry watchers had expected a smaller decline of only 170 bcf's.
Sometime this morning, the Fed released its weekly figures on outstanding commercial paper, confirming that the credit crunch remains a factor for corporations. As happened two weeks ago, those figures again showed a decrease in outstanding paper, by a seasonally adjusted $8.6 billion in this case. Most of that decrease came in asset-backed paper, with outstanding asset-backed paper falling $9.9 billion. Financials saw decreases across all categories (Total, Domestic and Foreign) while non-financials saw gains across all categories.
News from the bond insurers this week was meant to reassure market participants. Yesterday MBIA (MBI) announced its plans to raise cash. Today, investors and market watchers learned that Bank of American (BAC) had taken a 7.1 percent position in bond insurer Ambak (ABK). The news didn't appear to be particularly reassuring to investors of any of the three companies, but perhaps that was because of other news. Moody's has downgraded bond insurer XL Capital's (XL) credit rating to A3 from its previous AAA rating. ABK and MBI have been scrambling to avoid downgrades.
In addition, Standard & Poor's joined Moody's in attempting to revamp its rating system. Today S&P announced that it would consider changing its rating system as a result of the subprime mess and resultant fallout. S&P wants to include liquidity, volatility and other issues that can influence the performance of the securities it rates. S&P will appoint an ombudsman and also hire an external firm, with those assigned duties of determining any conflicts of interest.
Information from Exelon Corp. (EXC) confirmed some of our worst fears about the broadening impact of the subprime mess. EXC is a large U.S. power company. Today investors learned that its investment trusts hold securities that are backed by subprime mortgages. Those trusts are meant to support the company's pension plan and provide for the future costs related to shutting down nuclear power plants. Because the value of those mortgage-backed securities has fallen, EXC may need to add extra funds to those trusts, their 2007 report noted.
Reporting companies today included homebuilders that confirmed the impact of the credit crunch. Despite those confirmations, the DJUSHB, the Dow Jones Home Construction Index, and the stocks of many of the reporting builders gained.
One builder reporting earnings was D.R. Horton (DHI). The company took a charge related to abandoned land options and inventory impairments, resulting in a loss of $0.41 a share for the quarter that ended in December. Net sales orders were more than halved when compared to the year-ago figures. Cancellation rates were 44 percent.
M.D.C. Holdings (MDC) reported a widening loss, with this builder also taking charges related to abandoned land-option contracts and other costs. Net orders also were slashed in half for this builder when compared to year-ago levels. M/I Homes Inc. (MHO) reported a loss of $5.06 a share, including various charges.
Genworth Financial (GNW) reported net operating income of $0.71 a share against expectations of $0.69 a share. Without the exclusions, the company earned $0.40 a share.
Not all reporting companies were builders or financials, of course. PepsiCo (PEP) beat expectations but the year's estimate of at least $3.72 compared to the previous estimate of $3.74.
Tomorrow's Economic and Earnings Releases
Tomorrow's releases include December's Wholesale Trade at 10:00 am ET and the ECRI Weekly Leading Index at 10:30. Neither is anticipated to be market moving.
What about Tomorrow?
Annotated 15-Minute Chart of the SPX:
This chart suggests that gains could be sharp if the SPX breaks above that neckline and above Keltner resistance. I've seen such setups followed by the sharp moves they predict, but be wary of any predictions in this market environment. Be especially wary of a quick punch above 1350 first thing tomorrow morning that's just as quickly reversed.
If the SPX should instead fall first thing tomorrow morning, strongest support on 15-minute closes appears to be near 1319-1323.
Annotated 15-Minute Chart of the Dow:
Annotated 15-Minute Chart of the Nasdaq:
The Nasdaq's short-term Keltner support is weaker than that seen on the previous charts. There's support down to about 2268, but the Nasdaq needs to climb or consolidate sideways a while to pull that potential support up near other support, firming it.
Annotated 15-Minute Chart of the RUT:
So, what do I think? I think there's a chance there could be a gain or sideways consolidation tomorrow. If you were attempting to read charts and take positions based on those charts today, though, you know how much worth a chart reading has in these market conditions: about as much worth as a palm reading.
I think, on the intermediate term, we're looking at the markets being within choppy zones that may narrow their ranges a bit, making trading miserable as they narrow and narrow. I think that possible action must be put into the context of markets that might still need to retest lows or make new ones but are long overdue for a real relief rally. So, that's the reason, in my opinion, for the choppy and so far volatile consolidation.
What does that mean? That means you're trading at your own risk if you're trading those choppy consolidation zones that are setting up. You better be good at getting in and getting out quickly because markets are turning on a dime without even bothering to set up the typical signals that they're about to do so. You need to know where resistance or support might lie and have a plan in advance for dealing with that support or resistance, because sometimes you're literally given only seconds to react before the reversal begins.
This is not trading for the faint of heart, or, if I may be frank, for the "little of account size." You can be a great trader and great, too, at managing trades and keeping your losses small, and still get a small account chopped and diced until there's nothing but mush left. If you've got a big account and you're trading a contract here and a contract there, it's not going to hurt you, but even a contract here and a contract there are going to hurt if your account is a $3,000 or $5,000 one and you're getting whipsawed back and forth several times a day.
If you're finding that happening and lambasting yourself for not having adequate trading skills, it may not be your trading skills at fault. If they were working before and they're not now, you need to realize that trading conditions have changed. Almost every week, we're hearing about some "not since" loss or gain that's occurred, and I'm hearing people who have been in the pits or trading for syndicates comment on how difficult these markets have been to gauge. A trading friend wrote this afternoon and called this day's action "like shuffling deck chairs on the Titanic."
Particularly if you've got a small account, there is absolutely nothing wrong with stepping back, listening to some webinars, reading some books, and paper trading some great new combination trade you've heard about while all those craziness is going on. You can get excited about the new trades you're going to try when market conditions improve, with your trading account safe and sound while you're doing so.
My job is to tell you what's going on and to give you my best guess as to what
might happen next when a guess is reasonable, but I'd be remiss if I also didn't
tell you the times when it's just not a great trading environment.
Play Editor's Note: I was looking at shares of TNH today following their earnings report. I thought the trading action looked bearish and the move looks like a good place to buy puts and target a dip to the 200-dma near $113. Unfortunately, TNH doesn't have options!
Allegheny Tech. - ATI - cls: 75.19 chg: +2.16 stop: 69.75 *new*
Bulls bought the dip in ATI again and the stock rallied close to 3% on Thursday. Our biggest complaint was volume today, which was very light. Big gains on light volume is a warning sign. We are adjusting our stop loss to $69.75. More conservative traders might want to raise their stops toward $72.00. Our short-term target is the $79.75-80.00 range or the 50-dma, whichever is hit first. The P&F chart for ATI looks very bullish with an $87 target.
Picked on February 04 at $ 75.11 *triggered
Petroleo Brasileiro - PBR - cls: 111.60 chg: +5.59 stop: 104.95
PBR really out performed the market today. Shares added more than 5% and did so on above average volume. Fueling the move was some news regarding the Tupi oil field. Evidently estimates for the Tupi oil field reserves have jumped from 1.7 to 10 billion barrels of oil and oil equivalents to 12 to 30 billion barrels of oil and oil equivalents. This is very significant. PBR owns a 65% stake in the Tupi field with British Gas and Portugal's Galp Energia owning 25% and 10%, respectively. We seriously considered buying the bounce today. However, shares still have some resistance in the $114-116 zone. We're going to stick to our plan and use a trigger at $116.00 to open positions. However, we might change our mind if we see another strong bounce from the $105 level again. Our target is the $128.00-130.00 range. A move over $116 would produce a new Point & Figure chart buy signal. FYI: Another risk is PBR's earnings report. We can't find an earnings date and they normally report in mid February. That is a risk because we do not like to hold over an earnings report.
Picked on February xx at $ xx.xx <-- see TRIGGER
Ambac Fincl. - ABK - cls: 10.96 change: +0.02 stop: n/a
ABK continues to trade sideways in a narrow range as the market holds its breath on what happens next. Will a rescue plan materialize or will the bond insurers be downgraded forcing banks and financial institutions to unleash another round of write downs? While the rating agencies have held back on downgrading ABK and MBI for now they are not sitting still. Today Moody's downgraded Security Capital Assurance's credit rating six grades from AAA to A3. We're still betting on shares of ABK crumbling but this remains an aggressive, speculative play. The unofficial timeline for a rescue plan has somewhere between 9 days and the end of February before the rating agencies start downgrading companies like ABK and MBI. We do not have a stop loss on this play. It is a lottery-ticket strategy. However, if you want to use a stop consider a stop loss above $15.50 or above the $16.50-17.00 region. Of course if ABK rallies that sharply these deep out of the money puts won't be worth much. ABK looks like it has resistance at $15.50, 16.50, and then $20.00. Our target was a decline towards $5.00 or less. We were suggesting the May puts.
Picked on January 27 at $ 11.54
iShares DJ Financial - IYF - cls: 90.11 chg: +1.49 stop: 93.01
In spite of all the doom and gloom last night following CSCO's earnings report and the negative retail same store sales numbers today the financial stocks did pretty well. The banking indices were up more than 2% and the IYF followed with a 1.67% bounce. This back and forth volatility can drive you nuts and akin to playing in a busy street. Eventually you get hit. Wait for a failed rally near $92.00 or a new decline under $89.00 before considering new put positions on the IYF. We're aiming for a test of the $80.00 region. Our official target is the $81.00-80.00 zone.
Picked on February 06 at $ 88.62
MBIA Inc. - MBI - close: 14.20 change: -0.08 stop: n/a
Wow! The action in MBI today should tell you something. Last night they announce a $750 million convertible offering (50.3 million shares of stock) and the stock rallies more than 10% in after hours trading. yet the stock opens at $14.26 and closes down for the day. Looks like no one is buying that last night's deal was enough to really help MBI and most believe that Warburg Pincus, who backed the deal, is just throwing good money after bad. On top of its all MBI said they were raising their loan loss reserves. We remain bearish on MBI and don't believe the rescue plan will show up in time. However, the banks might find it easier to swallow investing a few billion to save ABK and MBI than let these companies drown and then have to write down several times what it may cost them to "rescue" these companies. The unofficial timeline for a rescue plan has somewhere between 9 days and the end of February before the rating agencies start downgrading companies like ABK and MBI. This remains an aggressive, speculative play. We do not have a stop loss since this was a lottery-ticket style of play but if you wanted to play one consider putting your stop above resistance near $17.50 or above $18.00. We were aiming for a decline to $5.00 or less. Our suggested options were the May puts.
Picked on January 27 at $ 14.20
Myriad Genetics - MYGN - cls: 39.36 chg: -0.68 stop: 43.01
MYGN continue to breakdown and fell through support at $40.00 today. The stock did hit our suggested trigger to buy puts at $39.75. The play is now open. Our target is the $36.00-35.00 range. The Point & Figure chart is bearish with a $34 target. FYI: We always consider a biotech stocks to be a more aggressive, higher risk play because you never know when an FDA decision will be released or some clinical trial info will come out that could send the stock moving sharply either direction.
Picked on February 07 at $ 39.75 *triggered
Simon Properties - SPG - cls: 87.56 chg: +1.47 stop: 90.61
There seemed to be a common theme today for stocks. Sell off in the morning,
breakdown under support so you can trip some stop loss and triggers, and then
rally back sharply. That's what happened in SPG today. The stock broke down
under support near $85.00 and hit a new two-week low and our suggested trigger
at $84.39 before rebounding back into the green. We would now suggest waiting
and watching for a failed rally near $90 resistance before considering new put
positions. Our target
is the $76.00-
Picked on February 07 at $ 84.39 *triggered
Suncor Energy - SU - cls: 92.07 chg: +0.81 stop: 95.01
Wow! What a surprise (not). SU turned in the same performance that SPG, BGC, MOS, and USO did today - one of slipping under support and then bouncing back sharply. This is a dangerous spot for the bears. The overall pattern remains bearish but readers need to wait for the bounce to fail before considering new put positions. We have two targets. Our first target is the $85.50-85.00 range. Our second target is the $81.50-80.00 zone. This should be a two or three week play at which time we'll consider switching to bullish trades in oil and energy.
Picked on February 07 at $ 89.75 *triggeredd
(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.)
DJIA 1/100 Index - $DJX - cls: 122.47 chg: +0.47 stop: n/a
The DJIA and the DJX look like they're ready to bounce. If we're in a bear market then the question is how long will it last before it rolls over again. We have less than two weeks left before February options expire. We are not suggesting new strangle positions at this time. The options we suggested were the February $127 calls (DJW-BW) and the February $122 puts (DJW-NR). Our estimated cost was $3.36. We want to sell if either option hits $4.85 or more.
Picked on January 29 at $124.80
Google - GOOG - close: 504.95 chg: + 3.24 stop: n/a
The major averages may have closed in the green but it was not a very bullish day. GOOG managed a meager 0.6% bounce although if you're bullish on the stock then holding the $500 region is probably a good sign. We don't see any changes from our previous comments. We need to be defensive here. At this point we would start taking money off the table every time the February $500 put starts trading near $20.00. We do have just under two weeks left and GOOG can still see some huge moves between now and February expiration but it's probably going to be a gut-churning two weeks. We are not suggesting new positions. The options we suggested were the February $600 calls (GOO-BT) and the February $500 puts (GOP-NO). Our estimated cost is $17.00. We want to sell if either option hits $27.00 or more.
Picked on January 30 at $548.27
General Cable - BGC - cls: 56.67 change: +0.32 stop: 54.95
Volatility was the name of the game in BGC today. Shares gapped open lower at $55.69 and spiked toward $53.55 before bouncing back and posting a gain on the day. The intraday move under support at $55.00 was enough to hit our suggested stop loss at $54.95 closing the play.
Picked on February 06 at $ 57.75 *triggered
Mosaic - MOS - close: 93.75 change: +0.31 stop: 88.99
The already volatile shares of MOS may have overreacted this morning to a gap down in shares of Bunge (BG). BG reported earnings this morning and beat estimates easily but the stock was punished anyway (BG does have a fertilizer unit). Meanwhile shares of MOS spiked lower opening at $91.17 and trading to $88.10 near its 50-dma before bouncing back. The stock hit our stop loss at $88.99 closing the play. Trading in MOS is almost always volatile but chart readers may note that shares look like they're forming a bull flag pattern over the last few days. A move over $96.00 might be a new bullish entry point.
Picked on February 04 at $ 95.51 *triggered
United States Oil Fund - USO - cls: 69.80 chg: +0.78 stop: 68.59
Crude oil futures rebounded after yesterday's beating but not before dipping a little lower this morning. Shares of USO slipped to $68.57, which was just enough to hit our stop loss at $68.59 and close the play. If the USO traded under $68.00 we would be tempted to consider bearish positions. As it stands now we would look for a new really over $71.50 as a potential bullish entry point to try again (and aim for the $77-80 zone).
Picked on January 24 at $ 70.93
Much as I try to get this column out on Wednesday, it keeps slipping to Thursday. Well, around or about mid-week I suppose is what I can say is when I get to this educational piece. At least I hope that this 'Corner' will illuminate useful aspects to trade entry and timing.
There are two subjects today I'll discuss relating to ways that technical analysis can tip us off to what is AHEAD in the economy or what are the likely limits of corrections. My two subjects:
1.) Dow Theory and the current (we're almost certain to be in) recession
"Alarm bells were set off Tuesday by a grim report on service businesses, which make up the majority of the U.S. economy. The Institute of Supply Management said that activity in the service sector declined for the first time in nearly five years. This report also indicated that employers are cutting staff. The survey covers the retail, transportation and health care industries as well as hard hit areas such as finance, real estate and construction.
Some economists argued that the normally low-profile ISM services reading, coupled with the government's report Friday showing the first monthly net loss in jobs in more than four years, is proof that recession is now a reality.
'My forecast had been that the recession would begin this quarter, but the hard data wasn't there yet,' said Keith Hembre, chief economist of First American Funds. 'But now we're seeing that. The service sector is a much larger component of the economy [than manufacturing] and this is very much a recession reading.'
The National Bureau of Economic Research is the official arbiter of whether the economy has entered recession. But the NBER typically does not declare a recession until well after one has begun."
WHY WAIT FOR EVENTS TO 'CONFIRM' NEGATIVE ECONOMIC TRENDS!
We have in the weekly/monthly price action of the Dow 30 Industrial (INDU) Average relative to the Dow Transportation Average (TRAN), a forecasting tool that predicted a major economic downturn some weeks back. The action of TRAN gave clues to coming economic weakness MONTHS back.
By the prediction rules for the economy and stocks, as laid out by Charles Dow
and known broadly as 'Dow Theory', we could have gotten a
The recovery rally in INDU after this sell signal carried up to the 13500 area and this period would have given even the slowest institutional money manager time to raise some cash and thereby improve his or her current performance.
I wrote about this topic in my Trader's Corner last week and updated my view on it in my most recent "Index Trader" column. My view being that I didn't assess the upside prospects for the recent rebound as much greater than the last week's closing levels. That the lion's share of the recovery gains had probably already been seen coming into this week. My reasoning and experience over three decades of trading suggests that rallies counter to the dominant trend (now down) won't typically carry more than a minimal 'Fibonacci' 38% to 50% retracement of the last price swing in the major stock market indexes.
What the Fibonacci retracement levels ARE and how they get used is at the END of this column for someone who wants to review this material and out of the way for someone who doesn't.
If you didn't see my last (Index Trader) article on my most recent update on the Fibonacci trade objectives (Sat, 2/2), you can click here if you want to review it.
Now that the market got slammed this week, I'll briefly review how the recovery rallies in the major indexes fared relative to the Fibonacci retracement levels for the S&P, Dow and the Composite and the results are amazing. Applying Fibonacci retracement levels to your charts can be an amazing tool for YOU to use. Traders use retracement objectives widely. Investors would probably benefit more from knowledge of Dow Theory to suggest the periods where it could be opportune to raise cash (or put cash to work).
A question in using the fibonacci retracement line tool in widespread use in charting applications is whether to measure the 'fib' lines from the highs of December (the retracement amounts for the second 'leg' down only) to the recent lows, OR the entire decline from the late-October peak to the recent low.
In this recent decline, I measured the fibonacci retracement levels for the last LEG down; i.e., starting at the December high and then (next) selecting the lowest intraday low (on 1/23) seen before the first rebound. The retracement charting tool will fill in the fibonacci retracement levels in between. The retracement percentages will be either pre-set or you can specify the ones just you want to see. If a rally has already gone beyond the 38% level, as was the case recently in the S&P and Dow, you can strike that one so as to not clutter up your charts.
The Fibonacci retracements are 38, 50 and 62 percent. We can say that a 100 percent retracement, or back to the start of the last price swing, is in the Fibonacci series also; retracements all the way back to a high or low, that hold those levels, are how double tops and bottoms come about.
In a bear market environment like the one we're in, don't generally expect more than a minimal retracement rally: either 38% in weaker stocks and indexes, or around 50% in the strongest stocks and most oversold indexes. This is not to say that the index or stock in question will necessarily go to a lower low as seen in the SPX, INDU and NDX daily charts below, but that the upside potential, especially on the first rally, is limited, often to retracing one-half of that distance or less; e.g., 38%.
I find the fib retracements to be a great aid in setting stop or exit points on some trades. For example, if I thought it unlikely that the Dow would climb much beyond a level equal to a one-half (to 12706) retracement of its last decline, I could buy DJX puts at 127 and set my exiting stop a few percentage points above that line; e.g., at 128.0.
In a retracement of a prior downswing, if prices climb much above one of the 3 Fibonacci retracement levels, an index or stock has some potential to go to the NEXT fib retracement level. No reason to risk more a little to see if you're right. (An explanation of some common retracement pattern is at bottom.)
How the strong becomes the weak. The Nas 100 led the August-October advance, but has been the weakest index on the second leg down. By the way, the second leg down in a decline is often at least a fibonacci 1.62 times the first decline. In the case of NDX, that's a close approximation as the second leg down (2147 to 1693) was 1.75 times greater than the first down leg (from 2239 to 1980).
WHO/WHAT IS FIBONACCI AND FIBONACCI PRINCIPLES?
There are some technical indicators whose formulas rely on the Fibonacci number sequence, but the main application is to look at price moves in stocks or index and use the fibonacci retracements of .382 or 38 percent, .50 or 50 percent and .618 or 62%.
Looking at the number progression of 1, 2, 3, 5, 8, 13, 21, etc. where each succeeding number is the sum of the two before it, there are certain arithmetic relationships that exist: .618 is the percent that each number is OF the next higher number; .382 is the inverse of .618 (100 61.8 = 38.2). Well stick to a shorthand and round off .382 and .618 to an even 38 and 62 percent %.
Imagine a stock that in 12 months goes from 10 to 20, for a gain of 10. The stock has had a fantastic double but you think it could go yet substantially higher. You wished you had owned it at 10 and but still would like to buy it, but cheaper than 20. The stock starts to trade lower. At what level could you hope to buy the stock?
Considering what would constitute the 38, 50 and 62% retracements of the 10 to 20 dollar advance would suggest the following:
1. If the demand is really strong for the stock, you might not be able to buy it
cheaper than 16.25 (.38 of the 10 gain subtracted from the 20 high point)
Also useful in trading index and stock options, is to track what would constitute the 38, 50 and 62% retracements, after a minor, intermediate or major price swing.
There is a simple pragmatic reason for this popularity; buying or selling in these retracement areas often results in coming close to buying at the low and selling at the top. Maybe the saying of "buy low/sell high" owes something to the common retracements.
You can set most charting applications to calculate retracements ranging from .33 to .38, .50, .62 to .66, In an correction (fall in price), to see what would be the retracement levels in a recovery rally, use of the retracement "tool" is by first pointing at the high, then the low.
The reverse of this method is used within an uptrend, where prices begin a counter-trend decline: first point at the low, then at the high to see what the retracements levels could be of the prior advance.
SOME GENERAL GUIDELINES ON FIBONACCI RETRACEMENTS:
A strong trend will usually see only a 'minimum' price retracement -- around 1/3 to 38%. If prices start to hold around this area, trade entry may be warranted.
In a normal trend (not powered by something extraordinary), a retracement will often be about half or 50% of the prior move. A common level to buy or sell by some will be at this point. After about this much of a return move has occurred; with an exit if it continues on much beyond 50%; e.g., 5% more.
Within the range of normal, but evidence of a weaker trend, will be a retracement of 62% or perhaps 2/3rds (66%). If prices hold this area, it can suggest initiating a trade, with an exit if the retracement exceeds 66%.
If a retracement exceeds one level, look for it to go to the next; e.g., if a retracement goes beyond 38%, look for it to go on and approach 50%. If it exceeds 50%, look for 62%. If a retracement exceeds 62% (or a maximum of 66%), then I look for what I call a "round trip" or a return all to the way to the area of the prior low or high this type action suggests a retest of the low or high and is the ultimate "retracement" so to speak, of 100%.
Retracements are done from the low to the high, high to the low, of the trading period being looked at; e.g., hourly, daily, weekly charts. If daily, measure from intraday high to intraday low; not usually based on the highest close to the lowest close, but this is another method also. I use retracements based on closing levels some and this way can show sometimes where prices might be headed.
GOOD TRADING SUCCESS!
Today's Newsletter Notes: Market Wrap by Linda Piazza, Trader's Corner by
Leigh Stevens, and all other plays and content by the Option Investor staff.
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