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Daily Newsletter, Thursday, 08/21/2008

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Table of Contents

  1. Market Wrap
  2. Trader's Corner
  3. New Option Plays
  4. In Play Updates and Reviews

Market Wrap

Two in a Row

Market Wrap

The market has rallied two days in a row and that means a reversal back down tomorrow. That's a rather bold statement but it's interesting to see the pattern on the daily chart of the S&P 500 (and DOW and NYSE). Since the first bounce up off the July 15th low we've had pullbacks followed by 2-day rallies, Wednesday and Thursday being the fifth occasion. This latest 2-day rally looks very choppy and corrective and that has me thinking it's only a bounce and we'll see continued selling. But watch for this pattern to change as it would at least be indicating some short term strength coming into the market.

Each rally since the January low has shown weaker internal market breadth and the one off the July 15th low is no different. It's a warning that it's very likely just another bear market rally built on hope that all will get better soon. But there is the potential for the market to rally further into September especially since there are many people talking about a weak market starting in August and running into October. When too many expect something it usually doesn't happen. In this particular case I believe we will see some very hard selling over the next two months and the bounce off the July 15th low may already be finished. If so I suspect we'll see some very hard selling start to kick in within the next couple of days.

But there remains the possibility for another leg up in the bounce off the July low to a high in early September. It would certainly be a disappointment to many bears who are banking on a market collapse into October. After flushing them out with another rally leg it would then be ready for a strong decline. If SEC Chairman Cox has his way and limits short selling we could see a brief but strong rally, similar to what we saw in the banking sector after moving them onto the endangered species and protected list. If the short sellers were forced out in something like that the market would then lose the buying power of shorts when it needs it most--after a crash. I strongly suspect a Cox-initiated limitation on short selling would have negative and unintended consequences. But these people usually only learn of these consequences after the fact.

I like to keep an eye on the bond market, even if not trading it, because that market often telegraphs before the stock market what could be coming. It's been a while since I've reviewed the charts of the 10-year yield so I thought I'd take a look at them this evening, starting with a longer term view of the monthly chart since 2000:

10-year Yield, TNX, Monthly chart

After dropping to a low in 2003 near 3.0% TNX then rallied back up into a high near 5.4% in 2007. The pattern of the 2003-2007 rally is a rising wedge and what followed was a typical move--a quick retracement of the wedge when TNX dropped to about 3.3% in January. I show two possibilities from here--the pink wave count calls for a little higher, perhaps up to about 4.6% before tipping back over and the dark red count calls for a resumption of the decline in yields (rally in bonds). At this point I'm leaning towards the dark red count that calls for new low in the yield.

A rally in the bond market would likely be an indication that money in rotating from stocks into the relative security of U.S. Treasuries. As the daily chart shows, TNX needs to rally back above its July high of 4.174% in order to suggest we've got new highs coming (which would mean there are greater concerns about inflation and that would likely have the Fed raising their rates too).

10-year Yield, TNX, Daily chart

Two equal legs down from the June high would take TNX down to 3.62% and the 62% of the March-June rally is at 3.68%. That makes for a good target zone for support if we're to see another rally leg (pink) in TNX. Otherwise a continuation below 3.5% would likely mean new lows are coming and that would be telegraphing greater concern about a slowing economy rather than inflation.

Another signal that comes from the bond market has to do with spreads. We've often heard of the yield curve and that's basically a measure of the spread between the shorter and longer term bond yields. An inverted curve means the longer-dated bonds are yielding less than the shorter-dated bonds and is typically a signal that we're about to enter a recession.

Another example of a spread is the TED spread which Linda has reported on recently in a Traders Corner article and regularly updated on the live Market Monitor. This is the difference between the 3-month U.S. T-bill rate and the 3-month LIBOR (London Inter Bank Offered Rate) and gets its name from the 'T' in T-bill and 'ED' is the ticker symbol for the Eurodollar futures contract. It measures the number of basis points between the T-bill and LIBOR so a 3-month T-bill rate of 1.80 and a 3-month LIBOR rate of 2.91 gives us a TED spread of 1.10. A wider spread means there is greater concern about market risk with traders demanding a higher yielding LIBOR rate.

If the spreads between other bonds and the U.S. Treasury bonds are rising then it's saying there's more concern about the risk of those other bonds against the perceived safety of U.S. Treasury bonds. And that telegraphs to us that there is greater worry about increased risks for investments in general. These spreads tend to move counter to the stock market which makes sense when you think about the bond market telling us there are increased risks in the market and the stock market obviously does not like increased risks. Since 2007 we've seen these spreads forecast a coming market decline. Therefore it pays to watch these interest rate spreads. There is a website called markit.com and they track all kinds of bonds.

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We've heard about and discussed the commercial mortgage-backed securities and how these have essentially blown up in the faces of those who own them. All the write-downs that we hear almost daily from the banks, pension funds, state funds and hedge funds are in large part because of the shrinking value of their mortgage-backed securities (and the alphabet soup of derivatives created from them). As the value of these bonds drops from mark-to-model to mark-to-market the funds have been required to write down the value of their holdings.

Because bond prices and yields are inversely related, as bond prices drop their yields go up. Or viewed the other way around, as investors demand a higher yield to compensate for higher risk it drops the price of the bond. Therefore watching the yield spread between these mortgage-backed securities and Treasury yields tells us when bond holders are becoming more risk averse or more comfortable with the current market risks. And when these bond holders are demanding higher yields we need to pay attention as they're telling us they don't like what they see heading towards us.

Markit tracks these spreads and you can see the spreads for various grades of mortgage-backed securities (CMBX in their nomenclature) at http://tinyurl.com/2hnqkf. What's particularly interesting right now is the fact that the spreads are increasing and have been doing so since before May, the high for the stock market this year. Over the past year each time these spreads have increased while the stock market rallies the bonds have been correct and the stock market soon declines.

Since the low on July 15th the stock market has been rallying (well, at least up until last week) but take a look at the spread on even the "safest" of mortgage-backed bonds, the AAA-rated ones:

Markit CMBX-NA-AAA 5 Index, Daily chart

It may be hard to read the numbers on the left side of the chart but basically the spread has doubled since May, from about 100 basis points (1%) to move than 200 basis points (2%). For reference, these AAA-rated bonds were less than 40 basis points in the first half of 2007. If you check the other lesser-rated bonds you will see that not only are large spreads being demanded but also there's been a spike up in the spreads just in the last week. This is a clear warning that the stock market's rally is very likely just another bear market rally. We will likely see many of them before the stock market finds a lasting bottom (and at much lower levels).

Some other evidence of the weak rally following the July 15th low can be found in the market internals. Each of the rallies since the initial lows in January have become weaker and this is another factor that convinces me that the market is preparing for a swan dive to much lower levels. Whether we're looking at advancing vs. declining volume or advancing vs. declining stocks we see less and less participation in each of these bear market rallies. On top of that we're heading into the weaker period of the year--September and October. The earnings picture has been weakening, we've got uncertainty about the upcoming election, more rumors about failing banks (a big one is coming) and the housing market is not showing any signs of bottoming. Simply stated, it's not a good time to be in the market and many participants know this.

I say many participants know it's not a good time to be in the market but the bullish sentiment is on the rise again. After nine straight weeks of bearish advisors outnumbering bullish advisors (a very short streak when measured against previous bull and bear streaks), the bullish advisors for the week of August 18th jumped up to 40.7% vs. 38.4% bearish advisors. We also see complacency in the VIX. To see this level of complacency while the DOW remains below the January/March lows (and failed a recent retest of those lows last week) is rather disturbing when you think of the number of people who could get hurt during the next decline, which is building up to be a strong one.

I guess a lot of people have faith in Uncle Ben and his printing press (and his investment bank rescue machine). And then there's Hank Paulson and his mortgage nationalization efforts (and helping the failed executives keep their obscene bonuses while allowing the little people beg at the gate). Last but not least there's the SEC's Cox who wants to dissuade the big bad bears from trying to short the market. Without shorts to help start the buying during a decline I can only imagine how much worse it might be. Why am I reminded of the "hear no evil, see no evil, speak no evil" monkeys when I think of this trio?

But there will always be hope in the markets even though in a bear market it's known as the slippery slope of hope. Rather than hope for a market direction let's just stick with the charts for signals as to the direction we should be trading (as traders we shouldn't give a hoot which direction it goes--just give me a direction and preferably a trend).

S&P 500, SPX, Weekly chart

A break below the July 15th low near 1200 would be a confirmed break of the long-term uptrend line from 1990. In the meantime there's nothing that says SPX can't rally up to its downtrend line from last October. In fact two equal legs up from the July 15th low is at 1373, which would be a perfectly normal correction. I'm not saying it will happen but if you're short the market, as I am, you want to respect this possibility, shown in pink.

S&P 500, SPX, Daily chart

I show the same possibility for another rally leg up to 1373 (in pink, matching the weekly chart). Otherwise a drop back below 1261 would be a strong indication that the strong selling has begun and we should see a relatively quick move below 1200. I show the possibility for support at 1170 for another bounce back up to the downtrend line from May but the kind of selling I'm thinking we'll see means it could just blow right through support and head below 1100 very quickly.

Key Levels for SPX:
- cautiously bullish above 1313
- bearish below 1261

S&P 500, SPX, 120-min chart

I show the more bullish possibility in green on the 120-min chart (vs. pink on the daily and weekly charts). If SPX rallies back above 1292 that would considerably improve the probabilities for a stronger rally into early September. Therefore I'm recommending shorts use 1293 for their stop. In the meantime I think short is the place to be.

Dow Industrials, INDU, Daily chart

The DOW has the same setup as SPX. A break back below Wednesday's low would be a strong indication that we'll see strong selling follow. The current bounce off Wednesday's low could have a little more life to it but any higher than 11720 would have me exiting short positions while waiting to see if the stronger rally develops (pink, with an upside target in the 12250-12300 area).

Key Levels for DOW:
- cautiously bullish above 11716
- bearish below 11125

Dow Industrials, INDU, 120-min chart

If we see a little more rally tomorrow, watch the 11550 area where the downtrend line from August 11th intersects the trend line across the two lows on August 8th and 14th tomorrow. It's possible the lower trend line identifies a H&S top in which case a retest of it would be an opportunity to short it as it does a kiss goodbye.

Nasdaq-100, NDX, Daily chart

Last week I had pointed out the Fib projection at 1967 and said it will likely be resistance if it was to be the end of the 3-wave bounce off the July 15th low. The turn back down from it, and now closing below both its 100 and 200-dma's, looks bearish. While it could certainly rally back up to new highs if the blue chips do so, I do not see that as likely at the moment. But certainly you know where your stop needs to be if you're short the techs.

Key Levels for NDX:
- cautiously bullish above 1967
- bearish below 1873

Russell-2000, RUT, Daily chart

The RUT broke support at 737, its uptrend line from July 15th and is back below its downtrend line from October. Bearish, bearish and more bearish. Back above 637 would have me looking for a retest of its high and broken uptrend line. Otherwise short is the place to be on this one.

Key Levels for RUT:
- cautiously bullish above 737
- bearish below 737

Banking index, BIX, Daily chart

The choppiness of the decline since early August has me feeling wary about the banks. I see an equal possibility for a waterfall decline to occur where we see a rapid selloff from here) as well as another rally leg up to the 240 area (for a larger 3-wave bounce off the July low). I show the key levels at 200 to the upside and 163 to the downside--let price lead the way on this one. MACD back below zero has me leaning to the short side.

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

The downtrend line from February 2007 has yet to be broken on a closing basis so that would be the first clue for bulls if they see that happen. But even if the downtrend line is broken I see the possibility for only a brief rally up to the top of a rising wedge pattern before heading back down for new lows. So either directly from here or after a brief rally I think the home builders have not bottomed yet (but could do so with one more leg down).

Transportation Index, TRAN, Daily chart

The Transports tried a few times since mid July to get through its broken uptrend line from January but instead has broken its shorter-term uptrend line from July and today broke its previous low in early August. While the choppy price action means we could still see another rally leg for one more attempt at that stubborn uptrend line from January I don't see that as the higher-probability trade. It did get a nice bounce today after nearly tagging its 200-dma, and left a bullish hammer at that support level, so it could certainly get a higher bounce over the next couple of days. It takes a push above 5211 to say it's going to try again at that broken uptrend line.

U.S. Dollar, DXY, Daily chart

The US dollar spiked above its long-term downtrend line from January 2002 (using Log price scale) and at 77.16 it tagged the level where the 2nd leg up in its rally off the March low achieved 162% of the choppy 1st leg up (to the June high). Right now it has completed a 3-wave bounce and therefore could have ended a correction to its long-term decline. In that case it will head back down now to a new low (dark red). But if the dollar starts to consolidate in a sideways/down type of move it will be a bullish indication that it will be followed by a 5th wave up. That would be the clearest indication that we could get that would say the US dollar has found a low and the trend has changed to up. It will take a couple of weeks and watching price action before we know better which scenario is playing out. If you trade Forex (currencies) or commodities, now is the time to be a little more cautious as we wait for price to tell us what it's going to do next.

Oil Fund, USO, Daily chart

USO found support at its uptrend line from August 2007 (did not quite tag it). It will either correct its decline from July before heading lower again (dark red) or else it will continue rallying to another new high before finding a longer-lasting high. Like the US dollar I'm watching now to see what kind of price action develops from here so as to provide me some clues what's coming next.

Oil Index, OIX, Daily chart

While oil could rally a little more I don't see the same thing for oil stocks. Between the 200-dma and broken uptrend line from March 2003 (Log price scale) coinciding in the 854-859 area, I suspect any additional rally will get turned back from there. The price pattern of the decline from May supports another leg down before finding a tradable bottom.

Gold Fund, GLD, Daily chart

Gold finished a 5-wave decline from its July 15th high and found support at its uptrend line from July 2005. It's a good setup for either a continuation of the rally to a new high (I'm watching the US dollar to see if it provides some clues in that regard), shown in green, or else a bounce to correct the decline from July before heading lower again (dark red). If it heads lower again it will probably head down to at least 60 (600 for gold). There were a lot of people sending me lots of emails saying why I was crazy to think gold would break below 800. It actually happened faster than I thought. If you're a gold bull and hanging on because you have people giving you beaucoup fundamental reasons why gold will rally to $1650 by January 14th, 2011 (or whatever), stick with the charts and not reasons why you think gold will rally. I thought tech stocks would keep rallying in 2000 too. Emotional trading and herd mentality trumps funnymentals every time. Trust me on this.

That being said, I don't know if gold will now rally to a new high. I'm watching price action to help me decide how to trade this next. I am long gold off the low because it's due at least a big bounce back up. But I'm trading gold and have no intention of holding it if the price action says it's only a correction. I'll keep you posted.

Economic reports, summary and Key Trading Levels

There are no scheduled economic reports for tomorrow. Today's reports included the Leading and Coincident Indicators and they continue to look depressing, literally. The following chart shows the history of this index:

Leading and Coincident Indicators chart, courtesy Briefing.com

The pink line is the Leading Indicators index and it dropped sharply in July to -0.7% from 0.0% in June (and worse than the expected -0.3%). It is now approaching the lows seen in 2001. Also, notice the large decline from the peak in 2004. It has done a round trip from the low in 2001 while the market has been holding up. Notice also that the Coincident Indicator index never rose as high as the previous highs in the 1990's. This chart is a picture of weakness that the stock market has not yet priced in. It will.

Only two more summer Fridays to go before we get into September. Between the charts and what I hear people trying to do to prop the market up, I don't discount the possibility that we'll see another rally leg into early September. As mentioned earlier, it would be a move that knocks out a lot of bears and make them afraid to short the market again. It's what the market does.

But I also see price setting up for a nasty decline, one that could literally start any day now. Therefore keep an eye on the exit door if you're still trying to stay in long positions. Once the decline gets started, assuming it will, you will not get another bounce opportunity to get let out of your positions. As the series of 3rd waves starts to unwind to the downside people will recognize that the market is in serious trouble (perhaps with news of a big bank failure and no bailout from Uncle Ben, or something like that).

Once again I'm sorry to be the 'bear'-er of bad news but I feel it's my job to protect traders, not tell them what they want to hear (and I know a good majority of our readers are bullish). Like some family members and friends who think I'm too bearish and who are in this "for the long haul", holding on as their financial advisor tells them to do, I can only advise what I see on the charts and provide my analysis based on broader market and economic factors. Throw in some historical cyclical studies, sprinkle with EW (Elliott Wave) pixie dust, shake the snow loose in my crystal ball and voila! a market forecast. Use it as you wish and certainly make your own financial decisions so that you can sleep at night.

My aunt, who is in her 70's is invested in the stock market and recently asked my opinion. After asking her repeatedly if she really wanted to hear it, since I'm bearish, she insisted. After telling her to sell all her stock holdings and go mostly to cash with some bonds she said her financial advisor recommends she stay invested because "the market always comes back." She told me she doesn't want to talk to me about the market unless I have something good to say about it. It reminds me of the countless stories I heard during the tech bust where people weren't even opening their statements because they didn't want to read the bad news. Unfortunately for them, and the survivors of the 1987 crash, the market did come back (well, not the tech stocks). It has lulled a generation of investors into the false belief that we only have a bull market and that bear markets have been done away with. Don't be one of those people--learn to trade even if it's only to move into and out of stocks every couple of years as the market swings.

We're facing hard financial times ahead, and not just in this country. We're a global market now and we're facing global issues. For those who get into conspiracy theory about government involvement in all kinds of things, including our markets, you might enjoy reading an article making the rounds on the internet from Catherine Austin Fitts, who served as Assistant Secretary of Housing and as Federal Housing Commissioner in the first Bush administration. I can't vouch for her or the accuracy of the story she writes but I must say it's a chilling piece on "The Housing and Economic Recovery Act of 2008". For your reading pleasure: http://tinyurl.com/6nr8z4


Good luck with this market and I'll be back with you next Thursday.

Key Levels for SPX:
- cautiously bullish above 1313
- bearish below 1261

Key Levels for DOW:
- cautiously bullish above 11716
- bearish below 11125

Key Levels for NDX:
- cautiously bullish above 1967
- bearish below 1873

Key Levels for RUT:
- cautiously bullish above 737
- bearish below 737


Keene H. Little, CMT
Chartered Market Technician
 


Trader's Corner

Resistance at Breakdown Points and Fib Retracements

 
Resistance at Breakdown points and Fib Retracements

OIN SUBSCRIBER QUESTION:
"...were there technical resistance areas that were hit at recent highs and what were they?"

RESPONSE:
There were a couple of types of resistance that got hit by key major indexes recently. ONE aspect of resistance is a rally that returns to an area of prior support. We could say that prior support once broken can 'become' resistance later on. This is the meaning of 'supply' or a supply overhand. I'll show a couple of examples on the charts.

If there is a support area that is perceived by many or most market participants, and that support gets pierced, there are a lot of market players that don't get out of all the stock that they might like to; especially institutional fund managers. They won't sell all the stock they want to (to raise cash) on a break of support as the prices of their stocks will go down too much if they just dump. Many times when a key index or average, such as the Dow or S&P, etc. comes BACK to that prior 'breakdown' point, there is considerable supple of stock that becomes for sale. This is the concept of a resistance at a prior BREAKDOWN point.

A SECOND aspect of resistance is what often develops after certain RETRACEMENTS, as measured as a rally or pullback measured as PERCENTAGES of a prior price swing. I'll show recent examples of some of these retracements, but first give an introduction to retracement theory.

Charles Dow made some early, maybe the first observations about the tendency for a stock or the overall market to retrace or give back anywhere from around 1/3 to 1/2 of the distance covered by a prior advance or decline, before the major trend resumes again. It was very common Dow noted, that retracements against the direction
of the main trend were often about half (50%)of the prior price swing.

There were further refinements on the theory of how much ground retracements will typically cover made by W.D. Gann, a famous stock and commodities speculator of the first half of the 1900s primarily, Gann found it significant to use charts that had retracements noted between a major low to high or high to low of 1/3 to 2/3rds of a prior price swing.

The origins of one of the major 'retracement' theory for stocks and other markets came from someone who lived in the middle ages and was studying the population growth of rabbits. Yep, Wabbits! Leonardo Fibonacci was an Italian mathematician who was doing such work in the early 1200s.

The number sequence that is named after Fibonacci is where each successive number is the sum of the two previous numbers; i.e., 1, 2, 3, 5, 8, 13, 21, 34, 55, 144, etc. Any given number is 1.618 times the preceding number (approximately) and .618 times the following number.

The technical indicators whose formulas rely on this Fibonacci number sequence, but the main application is to use the "fibonacci retracements" of .382 or 38%, .50 or 50% and .618 or 62%. The number 5 is in the Fibonacci sequence, and the others are ratios -- .618 comes from the percent that each number is of the next higher number and .382 is the inverse of .618 (100 61.8 = 38.2). Well stick to the shorthand and round off to 38 and 62% as the important "Fibonacci" retracements, beside 50%.

What I find most useful in trading is to track what would constitute the 38, 50 and 62% retracement points, after a minor or intermediate price. Use of these retracements is a very common practice and a quite popular point of reference, among traders.

There is a simple pragmatic reason for this popularity and that is that 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.

MEASURING FROM INTRADAY HIGH TO INTRADAY LOW VERSUS FROM A CLOSING HIGH TO A CLOSING LOW
This difference in these two ways of measuring retracements can be significant as I'll show. It's good to look at retracements of a prior decline or a prior rally on both a bar chart showing the High-Low-Close (HLC) versus a close-only Line chart.

The recent upside retracement of the May-July decline in the S&P 100 (OEX) equaled a bit more than 50%, but that was only seen on one intraday 'spike' high as seen in the OEX daily bar chart below. Also of interest here is that recent rally high, on an INTRADAY basis was back to the prior 'breakdown' point dating back to the March-April period. One that area, around 608-609 in OEX was pierced in June, there was another down leg that followed.

You can set most all charting applications to calculate retracements ranging from 25% to 38% (.38), 50%, 62% (.62), or a little beyond at 66% (2/3rds) or even 75% - often, by pointing first at the low, then the high (pullback retracements) or first at the high, then the low for retracement rallies in what you
perceive to be an overall downtrend.

In a countertrend rally within a dominant downtrend - once a minor downside correction begins look to see if a recent high represented a 38, 50, or 62% retracement of that high relative to the rally starting point. If the (up) swing high also failed at or under a key down trendline and was accompanied by an overbought condition, its a sure tip off to short the stock or play puts in the case in stocks or indices.

The strongest market segment has been in tech stocks and the strongest of the strong, in terms of the Nasdaq indices, has been the Nasdaq 100 (NDX). NDX recently rallied to and a bit beyond the 2/3rds or 66% retracement level. Given that there were two consecutive days where the Index closed above the 66% retracement level, it looked like NDX was going to go on and retest its summer highs, WITHOUT having a correction first.

HOWEVER, given that there was this 2/3rds retracement seen above and given that the market was getting overbought, the correction that followed wasn't surprising. By taking a look at the retracement levels on a LINE chart below, a more clear cut resistance is seen in terms of the 62 and 66% retracdment levels.

On a pullback or a retracement of a prior advance where the a correction "resists" dropping back even 38%, after a strong up move, I may add a 25% retracement line. If a deep correction falls below the 62% or 66% retracement, I may add a 75% retracement line, but this is quite rare in the case of stock indexes; it's more common in individual stocks.

If the correction of a prior rally goes above 66% retracement, I assume that the correction will a full 100% or a "round trip" back to the origin or starting point for the decline.

Again, it's useful to measure retracements both by use of a bar (or candlestick) start and look at the intraday high to intraday low or vice-versa in an advance, AND also to have a chart set up that uses a close-only line chart. Charles Dow, who I mentioned, used to ONLY consider CLOSING levels as being of 'true' significance. Candlestick charting describes the intraday day low or high as the "shadow".

A strong stock or strongly trending index will tend to have retracements that EXCEED the 50% level. A weak stock or weak/lagging index will tend toward retracements that are LESS THAN 50%, which is seen with the Dow 30 (INDU) below. The recent Closing high in INDU also reached a prior 'breakdown' point, where we can assume that there was more than average supply or selling interest.

In a downtrend, the 38, 50 and 62 percentage figures are added to the most recent low, when it becomes likely or your hunch is that a minor counter-trend rally is underway; e.g., prices and volume surge. The expectation is that in a normal or typical market, prices will rebound an amount that is equal to about half of the last decline; or, 'little bit' more, which would be 62%; a bit less than 50% in the case of a weaker stock or index like the Dow would be a 38% retracement.

If prices climbed to the 62% retracement level, in an overall downtrend, such price action tends to suggest a favorable exit if long a stock or in index calls, and favorable trade entry to short or buy puts. In terms of risk strategy after that, you can place a stop just over the retracement level.

Maybe shorting in the 62-66% retracement area will prove to be a profitable trade in NDX (more than seen so far), although I'm not counting out the ability of the Nas 100 index to challenge its prior high. In terms of trading STRATEGY if long calls, I myself don't like to hang in with a big option or stock position, hoping for that last rally potential before there's a major test of a major prior high!

SOME 'RULES OF THUMB' REGARDING RETRACEMENTS:

These guidelines mostly are related to the most common retracements, that of the fibonacci 38, 50 and 62% retracements.

1.) A strong trend will usually see only a 'minimum' price retracement of around 1/3 to 38%. If prices
start to hold around this minimal retracement area, this action may be suggesting trade entry as there may NOT be a deeper correction.

2.) A 'normal' trend in stocks, indices, commodities, currencies or bonds, that is one not powered by something way out of the ordinary (e.g., a hurricane or an act of terrorism), will often see a retracement develop of about half or 50% of the prior move. The most common level to buy or sell is this retracement amount, with an exit if it continues on much beyond 50%; e.g., 5% more.

3.) Within the range of normal trend, there is often a retracement of 62% or even 2/3rds (66%). If prices don't' exceed this retracement area, its also a good target for initiating a trade that favors a resumption of the DOMINANT or major trend existing before the countertrend retracement type move began.

4.) 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 a 'round trip' or a return all the way back to the prior low or high this type action suggests a retest of the low or high and is the 'ultimate' retracement, which is 100%.

5.) Retracements are commonly done from the low to high, high to low and not based on the highest close to the lowest close, etc. However, as I've discussed, also experiment with retracements based on closing levels as they also are worth exploring.

6.) The common retracement levels work on all time frames or chart types; e.g., hourly (or less), daily, weekly and monthly charts.

GOOD TRADING SUCCESS!

Please send any technical and Index-related questions for possible use in my next Trader's Corner article to Click here to email Leigh Stevens support@optioninvestor.com with 'Leigh Stevens' in the Subject line.
 

New Plays

Most Recent Plays

Click here to email James
New Option Plays
Call Options Plays
Put Options Plays
Strangle Options Plays
RIMM MICC None
  NYX  

Play Editor's Note: This is not the best environment to be opening a lot of new bullish plays. However, there were a few candidates that definitely caught my eye. BDX and VFC look like they have potential as possible call option candidates. Plus, if you're feeling really adventurous you could buy calls on the sell-off in Goldman Sachs (GS). Shares of GS pulled back to July 2008 lows and started to bounce. I would use a stop under today's low.


New Calls

Research In Motion - RIMM - cls: 132.30 chg: +2.02 stop: 124.65

Company Description:
Research In Motion is a leading designer, manufacturer and marketer of innovative wireless solutions for the worldwide mobile communications market. (source: company press release or website)

Why We Like It:
We were bullish on RIMM during the early August rally but then decided to cut it loose a couple of days ago when it looked like shares were going to breakdown under $125.00. The stock has recovered so we're suggesting readers buy the bounce. If you don't want to chase it here then look for a dip into the $130-128 region. We are suggesting a stop loss at $124.65, just under Tuesday's low. We have two targets. Our first target is $143.50. Our second target is the $155.00-160.00 zone. However, readers should expect RIMM to encounter some resistance in the $145-150 area.

Suggested Options:
We are suggesting the September or October calls. There are only four weeks left on September options.

BUY CALL SEP 135.00 RUL-IW open interest=12787 current ask $5.25
BUY CALL SEP 140.00 RUL-IH open interest=15712 current ask $3.35
BUY CALL SEP 145.00 RUL-II open interest=13447 current ask $2.01

BUY CALL OCT 140.00 RUL-JH open interest= 497 current ask $7.90
BUY CALL OCT 150.00 RUL-JJ open interest= 311 current ask $4.65

Picked on August 21 at $132.30
Change since picked: + 0.00
Earnings Date 09/25/08 (unconfirmed)
Average Daily Volume = 19.1 million
 

New Puts

Millicom Intl. - MICC - cls: 80.07 chg: -0.63 stop: 80.75

Company Description:
Millicom International Cellular S.A. is a global telecommunications group with mobile telephony operations in Asia, Latin America and Africa. It currently has mobile operations and licenses in 16 countries. The Groups mobile operations have a combined population under license of approximately 291 million people. (source: company press release or website)

Why We Like It:
It looks like the oversold bounce in MICC is on its last legs and poised to roll over. The stock was crushed back in July when MICC missed earnings estimates. The bounce made it back to the top of the gap down, which is typically resistance. Aggressive traders might want to jump in early. We want to see a new relative low. Our suggested entry point to buy puts is $78.49. If triggered we're listing two targets. Target number one is $75.05. Target number two is $72.50.

Suggested Options:
We are suggesting the September puts. September options expire in four weeks.

BUY PUT SEP 80.00 CQD-UP open interest= 127 current ask $3.80
BUY PUT SEP 75.00 CQD-UO open interest= 121 current ask $1.90

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/23/08 (unconfirmed)
Average Daily Volume = 1.0 million

---

NYSE Euronext - NYX - close: 38.77 change: -1.12 stop: 41.05

Company Description:
NYSE Euronext (NYX) operates the worlds leading and most liquid exchange group, and seeks to provide the highest levels of quality, customer choice and innovation. Its family of exchanges, located in six countries, includes the New York Stock Exchange, the world's largest cash equities market; Euronext, the Eurozone's largest cash equities market; Liffe, Europe's leading derivatives exchange by value of trading; and NYSE Arca Options, one of the fastest growing U.S. options trading platforms. (source: company press release or website)

Why We Like It:
NYX is a momentum play. The stock is in a long-term down trend and shares just recently broke to new lows. Investors are worried that the government might impose regulations on the exchanges that could impact their profitability. Plus analysts have been downgrading the stock following its latest merger. We are suggesting put positions now with the stock under $40.00. We have two targets. Our first target is $35.15. Our second target is $32.50. More conservative traders will want to consider a stop loss a lot closer to $40.00.

Suggested Options:
We are suggesting the September puts.

BUY PUT SEP 40.00 NYX-UH open interest=4189 current ask $2.93
BUY PUT SEP 35.00 NYX-UG open interest=2873 current ask $0.77

Picked on August 21 at $ 38.77
Change since picked: + 0.00
Earnings Date 11/03/08 (unconfirmed)
Average Daily Volume = 4.8 million
 

New Strangles

None today.
 

Play Updates

Updates On Latest Picks

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Call Updates

Arch Coal - ACI - close: 56.59 chg: +4.22 stop: 48.99

Coal stocks surged on Thursday thanks to UBS upgrading multiple stocks in the group. ACI was one of the stocks upgraded and shares ended the session up more than 8%. Volume was strong on today's rally, which is bullish. ACI hit an intraday high of $57.45, almost enough to hit our target. We're not suggesting new bullish positions at this time. We are adjusting the stop loss to $51.00. Our target is the $58.00-60.00 zone. The P&F chart is bullish with a $68 target.

Picked on August 20 at $ 52.37
Change since picked: + 4.22
Earnings Date 10/20/08 (unconfirmed)
Average Daily Volume = 6.4 million

---

Adobe Systems - ADBE - close: 44.51 chg: +0.23 stop: 43.34*new*

ADBE rebounded about 0.5% on Thursday but shares appear to be forming a short-term $43.50-44.75 trading range. This is the third day in a row that ADBE failed to bounce back above its 10-dma and the $45.00 level. The larger trend is bullish but short-term we remain cautious. We are raising our stop loss to breakeven at $43.34. Our target is the $47.50-50.00 zone. The Point & Figure chart is bullish with a $71 target.

Picked on August 05 at $ 43.34
Change since picked: + 1.17
Earnings Date 09/16/08 (unconfirmed)
Average Daily Volume = 6.5 million

---

Chesapeake Energy - CHK - cls: 49.39 chg: +0.77 stop: 45.75*new*

Energy and natural gas stocks continue to rally. CHK added another 1.5% and briefly traded above the $50.00 mark. If CHK does dip we would look for a new entry point in the $47.50-48.25 zone. Please note that we're raising our stop loss to $45.75, which is under the 10-dma near $46. We have two targets. Our first target is $52.00. Our second target is $54.85. FYI: As expected CHK produced a brand new P&F chart buy signal that now points to a $62 target.

Picked on August 20 at $ 48.05 *triggered
Change since picked: + 1.34
Earnings Date 11/06/08 (unconfirmed)
Average Daily Volume = 20.2 million

---

Illumina - ILMN - cls: 92.00 chg: -2.02 stop: 88.45

ILMN under performed the market today. Shares gave up 2.2% with an early morning swoon and spent the rest of the session churning sideways. The stock might be poised for a dip back to the $90 zone. More conservative traders will want to consider a slightly tighter stop loss. Wait for a bounce before considering new bullish positions. We have two targets. Our first target is $95.25. Our second target is $99.50. FYI: ILMN has a 2-for-1 stock split scheduled for September 23rd. Traders might also want to note that ILMN's short interest is about 19% of the 50 million-share float. That's high enough to spark some short squeezes.

Picked on August 14 at $ 91.55
Change since picked: + 0.45
Earnings Date 07/27/08 (unconfirmed)
Average Daily Volume = 1.2 million

---

Itron Inc. - ITRI - close: 103.43 change: +0.44 stop: 98.45

ITRI posted another gain. We don't see any changes from our previous comments. More conservative traders might want to inch their stop loss closer to the $100 level. We've set two targets. Our first target is $105.75. Our second target is $109.90.

Picked on August 14 at $ 101.50
Change since picked: + 1.93
Earnings Date 10/30/08 (unconfirmed)
Average Daily Volume = 616 thousand

---

CBOE Volatility Index - VIX - close: 19.82 chg: -0.60 stop: n/a

It was a mixed day on Wall Street but investors were not fearful and the VIX slid lower. A rebound from current levels or a new move over 22.50 could be used as new (very aggressive) bullish entry point. This is a speculative bet that the market will see another sharp sell-off strong enough to lift the VIX toward 30.00 before October option expiration. Our target is 29.75 but readers might want to consider scaling out of positions in the 28-29 region.

Picked on August 03 at $ 22.57
Change since picked: - 2.75
Earnings Date 00/00/00
Average Daily Volume = x million
 

Put Updates

Bank of Amer. - BAC - cls: 29.04 change: -0.25 stop: 31.55

Traders bought the morning dip near BAC's 50-dma again but the stock failed to post an actual gain. We remain bearish on the financials. Today's move may prove to be a new entry point for bearish positions. We have two targets. Our first target was $28.00. Our second target is $25.50.

Picked on August 07 at $ 31.52 /1st target exceeded
Change since picked: - 2.48
Earnings Date 10/16/08 (unconfirmed)
Average Daily Volume = 90.4 million

---

Chipotle Mex.Grill - CMG - cls: 70.53 chg: +0.47 stop: 73.65

There was little change in shares of CMG today and we don't see any changes from our prior comments. A failed rally in the $72.00-73.00 zone can be a new entry point or readers can buy puts on a new relative low under $69.00. We have two targets. Our first target is $65.50. Our second target is $61.00.

Picked on August 20 at $ 69.90 *triggered
Change since picked: + 0.63
Earnings Date 10/30/08 (unconfirmed)
Average Daily Volume = 888 thousand

---

Regional Bank HOLDRs - RKH - cls: 98.00 chg: -1.53 stop: 103.05*new*

There was no follow through on the RKH's bullish candlestick on Wednesday. This is good news for the bears. We would use this as a new entry point to buy puts. We are adjusting our stop loss to $103.05. We have two targets. Our first target is $91.00. Plan to exit all or most of your position there. We'll set an aggressive, secondary target at $86.00. FYI: The top three holdings in the RKH are JPM (19%), WFC (13.6%) and WB (10%).

Picked on August 18 at $ 99.80
Change since picked: - 1.80
Earnings Date 00/00/00
Average Daily Volume = 3.1 million

---

Uniao de Bancos Brasil - UBB - cls: 119.19 chg: -0.77 stop: 117.75

UBB is still trying to bounce but can't power past resistance near $120 and its simple 10-dma. Aggressive traders may want to buy puts now with a tight stop above $120.00. We are sticking to our original plan and suggested entry point at $112.50. If triggered our target is the $102.50-100.00 zone.

Picked on August xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 11/06/08 (unconfirmed)
Average Daily Volume = 1.5 million
 

Strangle Updates

(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.)

---

Lehman Brothers - LEH - close: 13.72 chg: -0.01 stop: n/a

LEH is trying to stage a recovery. Today marked the second day in a row that traders bought the dip near $12.50. This afternoon the stock spiked higher on an analyst upgrade to a "buy" yet the rally failed to lift LEH above the $14.00 level. LEH was in the headlines today after a Wall Street Journal article described how the Federal Reserve followed up on a rumor that Credit Suisse was pulling or closing credit lines with LEH. CS told the Fed that the rumors were not true - at least that is how the story goes. There was a lot of talk today about LEH being a takeover candidate since its market cap is down to $9 billion. Some believe that LEH's Neuberger-Berman business is worth $9 billion by itself, which values the rest of LEH at zero. We are not suggesting new strangle positions at this time. We have a few weeks left before September options expire and need to see LEH significantly above $24.00 or under $10.00. The options we suggested were the September $24.00 calls (LYH-IR) and the September $10.00 puts (LYH-UB). Our estimated cost is $2.15. We want to sell if either option hits $3.50 or higher.

Picked on July 27 at $ 17.05
Change since picked: - 3.33
Earnings Date 09/18/08 (unconfirmed)
Average Daily Volume = 63 million
 

Dropped Calls

None
 

Dropped Puts

None
 

Dropped Strangles

None
 

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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