Table of Contents
As you are probably well aware the markets had a nice bounce today, but not without a little volatility. For instance, the S&P 500 had a 78 point range today. The futures opened higher this morning causing the SPX and NDX to open with an 18 and 37 point gap up, respectively. Both markets sold off from the early highs and fell to lows not seen in years. Specifically, the SPX (chart below) fell to a low of 1133.50 at 1:00 PM ET before bouncing on news that the Brits would suspend all short selling in their markets. The SPX and Dow Jones Industrials pared their losses in 15 minutes after being down 23 and 150, respectively. The Dow had a 600 point range today and closed up 410 points. I dont normally follow the Dow because it doesnt represent the market as well as the SPX. I believe the market was reacting negatively to the fact that Morgan Stanley was in need to find a suitor rather than a partner. It appears that Wachovia and Morgan Stanley are in advanced merger talks. That means that Goldman Sachs and Blackrock may be the only independent investment banks that remain.
Charlie Gasparino of CNBC is credited on breaking the story that Treasury Secretary Henry Paulson is considering setting up a facility to take on the bad debts of various financial institutions. The plan would basically make the US a huge hedge fund that is providing liquidity to banks by taking on the debt and the corresponding margin requirements that curbs their ability to finance new loans. The hope is that the new facility would allow the housing market to advance because it would restore banks ability to lend. In addition, Paulson, with Bernanke as his date, is presenting the idea to House and Senate committees tonight. President Bush would like Congress backing of the idea before more time is spent on the idea. Note that this is still and idea a not the plan. The markets ran on the concept because it is the best solution so far and would possibly protect further companies from going under. It appears as thought the government would rather invest in the assets/loans that are causing the turmoil (read reduced credit ratings on the stocks and increased margin requirements) than continue to provide capital to back up further banking failures. I guess they think it will cost us less this way.
The internal statistics on the NYSE show that there were 2373 advancers and 563 declining issues on over 10 billion shares traded on and off the exchange. The NYA closed up 334.78 points or 4.5%. There were 1041 New 52 week lows and 72 New 52 week highs on the big board. The Arms index closed at 0.51 which shows that there were more advancing issues with higher volumes when compared to those stocks with declining volume. The NASDAQ Composite index closed up 100.78 points or 4.78% on 3.9 billion shares. The COMP had 2195 advancing issues versus 778 declining issues. There were 97 New 52 week highs and 396 New 52 week lows.
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After the bell Oracle (ORCL) reported earnings that were $0.02 above estimates. According to Reuters estimates, excluding special items such as acquisition-related expenses, profit per share was 29 cents, beating the average analyst forecast of 27 cents. Oracle is the worlds third largest software developer. The adjusted operating margin was 40%, up 3.5% from a year ago. The only negative in the report was that there was a 12% drop in business management software sale. ORCL is bid up to $19.86 in after hours trading after closing the regular session at $18.75.
As the chart above shows, ever since the SPX failed to break above the 1305 resistance on September 1st the market has been on a free fall. There have been a couple of attempts to stage a recovery but the declining 21 day exponential moving average (EMA) maintained its dominance. Even todays 50 point advance couldnt break above the 8 day EMA which is currently at 1213.5. Option expiration weeks are generally volatile anyway without all of the investment banks going out of business. As mentioned above the reason that the markets advanced so much into the close was that the media reported that the Treasury is proposing a new solution to take on the bad debt of financial institutions. The RSI on the SPX chart above has re-emerged from oversold territory. In addition, the Slow Stochastics crossed above its moving average. The upper Bollinger band is consolidating while the lower Bollinger band continues to decline. The spread between the upper and lower bands represent to existence of greater volatility. Should the market advance tomorrow, the 21 day EMA (1238) will provide the primary resistance level that the SPX needs to move above. With the 8 day EMA less than the 21 day EMA the trend is still a confirmed downtrend. Therefore, short at tests of resistance and cover at extreme lows. If we do get a run up to the 21 day EMA tomorrow and you short the SPX, set a stop loss if the SPX continues upward above the 9/12 high of 1255 or just closes above the 21 day EMA. The downtrend would revert if the 8 day EMA crosses above the 21 day EMA.
The SPX chart above shows the simple 50, 89, and 200 day moving averages (SMA) over the last few months. It also shows the Fibonacci retracement levels from the previous low of 1200 to the recent high of 1313. As you can see the SPX declined almost to the 161.8% extension level and then found support. The 50 day SMA is at 1260 and will almost coincide with the price resistance at 1255 mentioned earlier. The negative is that ADX, generally a trend indicator, is above 20 while the trend is downward. Money Flow is low but not at extreme lows. There wasnt even a tick up in the money flow indicator after todays huge run up. All three moving averages are on a downtrend. While I believe the market capitulated today (more on that with the VIX) the move occurred on a report of a plan of action that isnt approved by Congress. So we may see some consolidation before running to test the previous highs in August and the 89 day SMA at 1298.
I wrote the Contrarian this morning so the moving averages arent as fresh as those in the above chart. However, the VIX broke out to an intraday high of 42.16 which is a level not seen since 2001. I am sure you have heard the saying One day does not a trend make. The same is true with volatility. It is entirely possible for the VIX to try to run up and retest. A failure to break above the new high would confirm a bottom was set today. Trading the VIX spikes is difficult to do if you arent able to close out the position on a break above the recent high. Those breakouts signal that there is still more market volatility to come and the position should be closed. For instance todays initial gap higher in the SPX brought the VIX down. But by 11:15 AM the VIX had broken above the 36.39 close which therefore suggested more market downside was due. Once the market declined and bounced, the VIX had to confirm the bounce by breaking back below 36.39. By the close, the RSI and Stochastics on the VIX also declined below the overbought territory. The VIX closed down 3.12 at 33.10. However, the 10 day moving average did not decline which was needed to confirm a positive portfolio bias. See below for the Contrarian from earlier.
NASDAQ 100 (NDX)
The NDX broke down to an intra day low of 1606.30 before bouncing up 64.97 to 1697.42. The NDX had a 98 point range today and at its low was below the 161.8& extension level before bouncing to close just below the 127.2% extension level of 1698.04. The ADX moved up to 31.18 even though the NDX bounced today, but not higher than Wednesdays high. ADXs advance confirms the downtrend until the ADX declines. Money Flow is low but not at an extreme level like I would prefer before taking bounce trade. The bounce may extend up to the recent high on 9/12 at 1775. The 50 day SMA is at 1840 while the 89 and 200 day SMAs are at the 1887 level. The moving averages require a sustained advance that would occur on positive fundamental news.
As mentioned before, the high today didnt break above yesterdays high. The 8 day EMA at 1720 should provide the next level of resistance for the NDX. With the 8 day EMA below the 21 day EMA, the trend is down. While a break above the 8 day EMA would provide a short term long trade, a run up to the 21 day EMA would be a short trade. In either circumstance, risk management must be defined prior to entry. Risk management really depends upon the user. But a long at a break above the 8 day EMA should be closed on a break below yesterdays high, for example. A short trade at the 21 day EMA may be stopped at a break and close above the 9/12 highs and/or the 21 day EMA.
Gold began the week in an oversold state and was quickly snatched up as one of the only safe alternatives. Another safe money play has been the US Treasury bond and 10 year note. The TNX declined to 3.25 yesterday as fears arose. Clients fearing that their money isnt safe in the money markets or the brokerage firm requested being invested in the T-Bills. I had difficulty buying Treasury notes today because other traders and institutions grabbed them faster than I could. What is amazing is that there is no yield. Gold opened a little higher and traded flat until the markets sold off into mid day. At its peak, Gold ran to 925 before selling off to a low of 836 as traders took profits and closed the commodity at 848. I suppose there isnt as much need for safety if the government is going to save the world. The shiny assets are usually bought as an inflation hedge or a safe money alternative. Hard assets are thought of as the foundation of currency and in the case that the financial world comes to an end would revert to being the main currency for exchange of goods and services. Since traditional asset allocation hasnt worked during this bear market gold and silver and the Treasury long bond are where cash runs to when the equity market appear glum.
Last night at dinner with my wife and kids, mom and dad, my mom asked me why the
market was down so much and what happened to AIG and Freddie Mac and Fannie Mae.
I started to explain in great detail until I got the look from my wife and then
proceeded to explain what I about to go through. Of course this is my opinion.
My quick assessment of who is to blame goes all the way back to 1999. I will try
to keep this non-partisan. The Glass-Steagall Act of 1933 put in place the
of bank and brokerage to avoid the problems that caused the Great
Depression and 1929 stock market crash as well as establish the FDIC. For those
of you that dont know, over leverage from cheap money being borrowed by
everyone put the market in a vulnerable state. Back then the transfer of
information was very slow and transparency didnt exist. The crash occurred from
similar reasons that the current markets are declining, credit quality and
earnings. But the SEC Act of 1933 and 1934
set to do is provide consequences for
market manipulation. In addition, there wasnt the level of supervision and
regulation we have today. Much of todays rules are based upon the SECs desire
to establish a regulatory foundation that would provide orderly markets for
decades to come. In 1999 the rule that kept banks and brokerages was repealed.
As investors pushed exchanges to reduce spreads to pennies or less from
sixteenths, the margins that the brokerages and specialists reduced
nothing. The first reaction to tighter spreads was for Wall Street research
firms keep high ratings on companies too long while the companies paid for
analyst coverage. Spitzer took that profit source away. Then as the economy sank
into 2001 and through 2003, brokerages with the new found ability to lend like
banks took on leveraged investments such as Mortgage Backed Securities and their
derivatives, CMOs and CDOs (Collateralized Mortgage Obligation and
Obligation, respectively) while cheap money was plentiful.
Overexposure to these investments as Greenspan began to raise rates to curb
inflation from increasing home prices that occurred from too much cheap money
reduced the performance of the underlying assets. For instance, many of these
CMOs may have been floor bonds. A Freddie Mac floor bond pays interest as long
as the Fed Funds stays below the target floor rate, in many cases 4%. So when
rates moved past 4%, these bonds ceased
paying interest and principal in some
cases and became Non-performing bonds. Non-performing bonds decrease in value
and the balance sheets of the brokerages carrying these investments did as well.
But the manipulation The Fed didnt take into account that their incessant rate
increases were starting to break the foundation of the credit market. While the
inflation was occurring in 2005 2007 brokerages were being forced to liquidate
these non-performing CMOs as Bloomberg and Bear
Stearns pricing models differed
from the newly adopted Reuters standard. Then Bernanke took office and decided
to take an academic approach to running the worlds largest economy. He too read
the government employment, CPI and PPI data as inflationary and continued to
increase rates into mid 2007. He continued Greenspans rate increases to curb
home prices from increasing anymore. Back to CMOs, the benefit of these
investments is from buying at a discount and receiving the principal at
an accelerated pay down that occurs when mortgage holders pay down their balance
from prepayment, sales and refinancing, death and divorce. The SECs COX decided
it was a good idea to repeal the up tick rule in July 2007. The markets decline
and increased volatility in August 2007 was the direct impact from that
decision. Admittedly, I lost a substantial amount of money because the market
didnt react to the extreme levels in volatility as it had in 1996 - 2002. The
is why I get out of a long SPX trade when the VIX spikes above
the recent level. Without the up tick and an orderly market, the VIX could run
up to 100 or more. One of the main reasons for the 1933 and 1934 Acts were to
provide an orderly marketplace that didnt enable market manipulation. Repealing
the up tick rule for shorts gave investors the ability to push the market down
without any recourse and taken normal order from the markets. Now we have short
sellers borrowing across
brokerages and selling short until a stock is so
worthless it cant raise capital to continue operation (Read AIG and LEH). My
opinion is that the government had to bail out AIG because they caused the
environment that created the problem. That is why Cox should be fired, as
Senator McCain suggested on Thursday. Therefore, the one at fault for this mess
stems from who ever decided it was a good idea to repeal the Glass-Steagall Act.
Then I would blame the Feds inability to recognize
their policys effects on
the securities created and managed by the same government. Then I would blame
the SEC for creating the environment that the Acts set to avoid. If information
wasnt so transparent and the markets werent this liquid another crash would
occur. So if the SEC reads this, make it necessary for the security to up tick
and only allow shorts against existing long margin positions at the same
brokerage firm (i.e. Short on up tick only and short against the box). Short
selling provides liquidity and opportunity. And opportunity is another word for
capitalism. So dont get rid of short selling, just fix the rule.
OIN SUBSCRIBER QUESTION:
Well, I thought that before a next tradable bottom occurred, it would be in keeping with my past experience of many previous market cycles that certain indicator extremes would occur before we would see a tradable bottom, but I didn't think that it would be the 'SHOT' HEARD ROUND THE WORLD!!
For example, I tell the story in my book (Essential Technical Analysis) of the extreme coincidence of being at what we thought would be at a 1987 advanced options trading seminar at the Chicago Board Options Exchange in a glassed in room above the trading floor on so-called 'black Monday'. We didn't have the seminar, as we watched the latest fad of 'portfolio insurance' help send the market down a staggering amount.
The same indicators I'm speaking of now, suggested that that day (black Monday) was the 'CAPITULATION' point, when traders and investors did what they did this week when they fearfully, blindly, got OUT of the market in droves. Capitulation is when emotions take over and otherwise rational market participants take extreme flight in large numbers. Charles Dow, well over 100 years ago, wrote about the tendency for bear market lows to occur only AFTER a certain degree of extreme PANIC sets in. What is it that they say about human nature EVER repeats itself?
The tradable bottom and call buying opportunity I was anticipating likely occurred yesterday (WED). I'll look at key TECHNICAL chart and indicator patterns that suggested this from a technical analysis perspective; you have tons of 'fundamental' factors and news to consider without me adding my 2 cents to that!
My key indicators, plus the price pattern and history of course, as of this past Friday suggested that there should be another decline in the S&P before there was: 1.) a retest of the July 1200 low in the S&P 500 (SPX); 2.)the 13-day RSI registering a 'fully' oversold reading (i.e., in the 30 to 25 area or below) and 3.) my hunch that my 'sentiment' indicator would hit 1-2 more bearish extremes. I somehow compartmentalized the Nasdaq as having already hit the conditions of a bottom; this couldn't really be the case if the S&P had some significant downside potential.
One bearish (1-day) sentiment extreme had already been seen on Tues the 9th, but given the nature of this market having the bearish influences it has had, it seemed plausible if not likely that the next tradable bottom would be more like the March low. The March bottom saw a fully oversold market as measured by the 13-day Relative Strength Index or RSI AND daily call to put volume ratios hitting bearish extremes (high put volume relative to calls) on at least 3 different days, with the last 'oversold-extreme bearishness' reading in March showing the biggest single day equities call-to-put volume imbalance seen in several years prior. That day, with these two indicators (RSI and "CPRATIO") both at extremes, marked the turning point in March and a 70-point rally followed.
SENTIMENT & RSI
Monday's "CPRATIO" (my sentiment indicator) reading, as highlighted below (green up arrow within the yellow circle) on the S&P 100 (OEX) chart, was very bullish. Assuming that PRICE and indicator patterns concur, a bottom would typically be seen within 1-5 trading days after such extreme bearishness is indicated by the high level of equities put volume that day. Like any other overbought/oversold indicator, a LOW reading in my call TO put volume indicator is an 'oversold' extreme. The RSI finally hit an oversold level as well yesterday (Wednesday). Was there PRICE (pattern) concurrence also? Some but not on this chart.
The March bottom wasn't a final low of course, but we're talking trading opportunities here. The May top showed the opposite extreme, with CBOE daily equities call volume running 1.7 times put volume on 3 different days, in fairly rapid succession with the final bullish sentiment extreme right at the top comprised of a day with the heaviest call volume (relative to put volume) for that period.
I'm working with the following guidelines: for a bear market cycle: extremes in bullishness are a 1-day CBOE equities call volume number that is 1.7 times (or more) greater than the total CBOE equities put volume that day; in a bull market cycle a top would be suggested by call volume that was 2 times (or more) greater. The 13-day RSI would be at, near or above 70. In a bear OR bull cycle, a bearish ('oversold') EXTREME is when daily CBOE put volume is at least equal or GREATER than total equities call volume that day.
PRICE & RSI CONCURRENCE
SPX finally reached or touched support implied by the low end of its broad downtrend channel that dates from the top made last year and highlighted below. Tellingly, the strong rebound from there has taken SPX back above 1200. In terms of the weekly chart RSI, which I usually measure on an 8-week basis ('length' setting equals 8), SPX has reached the level where it is 'fully' oversold and tends to make a tradable bottom.
Is yesterday's low a 'final' bottom? Do I care? No, only that one could buy SPX calls on the dip to implied (1133) support at the lower trendline and that the trade offered an excellent risk to reward; assumes an exit/stop point not far under the trendline; e.g. at 1100. Did I see this (dip to the lower trendline) coming? No, I wasn't that bearish, but when the decisive downside penetration of 1200 happened, I went back to the drawing board so to speak or back to looking at the various charts.
There's a bit of 'fudge' factor in the way the final 'best fit' or internal trendline came out (blue line) above versus the 'external' projected line intersecting around 1120 (dark magenta line). With a major weekly chart trendline like this one and given that yesterday's low fell in an area where an internal trendline (cuts slightly THROUGH the second trendline point), could be drawn, once prices started rebounding strongly from intraday lows, I assumed that SPX had reached an area of significant technical support.
Another chart that had to be looked at for signs of a PRICE pattern that suggested a bottom or upside reversal, is seen in the Nasdaq composite (COMP). Tech had been leading the overall market after all. A good indication of at least a solid interim, if not 'final' bottom is seen in a key upside reversal pattern.
A key upside reversal is when there is a decisive new intraday low, followed by a strong rebound such that the CLOSE ends up being above the prior day's HIGH. The fact that COMP closed back above its prior 'line' of support or prior intraday lows also supports the idea that a significant (i.e., tradable) low is in place. COMP's 13-day RSI also dipped to a fully oversold reading under 30 with Wednesday's close, which is a good concurring indicator relative to the key upside reversal pattern of yesterday/today.
Would I conclude here that there is no further shoe to drop in this market? No, but for example, if you covered NDX puts with the COMP dip to under 2100, which brought the tradable NDX calls into the area of its March closing low in the 1700 area (not shown), the risk to reward involved looked quite favorable and that's what counts in a trade; a favorable risk to reward ratio which implies an exiting 'stop' point that is at least 1/3rd of what you could project making on even a modest snap back rally. Or, we could just be talking about figuring that put profits had been maximized. Stay tuned on this outcome!!
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 email@example.com with 'Leigh Stevens' in the Subject
The CBOE Equity Put/Call Ratio
I sent out a brief update on Tuesday to notify everyone that the 10 day
moving average of the CBOE Equity Volume Put/Call ratio had continued to advance
through the historically high 0.80 level. The update also noted that the 10 day
moving average broke above the highs set in July thus confirming the Negative
Today's Newsletter Notes: Market Wrap and The Contrarian by Robert Ogilvie, Trader's Corner by
Leigh Stevens, and all other plays and content by the Option Investor staff.
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