A Bronx cheer, otherwise known as blowing a raspberry (sticking one's tongue out between the lips and blowing to make a sound that any child would find humorous), has been the market's response to the election of our new president. Poor President-elect Obama has not been greeted with the kind of enthusiastic response from the market that he, I'm sure, would have preferred seeing. But if he understands the buy-the-rumor, sell-the-news kind of thing that happens all the time in the stock market he won't take it personally.
The stock market rallied strongly on Tuesday for who knows what reason. Sometimes I'm reminded of the home video of the dog pushing a big rock around the yard--he wasn't going anywhere in particular but just pushed the rock around. The market has been doing that since the October 10th low--big volatile price swings as the rock gets pushed around the yard but we haven't gone anywhere. But I suspect Tuesday's rally, if not manipulated higher by a Republican administration in hopes for some last-minute Republican gains, may have been from those who were buying in anticipation that we would see a post-election rally. (The Republican comment is not a political comment but instead is simply reflecting the party of the current administration).
The market hates uncertainty and coming into this election both sides were making all kinds of threats that thousands of lawyers were prepared to do battle and blame the other for corruption, blocking voters, counting illegal voters, you name it. What many feared, particularly when the race was closer before the election, was a repeat of the past two elections, particularly the Bush-Gore fiasco. That kind of uncertainty, and all the questions that go with who would implement what kind of changes, was making it difficult to make some end-of-year decisions.
As we got closer to the election it became clearer that Obama was pulling ahead. Taking away the uncertainty may have led to the rally, especially on Tuesday. There are also many who believe we'll see a year-end rally (November-April being typically the best six months for the market) and have been positioning for it. You could see that in the outperformance to the upside by the small cap index (RUT). It was a rally built on hope (another one).
It probably would not have mattered if McCain had won the election (well, except for maybe gun owners and sellers of moose-hunting licenses--wink). With the strong run up in the market there were many who were ready to take their profits off the table (many are not convinced we've seen the bottom yet, or are at least waiting for a test of the bottom). And once some profit-taking started it snowballed into a rout of the bulls. There is still a lot of nervousness in this market. Whether people are worried about more financial institution failures, a continuing credit freeze, more home owners being under water, hedge fund redemptions (people have until November 15th to submit their redemption requests), or a myriad of other concerns, we're clearly in a period of lowered expectations.
The bounce into Tuesday's high from the October 28th low looked like a nice completion of a bearish rising wedge pattern that had confirming negative divergences on the oscillators. As I had reported at the end of Tuesday on the live Market Monitor I thought it was a great setup for a short play. I expected at least a pullback to correct the rally from October 28th and potentially a more bearish setup for the start of the next leg down to new annual lows. Even though the decline from Tuesday has been very sharp there remains the potential for us to stay stuck in a large consolidation pattern for another couple of weeks before heading lower again. This consolidation pattern since October 10th has been marked with huge price swings and even though the loss of 900 DOW points in the past two days seems huge, it could simply be part of this consolidation pattern.
It was another very negative day (look at the internal breadth measures in the table above) which followed an even more negative day yesterday (it was a 90% down day, meaning down volume was greater than 90% of the day's total volume). But there's no panic in the air--the selling has been steady but with no panic flushes to the downside. Total volume has been respectable but not strong. That's actually bearish since there's no one hurrying to get out the door but instead there's very little interest in buying. So the last two days have inflicted some damage and there's probably more to come. With that in mind, let's take a look at this week's charts.
S&P 500, SPX, Weekly chart
For the past few weeks, since the October 10th low, I've been expecting a 4th wave correction for the wave count for the decline from May. That 4th wave may have ended at Tuesday's high and that's how I've labeled the weekly chart. This calls for another leg down in a 5th wave that will complete a larger degree 3rd wave for the move down from October 2007. As shown on the chart, the next leg down should set up another larger 4th wave correction (it might be filled with even more volatility than we've seen since October 10th). The bounce should take us into about February before we get another leg down into April/May.
The interesting thing about this scenario, which is based on EW (Elliott Wave) time and price projections for typical wave relationships, is that the idea to buy in November and sell in May could get completely turned on its head for the next year. After the low next year we should be due a large rally, for at least a year, to correct the 2007-2009 decline. That bottom next year will likely have most people swearing off stocks and it will be a great time to do some buying.
As shown on the chart, I'm projecting the next leg down from here to find support at the October 2002 low of 768. Obviously that should be strong support but there's also a Fib projection at that level, shown on the daily chart:
S&P 500, SPX, Daily chart
If Tuesday's high was the end of an a-b-c bounce off the October 10th low, thus finishing the 4th wave correction, we should continue down to a new low, shown in dark red. A typical relationship between the 1st and 5th waves in a 5-wave move is equality. The 1st wave was the move down from May to July. Using that to project from Tuesday's high (which would be the start of the 5th wave down) I get 767.71. You can't get much closer to the October 2002 low of 768.63. It's almost too perfect. That would be a buying opportunity for a bullish trade for a choppy rally into early next year (won't get a whole lot of points though).
Another possibility is the large sideways triangle pattern, shown in pink. As depicted, we could see the current leg down followed by another push back up to the top of the pattern, perhaps around 975 by November expiration (so be careful if in November puts and holding on too long). The triangle pattern would be negated with a break below 845.
Not shown but still a possibility (but one I consider low probability, which is what this game called trading is all about), is for the rally to continue up in a larger degree 4th wave correction from the October 28th low, which shows green wave (3) at that low. While I consider it a lower probability scenario any rally back above Tuesday's high would be bullish and I would exit all short positions until we see what sets up next. This short-term bullish possibility is shown on the 60-min chart below.
Key Levels for SPX:
S&P 500, SPX, 60-min chart
The closer view of the daily chart shows what I pointed out above. The dark red wave count calls for a new annual low by the end of next week. There are some cycle studies pointing to mid November as a turn window. I show the market as being ready for a bounce tomorrow but that's just a guess at this point. Whether it bounces immediately or from a little lower level first we'll just have to wait and see. The market is clearly short-term oversold.
The pink wave count (for the larger sideways triangle) shows support near 850 (shallow uptrend line from October 10th). If we do get a bounce tomorrow and it looks strong I'd start feeling nervous about any short positions, certainly any long November puts. And again, any rally above Tuesday's high would have me exiting short positions while I wait to see what's next.
While I show potential support near 850, it could be higher for a bounce back up inside a sideways triangle pattern. Using the Gann Square of Nine chart I come up with 882-883 as potentially very strong support. Think of a Square of Nine chart as a spiral of numbers, starting with 1 in the center and spiraling out from there. It's drawn as a square circle so the numbers run along horizontal and vertical lines. Here's the center of one just to give an idea:
Gann Square of Nine chart
The chart has radials every 5 degrees. If a number is on the same radial as another but at a different level (one or more cycles around the chart) they are considered "square" to each other. There are many other relationships for the numbers (for example, 180 degrees or 540 degrees, which is 360 + 180, can be considered a good level for a correction) but for now I'm just focusing on the numbers that are square to another. So on the chart above, 311 in the top row is square to 245 in the row below it on the same radial. Now we look at the section of the Square of Nine chart that shows the current SPX prices:
Gann Square of Nine chart for SPX prices
Notice 1576 highlighted in yellow at the top (the October 2007 high) and 768 in the middle (the October 2002 low). These are square to each other (and was one of the reasons for me pounding the table back in October 2007 for my call for a market top and to get out of longs and into a short position). I also highlighted 1005, again, along the same radial. Tuesday's high was 1008--close enough. So the next potential support level on the chart is one cycle away from 1005 and 768--882 to 883. If SPX drops to that level tomorrow, watch for support.
Dow Industrials, INDU, Weekly chart
The DOW's weekly chart looks the same as SPX. It's downside projection for the 5th wave down is just shy of its October 2002 low near 7200. Notice where the DOW has been struggling in its bounce off the October 10th low--right underneath the long-term uptrend lines from 1974 and 1982. It's obviously bearish to test it from underneath and fall away (kiss goodbye). Even the bounce into next year will very likely stay below those trend lines. Maybe they'll be tested in late 2009/early 2010 with the bigger rally off the low next spring.
Dow Industrials, INDU, Daily chart
Again, the DOW's chart is very similar to SPX. Not shown is the possibility for a continuation of the bounce above Tuesday's low. The other two stronger probabilities in my mind are for either a drop to a new annual low next week or stay trapped inside a sideways triangle until about Thanksgiving before breaking lower in December. Either scenario points to a low for the year near the October 2002 low.
Key Levels for DOW:
Nasdaq-100, NDX, Weekly chart
Different index, same weekly chart. I've been showing the Fibonacci 55-week projection from its October 2007 high and it continues to line up with other cycle studies pointing to a mid-November turn window. A Fib projection for the 5th wave down for its 5-wave move down from May is to about 940 which is also price support from its 1998 and 2003 lows.
There's just enough difference in the NDX pattern for price action since October 10th to open up a slightly different possibility for the move down to new lows, and is shown on the daily chart:
Nasdaq-100, NDX, Daily chart
If the 5th wave down actually started from the October 14th high we could be in a type of descending wedge pattern that is depicted with the pink wave count. It would mean more volatile price action as it works its way down to a low in December (possibly coinciding with the sideways triangle idea followed by a leg down as shown on the SPX and DOW charts). It's a tough pattern to trade (4th wave chop potentially leading into a choppy descending wedge pattern for a 5th wave, called an ending diagonal) so don't be bashful about taking profits early on either side of the market.
Key Levels for NDX:
Russell-2000, RUT, Daily chart
The RUT has a pattern very similar to NDX and I'm showing the possibility for one more leg down to put in a low for the year (similar to SPX and DOW) or a down-up-down sequence (light dashed line) to finish the decline in December, like that shown for NDX. The short-term possibility for another leg up in its rally from October 28th is shown in pink. Again, I consider this a lower probability scenario but any rally above Tuesday's high would elevate to the most probable scenario. All scenarios lead to new lows but clearly they have different timing and that makes all the difference to options players.
Key Levels for RUT:
Banking index, BIX, Daily chart
The price pattern of the banking index is giving me the impression it's going to form a descending wedge pattern for what could be its final leg down (common pattern and the reason it's called an ending diagonal in EW terminology). I've shown what it might look like but that's just an idea for a typical pattern. It points to a bottom in December just below 100 and it should be accompanied with bullish divergences. I fully expect banks to make a bottom months ahead of the broader market. If the banks bottom in December and then the broader market bottoms the following April it would be fairly typical.
Transportation Index, TRAN, Weekly chart
The weekly chart for the transports looks similar to the broader market for the leg down from May--it looks like a 5th wave down should set up a larger bounce into next year. Right now I like Fib projections near 3100 for a low.
Commodity Related index, CRX, Monthly chart
Even the commodity related index is looking like it needs a 5th wave down to complete its leg down from June. In the thinking that "all the markets are the same" we've seen commodities, especially the stocks, do some catching up to the downside. Whereas the stock market started down from October 2007 and therefore has a year under its belt, commodities have only been declining for 5 months. Both should retrace their 2002-2007/8 rallies at the same time, either this month or next.
Since I know many of you follow the oil stocks I thought I'd update the oil index chart tonight:
Oil stocks index, OIX, Daily chart
This particular index does a good job at showing the a-b-c bounce off the October 10th low and actually reinforces my belief in this particular wave count for the broader market. It just missed equality between the a-wave and c-wave (shown at 635.88), a very typical relationship in what's called a flat correction (common for 4th wave corrections). Some internal Fib projections for the 5th wave down are pointing to a bottom just above 400. From there we should see a rally into the new year.
Economic reports, summary and Key Trading Levels
Today's two reports were not a surprise to the market so they couldn't get the blame for the selloff. Sometimes traders just sell and the reason is simply they wanted to sell. But TV pundits don't make all that money to say something simple like that so they come up with all kinds of silly reasons. But I think it's important to see what's happening to the unemployment claims:
Initial Unemployment Claims, chart courtesy briefing.com
The sharp spike up in claims looks like what happened in previous times that marked recessionary periods. I expect nothing different this time. The only question now is how bad it will get.
Tomorrow's reports certainly have the impact to move the market. One of the reasons for today's selling may have been nervousness in front of the jobs reports. We might have a sell the rumor, buy the news setup for tomorrow morning (and is one reason I've depicted a bounce tomorrow on my charts). I have no idea if we'll get a bounce but there's the setup for it.
One last chart to show is for the VIX:
Volatility index, VIX, Daily chart
VIX found support at its 62% retracement of the "rally" from August. At the same time SPX barely retraced 38%. Fear subsided quickly while price marched sideways, another bearish signal. And the VIX chart shows you can certainly "trade" it with the same technical signals that you use on any other symbol.
Summarizing, we could remain trapped inside a large whippy consolidation pattern for a couple more weeks and therefore trading could remain difficult. Just when you think you've got a trade working for you it does a 180 turn and with speed. Holding trades overnight is especially risky. For those who are short the market, keep your fingers crossed for a swift move down to a new annual low by next week and then look to exit short positions. I will be covering every one of mine, some of which I've been carrying since May and added to in August.
We're nearing the part of the price pattern where holding short for bigger gains will be the riskier trade. Don't get greedy and don't berate yourself for exiting a profitable short position too early. There is the possibility we'll see SPX blow through 768 and find support near 661 (the next level down on the Gann Square of Nine chart). If I exit most of my positions at 768 I'll be working hard not to kick myself for not getting more of the move down (we're only human and it's hard not kicking yourself about "lost" profits).
Regardless of whether or not you cover your short positions early and/or you might be on the sidelines, I think it's too early to be looking for a bottom. There are a lot of analysts, using some very good reasoning, that are calling for these lows to be great buying opportunities. The idea that you should buy in November for a good run up into May is one I'm hearing a lot lately. It's too early. If we get a low next week then we'll have a good buying opportunity.
If we see a flush to the downside and see SPX tag 661 it should be a v-bottom kind of reversal. I'd buy 661 with both hands and feet and load up the truck with long positions. It would be a MOAC (Mother of All Calls) setup. If it instead works its way down to 768 by next week I should be able to have a much better idea about the setup in next Thursday's newsletter. But keep in mind a long play off the bottom won't be any barn burner to the upside. It will probably be a lot like what we've seen for the past four weeks except it will probably go three months. There will be lots of trading opportunities inside it.
It's a trader's market and will likely stay that way for quite a while. More and more people are recognizing that it's not a buy-and-hold market (the 3rd wave in the EW pattern is called "the wave of recognition" for a reason). That means you need to identify good levels for buying and selling. And if you think that's easy I've got some great condo deals in Florida for you. I like EW analysis because I believe it's one of the best tools available for showing where you are in the larger pattern. Combined with the plethora of technical trading tools available to us, from simple trend lines and channels to oscillators, I can get higher-odds scenarios to watch for market turns. One's coming but it's not here yet.
Good luck and I'll be back with you next Thursday.
Key Levels for SPX:
Key Levels for DOW:
Key Levels for NDX:
In Play Updates and Reviews
Volatility Index - VIX - cls: 63.68 chg: + 9.12 stop: n/a
My, my how quickly the volatility returns to the market. We were expecting a corrective bounce higher but today's move seems a bit too much. I am tempted to sell at-the-money or out-of-the-money November calls here but you might want to wait to see if there is a continuation spike toward the 70 level first, which would be a better entry point to sell calls. If you do choose to sell calls you'll want to keep a mental stop loss in place where you'll buy them back should the VIX keep climbing. You don't want to be short calls if the VIX spikes back to 90 again.
We have about two weeks left before November VIX options expire.
If the VIX is under your call's strike price at expiration (11/19/08) they'll expire at zero ($0.00) and you keep all the premium you sold it for.
Note: The VIX options, which are European style options, have a unique expiration date. November VIX options expire on November 19th, 2008. The last day of trading for these options is the Tuesday before expiration. For more information check this link:
Our September 16th put position (suggested entry at 30.30) has a 25.50 target. In all honesty this position may be dead. We still have plenty of time with these next two. The September 29th position (suggested entry at 46.72) has two targets at 36.00 and 31.00. Our October 8th position (entry 57.53) has two targets at 40.00 and 35.00.
CBOE Volatility Index - VIX - cls: 63.68 chg: + 9.12 stop: n/a
This two-day spike in the VIX is bad timing for our spreads. The delta on our deep in-the-money calls is rising quickly as time runs out on option expiration. I do think it's a temporary spike and the VIX will roll over again but nothing is guaranteed and it doesn't have to happen in the next two weeks. The spike to 90 last month was proof that the VIX can continue to break records and do the unimaginable if the market conditions warrant it.
We are not suggesting new positions at this time. If you don't have a protective (long) call in place then you may want to buy one now (not necessarily those listed below, maybe something around the 65 strike). If instead you think buying the higher-strike call as a hedge at this point is just good money after bad then you may want to consider just closing this play for a loss. Otherwise without a hedge we're really gambling, roulette-wheel style, on where the VIX falls come expiration day.
Please see the CBOE website or our Sunday, October 12th play description for details on margin requirements for selling VIX options. Link:
Note: VIX options are European style options that settle for cash at expiration. Furthermore VIX options have unique expiration dates. November options expire on Wednesday, November 19, 2008 and will stop trading on Tuesday, November 18th.
VIX spread #1 has been completed.
VIX spread #2 with November options (date Oct. 12th):
We wanted to SELL the November 30 calls (opening price 10/13/08 was $ 8.60) and BUY the November 50 (opening price was $1.61) as a hedge against the VIX remaining elevated.
In a different format the play is:
VIX spread #3 with November options (published 10/22/08):
We wanted to SELL the November 35 calls (10/23/08 opening price was $ 14.00) and BUY the November 60 (10/23/08 opening price was $3.00) as a hedge against the VIX remaining elevated. We'll fill in the prices Thursday morning. Our account will be credited with the amount for selling the November 35 calls, while it the price paid for the 60 calls will be deducted.
In a different format the play is:
Apple Inc. - AAPL - close: 99.10 change: -4.20 stop: 99.45
The worst two-day decline in the market since the 1987 crash was too much for AAPL. The stock spiked down to $98.00 and hit our stop loss at $99.45 closing the play. If the volatility index hadn't spiked so much it might be tempting to try a strangle or a straddle on AAPL at the $100 mark but the options are too expensive.
Baker Hughes - BHI - close: 33.40 change: -1.12 stop: 32.30
BHI was also caught up in the market's widespread sell-off and shares hit our stop loss at $32.30 ending the play. A new bounce over $35.00 might be a bullish entry point and shares were on the rebound this afternoon.
CSX Corp. - CSX - close: 42.66 chg: -1.85 stop: 43.45
Railroad stock CSX plowed through support near $44.00 and its simple 10-dma and quickly hit our stop loss at $43.45. The move today closed both positions in CSX.
Lockheed Martin - LMT - close: 76.82 change: -7.57 stop: 78.79
Shares of LMT gave up any resemblance of relative strength today. The stock cratered with an 8.9% sell-off that crashed through support near $82, $80 and its 10-dma. Our plan was to buy calls on a dip at $82.75 with a stop loss at $78.79. Shares of LMT hit our trigger and our stop loss in the same decline with barely a pause to catch its breath.
United States Oil (ETF) - USO - close: 50.15 change: -3.69 stop: 51.95
In the last three days the USO has gone from a brand new P&F chart buy signal to a sell signal. This ETF has moved more than 16% with a $58.78 high to today's $49.31 low. There appears to be no bottom for oil. OPEC nations are doing everything they can to show the world they are obeying their production cuts. Yet oil keeps sliding. The media will tell you it's fears of a global economic sell-off but that's been the story for the last $30.00.
The USO hit our stop loss at $51.95 closing the play.
Energy SPDR - XLE - close: 47.60 chg: -3.05 stop: 47.75
The XLE energy ETF gave up 6% as oil continued to implode. This ETF hit our stop loss at $47.75.
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