By Mark Phillips
Have you noticed what I have? Oscillators are oscillating between overbought and oversold extremes again and that is great for our trading purposes. Rangebound markets tend to make oscillators like the Stochastics and RSI (Relative Strength Index) really shine as tools for picking ideal entry points. By their very nature, markets (or stocks) that are stuck in a range tend to reverse when they reach the overbought or oversold extreme.
The runaway bull market of 1999 and early 2000 had Stochastics frequently remaining glued to the ceiling in overbought territory for weeks and months at a time, making momentum strategies ideal and long-term oscillators difficult to use. Similarly, the most recent leg of the corrective bear market (September 2000-March 2001) had the oscillators of numerous stocks nailed to the floor in oversold territory, seemingly unable to recover.
Since hitting its lows in early April, the market seems to be telling us that rangebound trading strategies are starting to work again as the bulls and the bears fight for dominance. While this up and down action can be frustrating to long-term buy and hold investors, it gives us exactly what we are looking for in the LEAPS portfolio, especially as we target covered calls on our LEAPS in an attempt to reduce our cost basis, preferably to zero.
Helping to underscore the case for rangebound trading is the fact that many pundits are still trying to call the bottom of the market in the worst seasonal time of the year. August and September are historically the worst months of the year for the bulls, but that didn't stop Abby Joseph Cohen from grabbing a microphone this morning to reiterate her year-end targets of 12,500 for the DJIA and 1550 for the S&P500. With earnings season winding down, there are fewer opportunities for really bad news to crater the market and of course, investors are once again focused on the Fed and the expectation of more interest rate cuts to prop up our still-sagging economy.
In the past couple weeks I've had a number of emails requesting further clarification on when to enter new positions -- both when to buy the LEAPS and when to sell the Covered Call. With my observations of the change in behavior of technical indicators, I thought I would use our time together to highlight a couple of plays from our Portfolio, showing the details of our LEAPS entry and what I am looking for in terms of Covered Calls entries.
So let's go to the charts, shall we? After the artificial Fed-induced spring rally in the markets, I noticed that some of our old Technology favorites like Cisco Systems (NASDAQ:CSCO) and Sun Microsystems (NASDAQ:SUNW) had begun to bounce from major support (but above the spring lows) as the weekly Stochastics oscillator reversed from the oversold region. Contrary to the pattern seen in the September-March period, the weekly Stochastics oscillator is running from oversold to overbought and back again. This gives us a much better tool for gauging our long-term entries.
While the stochastics oscillator continued to provide false or non-existent entries during the October-March timeframe, we can see that things have improved significantly over the past four months. Support held up nicely near $14 as the daily Stochastics posted a series of higher lows in July, helping to push the weekly Stochastics into ascent mode. We took our entry on the bounce from $14 on July 24th, and so far the stock is moving nicely, breaking out above the $16 resistance level today.
Although the chart is a little different, CSCO presents us with much the same picture. The frustrating days of watching weekly Stochastics meander in the lower half of its range for months at a time are behind us, and the recent recovery from the $16 level set us up for an attractive entry in early July.
With the weekly Stochastics reversing into ascent mode, all we had to do was look for a reversal of the daily Stochastics from oversold territory. And looking at the daily chart, there it is, accompanying a renewed bounce from the $16 level. The dip and bounce from $17 a week later was confirmed by a higher low in the daily Stochastics, allowing us to breathe easier with the additional evidence that our indicators are giving us good signals again.
CSCO and SUNW are just a couple of recent examples of how my favorite indicator is once again providing reliable entry signals. The convergence of buy signals on the daily and weekly charts gives us strong long-term LEAPS entries and then all we have to do is focus on the daily charts to gauge our entry points for selling the covered calls.
While the high-odds entries on these plays have passed into history for this cycle, there are other plays on the Watchlist that look like they are quickly approaching our desired entry points. Barrick Gold (NYSE:ABX) has almost fallen back to the $14 level and the daily Stochastics have dropped back into oversold territory. I'm betting we get a tradable bounce in the next week, and if it comes above our entry target, we'll step into another attractive long-term play. With weakness still keeping the Oil Service stocks under pressure, we're similarly setting up for an attractive entry in our Global Marine (NYSE:GLM) play as daily Stochastics head back for another reversal in the oversold region.
I'll finish up this discussion on entry points next week with an equally detailed analysis of how to target the Covered Call side of the position. Who knows, in the intervening time, we may see some weakness emerge on the CSCO and SUNW plays, providing us with some attractive setups that that we can dissect to our heart's content.
The key to successful trading is to recognize what is working and what is not working in the current market environment. Now that we can see oscillators providing reliable signals again, that gives us some valuable information for planning our trades.