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Trader's Corner

Looking for Bottoms

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From my morning E-mail bag.

" looking at the expiration calendar I got 7 more days after today on my OEX puts wish I had more but what to do with what I got is the question. What price levels are you thinking of as a place to exit major index puts? Any thought of buying calls when this fall gets overdone? I noticed your call put ratio got pretty low the other day."

RESPONSE: Finding a bottom is sure harder than finding a top usually. Tops tend to 'hang' up there for some time very often. This is in the nature of investor habits and psychology. Most market participants are not playing the short side so there some less selling that goes on that way and tops tend not to be as abrupt.

Institutional investors especially tend to gradually accumulate stock and buy buybacks. They're used to this in a generally rising market. However, it may be that this market, given the break of some key longer-term trendlines, is no longer in the long-term uptrend in effect since the late-2002/early-2003 low.

When market 'sentiment' as you mention finely turns pessimistic-bearish and stocks keep falling, selling tends to come all at once. There is not more buying on pullbacks. Stock money is mostly 'herd' money, as the trend ITSELF tends to force more and more selling. Professional investment managers today manage so much money in equities.

These managers can't UNDERPERFORM their peers, at least not consistently, or they won't have their high paying job managing our funds anymore. Having been there I know that money talks!

What is our poor manager to do when the market heads south, but keep exiting some percentage of their stock portfolio as the market falls. There tends to be more dumping all at once this way as the institutions dump mega amounts of stock collectively. This used to be called "portfolio insurance". This selling then creates more selling and it snowballs, more likely to a SINGLE climatic low. But, the 'bell' rings at the bottom for very few!

Buyers never get faster out of the way as when getting a dose of FEAR about losing on stocks. It may just be paper profits that get shredded but it feels like a loss none the same. When Apple (AAPL) first got to $45 I suggested its sale to someone I advise and this person took a fat profit relative to their purchase price. Then when AAPL went to $55 it couldn't be helped that this person had some gnashing of teeth. Not me. Today's break could easily be the start of a slide that takes the stock back to $40. At 40 there will be many owners of the stock that would be HAPPY to sell at 45.

BBottoms tend more often than tops to complete themselves with a single sharp downward 'thrust'; these type turning points, bottoms in this case, can be aptly called a 'spike-low' and are most often referred to as 'V-bottoms'; or, V-tops in the case of tops, but this pattern is less common at tops. With bottoms there is a tendency to try to anticipate where the stock or index will reverse. With stocks it can sometimes be much easier.

If we look at just what the PRICE trend has been doing in the OEX weekly chart up above, it's clear that the market has stopped maintaining its same rate of forward/upward momentum; the falling 'fan' lines of up trendlines show visually the FALLING trend now.

The 'V' type pattern is common at reversal-bottoms. It reflects this tendency for the market to turn around and surge back up so quickly because so much stock has been dumped that, with the sellers 'out' of the market, relatively small amounts of buying drive prices up fast.

The most money is made when buying when no one else wants to. It's been forever this way in trading, going back to those rice markets in Japan. Not for nothing did they try to find patterns that suggested a (trend) 'turning point' high or low. If a low or high is true, the advantage gained is tremendous. It's all information. Rothschild got his carrier pigeon word that Napoleon was defeated at Waterloo and bought up cheap English bonds and started the family's banking fortune.

All this said it's darn hard to 'see' a final down-thrust that is scary and deep AS a bottom, and is also one you are going to buy into. The great traders do this, you can do, but it's helpful to develop some skill in technical analysis.

For a response about what S&P 100 (OEX) targets I am working with, the following chart is offered. The OEX Index got into some possible support today around 545. 542-545 is a just a possible guess as also being 'major' support.

The steepness of the recent decline is suggesting some 'panic' selling, which happens with most bottoms. How far this will go is just a guess. At 540 the OEX is likely to garner substantial buying interest in normal conditions. Given the oversold level on the RSI indicator, the market is oversold.

Tough to pick bottoms and this one is no exception! What gets me surer of an approaching reversal, is me going AGAINST the opposing view. I most like to buy index calls when traders have gotten much more bearish than was the case over the course of the Sept decline. We're much closer to that point and, speaking of down 'spikes', we just recently got a couple of sharp drops to close to an oversold ('extreme bearishness') reading. Bearish 'sentiment' or outlook is growing.

After even 1-day readings at the 'extreme' zones shown in the lowermost frame of the chart above, there is often a buying surge within 1-5 days after. The 'CPRATIO' line measures graphically the 'fear' part, in bearish phases. Two flavors on the Street of Dreams when they get extreme: bull markets where greed takes over good sense at major tops, versus bearish 'fear' of loss in bear markets.

I didn't have much in puts either, as the recent sharp downside reversal mostly came from out of 'nowhere' so to speak. EXCEPT that a good trade was 'signaled' technically for Nasdaq 100 (NDX) when NDX made an exact double top around 1620; the subsequent rapid fall to under 1600 tended to 'confirm' a top. My downside target has been 1520 and 'enough' for me. The Index could go to 1480-1485 if there is more free fall. Let someone else stay in.

I have an attraction now toward buying calls on a dip to 1480-1485, especially if it happened after a final build up of bearishness, as I've been writing about. A low in this area would be a double bottom, out of an oversold condition.

You can't know if it's going to be a double bottom, but if you risk to just UNDER the prior low, the upside when RIGHT (a strong rally follows) is huge relative to risk. Rallies like this tend to come after some major discouragement and we've had plenty.

If the prior 1485 low is taken the index goes OUT of the realm of how an uptrend is defined: higher rally peaks AND progressively higher pullback lows. NDX failed to make a new high above 1620-1630 it's true, but technically the index is not defined as being in a downtrend UNTIL a prior low is exceeded. Stay tuned on that!

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 [at] OptionInvestor.com with 'Leigh Stevens' in the Subject line.

** Good Trading Success! **

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