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Trader's Corner

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This week also brought some OIN SUBSCRIBER QUESTIONS about where I see this market going, which included this question:
"How would you characterize this market? You wrote recently that the market was getting too far ahead of itself, but prices keep going up. Is there a best way to trade these kind of moves?"

I would characterize this market as being in a 'runaway' kind of price move or trend. The current market cycle I have also called a 'leg', which is a trend of ABOVE average force and staying power. It is fueled by very bullish sentiment and, at times, by bouts of short-covering type buying by those thinking that it was overdone but prices have kept rising anyway. So much of the market is driven by perceptions of earning trends not yet realized and hence by market psychology or 'sentiment'.

There is in technical analysis, a fair amount that is written about price 'gaps'. This is where a stock or where in SOME indices, prices open higher, even substantially higher, than the preceding day's close and the preceding day's high.

You won't see price gaps in the daily charts of the S&P indices: when there is not an immediate open in some of those stocks due to delayed openings stemming from order imbalances, 'opening' price levels for the S&P 100 (OEX) and S&P 500 (SPX) stocks are 'assumed' to be the prior close. This is not the case in the Dow average, or the Nasdaq indices. You CAN see where the price 'gaps' are in the HOURLY OEX and SPX charts however.

Upside or downside gaps that form in the beginning of a price move are typically called 'breakaway' gaps, implying that the trend is 'breaking away' from what came before, the trend has accelerated, and a move is starting that has a great degree of buying or selling driving it.

After such a strong move has been underway for a while, there sometimes comes another gap or series of gaps, also in the direction of the preceding trend; i.e., in an uptrend, a further price gap(s) form that is above the high end of the preceding day's price range. This kind of gap is called a 'runaway' and is sometimes also called, a 'measuring' gap.

It's as if the trend has gone into high gear; e.g., in an uptrend, the bulls go for 'broke' and buy still more ('greed' rises or takes over) and the more diehard bears start covering short positions or exiting puts ('fear' rises or takes over).

Runaway gaps are often seen about half way in a move and are said to have a 'measuring' implication that way. If a move began at 100 and a stock has reached 125, followed by a another gap higher and an even stronger move, a possible MINIMUM objective is to 150; to 'at least' 150, but prices can overshoot this rule of thumb price target.

Substantial buying (or selling) was underway for some time already, but accelerates again. In recent market circumstances, a perception develops that the Federal Reserve may be nearly done raising interest rates, which is seen to take away a bearish cap on how high stocks will rise. Buying increases even more dramatically. Perceptions of risk tend to diminish significantly.

The first gap in the daily chart for the Nasdaq 100 (NDX) below, occurred between the Friday 10/28 NDX high at 1157.5 and the following week's low on (Mon) 10/31 at 1559.8. So the gap was a about two points. Nothing dramatic, but it was showing a definite change and that bullishness was increasing.

This gap was a 'breakaway' gap. The bull had gone into a trot. It went into a gallop between 1601 and 1611; not surprising that the distance between the prior day's high and the next session's low had increased to 10 points! This was the runaway type gap.

We measure the start of an advance from the low, in the case of the move seen on the NDX chart above, from 1515. To measure a possible minimum upside target once the breakaway (measuring) gap is seen, we consider the first segment of this move to be 86 points, from 1515 to 1601. From the gap area, taking the high end of it at 1611 and adding 86 points, a target implied by the measuring gap is to 1696. Hey, where we closed today!

If this was a POSSIBLE objective, why was I suggesting taking profits on NDX calls BEFORE today's peak was seen? Besides apparent stupidity you mean? Well, I raised the possibility that the sharp upside price acieration seen early this month could be about half way in a move.

But, such simple rule of thumb measurements as I have just described above, don't always work out of course. This is the 'we'd all be rich' axiom or truism of trading the market. If the market was this simple to figure out all the time, we'd ALL be rich or 'too' rich for the market to work as a mechanism to transfer wealth.

Plus my particular STYLE of trading is not that of trend following. Trading styles tend to break down into two styles or methods: that of 'trend following' and anticipating and trading typical trading ranges. Since the market 'TRENDS' strongly in one direction only about one-third of the time and VERY strongly only about a third of those times, the market most often is in a trading range.

I tend to try to locate and buy the low end of a probably price range and sell near the high end of the PROBABLE range. Only in the middle am I a trend 'follower'; e.g., I will stay with the trend UNTIL what we would normally expect for the duration of a move or there is a trendline break of significance.

The limitation here is that in strong to very strong trends, ONLY staying with the trend until definite signs of a REVERSAL and slowing momentum occurs, will keep you in that trend for most or more of the rare tsunami moves. And, we've come a long way baby indeed!

You can also modify and mix trading styles. For example, when the strong upside acceleration suggested by the runaway price gap occurring around 1600 in the NDX chart above, you could decide that the move underway might exceed 'normal' trading parameters and switch to a trend following mode.

Unlike a trading range market, a runaway move would see the major indexes get VERY overbought, index leadership might shift (e.g., the small caps might UNDER-perform for a change), bullish sentiment would get very HIGH or extreme before a correction set in, etc.

At that determination, a trader could switch to a 'trend following' mode; e.g., exit only when there was a dip under a moving average like the 21-day average shown in the NDX chart above. OR, effective in an instance of a very steep trend, ONLY on a break of a well-defined up trendline, even though steep.

Exit on calls could have been after the achievement of the 'measured move' objective implied by adding the distance of the first advance to the mid-point gap; i.e., at 1696. There is no one 'right' way to trade. There are some limitations in any one trading style.

But I digress, as I want to also look at the other '100' trading index, the S&P 100 (OEX) index in terms of any gaps seen there by using the HOURLY charts as is necessary in the S&P. While there are a couple of small gaps, both got 'filled in' by prices later coming back to the low end of the price gap. We have to look at other ways to measure either measure price targets for the current move OR to stay in AS LONG AS the uptrend continues.

There is a definite shift in upside momentum in the up trend from late-October to mid-November and after. The first advance is 20 points: 545 to 565. The next accelerated move (trendline slope is higher) has also run nearly 20 points; from 545 to 584. The moves are getting close to equal. A measured move objective, where we assume two price swings of equal length, would be to 585.

In terms of exiting OEX calls ONLY if the trend appears to reverse, use of a relevant up trendline can be opportune, such as would occur on a dip below the green up arrow on the hourly chart below. Profits are major if calls were held from near to the starting point of this advance (from late-Oct/early-Nov.); many traders will seek to stay in the trend, but ALSO attempt to protect most of those profits by having a tight exit 'trigger'.

A technical exit trigger when prices pierce an up trendline takes that event as forewarning of a deeper pullback and correction to a prolonged advance. Other traders might assume a further 'Santa Claus' rally occurring in December, like last year and only exit on a break of the 21-day moving average; or, on a break of a shorter 'weighted' average like a 10-day weighted moving average.

As always, even after exiting the high leverage of call options, a lower risk instrument (less leveraged) like staying long something like the QQQQ Nasdaq 100 tracking stock is a way to continue to profit if the this trend continues to blast higher; with the risk of a substantial correction growing with it.

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

** Good Trading Success! **

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