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Trader's Corner

WHEN TECHNICALS 'TRUMP' FUNDAMENTALS

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OIN SUBSCRIBER QUESTION: "Hi Leigh. Is this the retest of the prior lows you were looking for and why did todays big reversal happen do u think?"

RESPONSE:

Yes, and it hopefully will be useful to recap some technical considerations regarding today's low and upside key reversal, whether it's another short-term bottom or not. It's sort of in real-time to make my Trader's Corner today on the key provided by the technical (analysis) approach to market timing. I hear all these pitches on TV about not trying to time the market as we all should just be investing for the long-term, etc., etc.

Tell this "we can't/shouldn't" time the market to the 5 big-time billionaire hedge fund managers (e.g., George Soros) that were in front of a congressional committee today. They wouldn't BE there today if they couldn't anticipate trends and reversals. So, the question for us options traders is (instead) what are some of the key things to look for in timing today's bottom?

If you believe the various media talking heads, including even some stock market commentators, yesterday (Wednesday) saw a negative market reaction to Paulson's 'reversal' of course in that Treasury is committing most all the rescue plan money to direct capital infusion into the banks rather than buying up the 'distressed' assets. Then today, miracle of miracles, traders and investors had second thoughts on the matter, etc.

Talk about 'low-information' voters! It was well discussed at the time of the bail-out plan passage that most economists did not see how buying up bad paper was going to work, nor is what England did and Congress didn't see it working either and is why Congress built in a provision that the Treasury could buy preferred stock also to inject money, a la Warren Buffet. We need to pay attention to what is REALLY going on day to day.

PATTERN RECOGNITION

In a bear market, just as in a bull market top, the major indexes are NOT, repeat never, nada, no way, going to make a V-type pattern. That is (in a bear market), a SINGLE spike low, followed by a sharp rally, followed by NO re-test of that prior low(s). There just won't be short-covering, speculative buying, lifting of put index hedges, etc., UNTIL participants see if there is a price area where there's a floor under the market. That's what price discovery is all about.

It should have been at least seen as a STRONG possibility if not certainty that this market was going to keep going down until that prior bottom was re-tested. The fact that some of the major indexes went to a lower low intraday doesn't matter much, especially if you are looking at the right index or index cluster.

Number one, this market is being led by the S&P 500 (SPX), but even just focusing on SPX is not enough. You have to look at the pattern also being traced out by the S&P 100 (OEX) and the Dow 30 (INDU), in that order of importance. The Dow assumes some added importance in oil and GM are well represented in just 30 stocks.

The Nasdaq is not the key market to look at here, as it will be a follower. However, ALL of the key indexes traced out the same pattern, that of a KEY upside reversal; i.e., a move to a new low for the move, followed by a close above the prior day's HIGH. If you were going to buy calls, the trick was to go in when it was apparent that the pattern was that of a double bottomlow, which was readily apparent in OEX and INDU. OEX is a key index here in that it has long-term support in the 400 area.

SENTIMENT

Those of you who have been following my commentary a long time may be tired of hearing about the importance of gauging sentiment AHEAD of possible reversals. Bearish sentiment always gets extreme before market reversals and it is a priceless indicator for this reason (being a leading indicator)if you know how to measure it. As you'll see on the OEX chart further one, there has been a recent cluster of equities call to put readings in my oversold-extreme bearishness zone.

By the way, the aforementioned sentiment indicator graph (CPRATIO) seen with the OEX chart does not reflect today's call/put ratio due to a glitch, but the readings BEFORE today's upside reversal is what is important, especially when there are two days' running in the oversold zone; and, secondarily, when the 5-day average also gets to or into the 'oversold' area.

The S&P 500 (SPX) did make a nominal new low today, 819 versus 839 and over-shooting a prior low can be anticipated sometimes due to the effect of stops being run, especially in SPX futures. The pivotal moment is what happens when downside momentum slows and stops and then to see what kind of volume starts coming in on the upside. Watching UpVolume figures in both markets is a key read and you can tune into Up versus Down volume figures occasionally during the day. Pivotal technical resistance is at 950, at the down trendline; next, around 1000 again.

[Image 1]

The S&P 100 (OEX) behavior around long-term 400 support was very important in seeing a potential double bottom develop. I have a trading concept called the 'assumed bottom' or assumed double bottom, where I'll have orders in ahead of time to buy at the money (ATM) calls or slightly out of the money (OTM) calls where those options could reasonably be expected to be trading IF the index trades at its prior low. If I want I can get an (e.g., in TradeStation) alert sent to me if there is trade at a preset number like a prior low.

Such an alert allows me to usually check market prices even if I have to go out of a meeting briefly or break off some other work. It doesn’t take that long to implement a trading PLAN already thought out. I may go in on the options I want at market and set another alert in or use a broker that is set up to trigger my exiting order based on the underlying index, not on the price level of the option.

[Image 2]

You'll recall my talking about a cluster of readings in my sentiment indicator that occurred ahead of today, especially two in a row, Tuesday and yesterday (Wednesday) and where a confirming 'buy signal' ahead was suggested by the 5-day moving average touching the same 'oversold-extreme bearishness' zone as seen (above) with the violet line on my CPRATIO indicator.

With the Dow chart below, there's not much more to say on the subject of a significant upside reversal setting up after a second low was established in the same (8000) area as previously. Today's low was not quite as low as back in October, but hey, this is the Dow we're talking about! A 60-80 point difference still makes it a DOUBLE bottom.

Moreover, the fact that the absolute low was a bit above the prior low makes the bullish/bottoming case stronger. My preset order 'trigger' was to buy DJX calls when the index traded at 80, with an exiting stop at 78.5; I took as my ('minimal') upside objective expectations for a rebound back to the down trendline; currently, back up to 92 basis DJX.

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With the Nasdaq, as should be well anticipated by now, the Composite (COMP) had a weaker pattern than the S&P and Dow and COMP overshot its prior low by some 60 points.

There was a slight edge in analyzing COMP's chart in that today's low came again to a down trendline connecting to the prior 2 lows. This was at least suggesting that COMP was in a minor support area. As we know a heck of rally followed!

[Image 4]

Looking last at the chart of the Nasdaq trading index. Whether looking at trading options on the Nasdaq 100 (NDX) index or by buying the tracking QQQQ, it was important to key off what the S&P and Dow were doing and the double bottom apparent in the OEX and INDU.

This was not the index to have a preset buy order in place with a blind purchase of calls at levels equivalent to the prior index low. Projection of a down trendline did suggest a next low under the prior one and today's did intersect the trendline after NDX overshot its prior bottom by approximately 39 points or around 3%, sort of as they say with polls, within the 'margin of error'.

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GOOD TRADING SUCCESS!

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