MAILBAG QUESTION:

"You recommended getting out of bullish plays lately but not to go the other way in puts and such. I wondered why you go half way since you predicted a top?"

MY RESPONSE:

I didn't predict a top exactly given that Nasdaq hadn't pierced key support(s), but that the risk of one had grown; enough so that I suggested exiting bullish plays. I look at my positions on an ongoing a risk to reward basis 'as if' I was adding new positions. Even if I have a huge gain in my current position(s), I favor looking at staying in AS IF I were about to go into new calls, etc. at current price levels. If I make this equation, what is my upside potential (after a major upswing already) relative to downside risk of a pullback?

About predicting a top in the present Market: It's exceedingly difficult to accurately predict a top in one of the major indexes like the S&P or Dow, during a period when the tech heavy Nasdaq seems to have willing buyers on dips. We seem to be in a 'rotational' type correction. The small cap Russell is out of favor right now. Tech still has fans and bullish players, lots of them.

You reduce risk to hits in your account if you exit bullish positions when the further upside potential doesn't look to be greater than current downside risk if the Market moves against you. The S&P 500 (SPX) today at 1974 has further upside potential, many would agree, to 2000 or 26 points. There could be upside potential longer-term in SPX to 2080-2100, but I'm taking an 'easy' near term target so to speak.

The way price action went today, I calculated that SPX has risk of a pullback to 1942, which would be a relatively minor pullback equal to a Fibonacci 38% retracement of its mid-May low (1862) to its 7/24 peak at 1991. A 50% retracement would be a quite 'normal' correction and take SPX back to the 1926 area. In this perspective, downside potential from today's (1974) SPX close could be between 32 and 48 points. A risk of even 32 points relative to further upside potential of 26 points is a losing equation for a bullish play. It's also not favorable for buying puts. The dominant trend remains up and that's the backdrop to this Market overall.

I like to get in and stay in trades where the winning potential is or remains ideally 3 times the risk of being wrong and what I would lose on an exiting stop loss. Never trade without knowing how much you are willing to LOSE. Wins can take care of themselves if you control risk.

I'll leave risk to reward considerations and look at what I see that suggests a top, or not, here in the TWO markets: the S&P and Dow and the market comprising mostly mainstream economic plays versus the Nasdaq magic of tech and big price gains if right on major internet businesses and technology plays. We could almost say that the small cap universe, represented by the Russell 2000 (RUT) is a third market we could play in.

I started off on SPX and its chart, trendline and indicators shows the Index with declining upside momentum. This could be an interim short-term top building. A sideways trend for sure for now at least, absent a decisive upside penetration of 1986 (and a bullish trade objective I've had) to 1991.

The big cap S&P 100 (OEX) has been the best play within the S&P universe and a look at its hourly chart is of interest here.

There's the initial bearish downside price gap, a return TO resistance, but not above it, implied by the low end of the downside gap. Relevant here as well, is the 3 'dome' or 3 tops characteristic of a Head & Shoulder's top and an H&S so-called 'neckline' intersecting at 876.

A break of this trendline at 876 would suggest further downside potential to 865; or more. This pattern, whether the lead in to a further down leg or not, isn't one that suggests I should still be in bullish positions.



The Dow 30 (INDU) has traced out a possible 'rounding top' pattern, so is another chart not filling me with bullishness currently. The INDU trend is sideways to lower currently as is trend/price momentum, which is something measured here (among other things) by the down-sloping Relative Strength Index (RSI) line.

WHEN ALL ELSE FAILS, HOPE IS IN THE AIR WITH TECH MAGIC

Having been through tech bubbles, followed by some tech wrecks, I don't automatically gravitate to this sector AFTER very prolonged advances that keep traders salivating for more gains. I tend to try to ascertain a sizable upswing EARLY and then stay with the trend as long as possible, which for me is until signs of froth and excess in which case, as they say, I won't go broke taking a profit.

I think the advance in the big cap Nasdaq 100 (NDX) is getting a little 'old' and I'll go to NDX's weekly chart next for a further view on that.

There is a way of measuring potential resistance in the 4000 area in that NDX at its recent weekly high in the 4000 area, is at the top (resistance) end of its broad uptrend channel.

This is not to say that the Index won't just keep rallying up along ('hugging') its upper channel line as its done previously, or even break out above it (less likely), but it does give me pause in staying in bullish positions in NDX. Let's see how NDX performs over August.


GOOD TRADING SUCCESS!