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Daily Newsletter, Thursday, 5/6/2010

Table of Contents

  1. Market Wrap
  2. New Plays
  3. In Play Updates and Reviews

Market Wrap

What's a few extra zeroes amongst friends--the fat-fingered trade, or was it?

by Keene Little

Click here to email Keene Little
Market Stats

This afternoon's joy ride in the market reminded me of my Navy pilot days. But this time I couldn't find my adversary and was left wondering whether or not I'd been shot. I think there were a few bewildered folks after today's session. Between managing trades, making posts in the Market Monitor and preparing charts for tonight's wrap (which were all destroyed by that plunge/recovery), I needed about another 3 sets of hands this afternoon.

They're still doing forensics on what happened today but many believe that a fat-fingered trade may have caused a huge sell order that then hit most stocks (so many stocks are now in baskets, be they indexes or ETFs, that one sell order can cover all stocks). As an example, if someone entered a trade to sell 1,000 S&P futures contracts and accidently rested their finger on the zero key for a little too long, an order to sell 1,000,000 S&P futures contracts is a little different than 1,000. Add the sell orders from stops getting hit on the way down (and you know there were many that got hit with that kind of drop) and it's not difficult to understand how selling can snowball from there.

Others believe it's the quants and their quaint programs. The quants program the computers to do all the trading at the speed of light based on their algorithms. They have direct access to all the electronic exchanges and can basically take over the market in the blink of an eye. Each firm thinks they have a proprietary trading system but in fact they're all trading similarly. That's why this market tends to go in one direction with very few corrections along the way. They're essentially momentum models. And when the momentum started down this afternoon those computers took control and gang-piled the market. So goes the theory and I think it's a pretty good one.

Another idea, and one Jim commented about this afternoon on the Market Monitor, and something I've discussed many times, is the carry trade. Many hedge funds, which include the likes of Goldman Sachs, have made a good deal of money borrowing the dollar and buying other assets with the borrowed money (especially since GS and the other banks can borrow for free). Commodities, stocks and even bonds have been riding higher with the help of the carry trade.

So what happens when the dollar rallies and stocks/commodities decline? When you're talking about leveraged trades it doesn't take much of a swing in either to start causing pain. Many funds, such as GS, leverage more than 20:1. It only takes a move of 5% in the underlying to wipe out your entire capital since you're only putting up $5 for every $100 traded. The dollar has rallied about 4% in a week. When the S&P hit 1120 this afternoon, about where the market suddenly let go, it was down 100 points (-8%) from its high just two weeks ago. At today's low near 1065 it was down almost -13%. If someone big had been leveraged big in a carry trade and got liquidated today that would have triggered a lot of selling (many brokerage firms, such as Interactive Brokers which many funds use, simply liquidate positions rather than issue a margin call). A lot of margin calls went out today and may result in more selling tomorrow.

So was the cause of this afternoon's sudden plunge due to a large fund getting liquidated? Not a good day for that manager if so. And then stop orders for others simply added to the selling pressure. But as so often happens, once the selling stopped (or was stopped by "someone", whose initials will remain nameless (PPT), with very deep pockets) some buy programs kicked in and short covering then helped the market rocket back up. In about 10 minutes the DOW had recovered about 600 points. To have finished down "only" 347 points today I'm thinking many are feeling grateful. And was it just an accident that today's plunge stopped within 7 cents of the 50-week moving average for SPX (1165.79 low vs. 1165.72 for the 50-wma)? I'll review the SPX weekly chart below to show that.

So now that we have these huge spikes (tails) on our daily and weekly candles, what the heck are we supposed to do with them? I use EW (Elliott Wave) analysis and draw my trend lines from highs and lows based on the EW counts. To ignore the spike is not something I like to do. But clearly on a day like today it doesn't look "normal". For the time being I'm going to make believe the spike low is not there and show charts based on what I think will play out regardless of today's plunge. One other thing to think about and take note--oftentimes these big spikes point to ultimate targets. So look at the lows of today and watch for price action to gravitate towards them, which is basically what I'm showing on some of tonight's charts.

But before I get to the charts I wanted to shows two charts I came across that I think are very telling. After this week's selloff there should be little doubt in everyone's mind that we made some kind of important high at the end of April.

This first chart shows buying climaxes. A buying climax is when you get a new high followed by a lower closing low. They can be viewed on a daily, weekly or monthly basis, just like any other indicator. Obviously the longer the time frame, the more significant the signal. The chart below shows weekly climaxes and last week's number of 1,079 was the highest on record.

Buying Climaxes, 2009-2010, chart courtesy InvestorsIntelligence.com

There were 1,079 stocks that made a new high for the week and then closed the week lower. That is extremely significant and what it says is that there was a major distribution effort going on at each of the rallies. You can of course see that on the daily charts with the large daily swings as the market was manipulated higher (large retracements of the previous day's declines) and then sold into, rinse and repeat. The net result was a lot of buying climaxes and provided a heads up that the distribution was occurring. I had mentioned last week that the increased volatility was a good sign of topping action and the chart above puts the icing on the cake. This is a confirming signal that a very important high has been put in place.

Another telling chart, which fits into the market sentiment category, is the one below that shows the NASDAQ/NYSE ratio of volume. Whenever bullish sentiment reaches an extreme in the market, as it did up until last week, you'll see more and more buying interest (frenzy?) in the riskier stocks. If the market is going up and people are becoming more bullish they'll want to get what they feel will be a better ride in the higher-beta stocks. The line at the bottom of the chart is a 5-week MA of the ratio that reached a peak in April that was a 10-year high and reached even higher than it was during the tech bubble in 2000-2001.

NASDAQ/NYSE Volume Ratio, chart courtesy ElliotWave.com

The chart above shows the very strong move from the low in 2009 towards extreme speculation and can be thought of as another bubble (brought to us once again by our good friends at the Fed and their easy-money policies). This bubble will likely pop just like all the others preceding it.

A lot of things came together at the April high, including cycle studies (and even a full moon), so it was with great interest that I've been watching this week's decline for signals that last week's high was THE high and not just another one in the long line of them since the initial high back in June 2009. Even without today's plunge (and partial recovery), the price pattern was signifying a top of importance had been made. So let's take a look at tonight's charts to see what might be next.

The SPX weekly chart shows this week's red candle is the biggest one (even excluding the long tail) since the final plunge into the March 2009 low. It looks like a kickoff to the next leg down. As I mentioned earlier, today's big plunge stopped within 7 cents of its 50-wma at 1065.72. Coincidence? I don't believe in coincidences in the market. Somebody big had a very large buy program set at that level and I have little doubt it was the PPT. I'm sure they have their computers programmed to protect the downside. Expect more of the same all the way down. They'll let the market decline but only in an orderly fashion.

S&P 500, SPX, Weekly chart

After bouncing off its 50-wma today SPX climbed back above 1121, which is the 50% retracement of the 2007-2009 decline. I was actually very surprised when I saw price slice right through that level this afternoon. At that point I knew something was seriously wrong. So a recovery back above it into the close was a good save for the day. Look out below when that 50-wma is broken the next time.

Looking at the daily chart below you can see how SPX dropped to its uptrend line on Tuesday. It broke it briefly, tagged its 50-dma (just to be sure it was there and would hold) and then closed on it. Wednesday's gap down was at its 50-dma but it couldn't hold, not even on a closing basis. You can see how the broken uptrend line acted as resistance when tested yesterday. These were all signs that the decline would likely continue. And then today's gap down and plunge. My best guess here is that we should see at least a little more downside before we'll get a bigger bounce back up to retrace some portion of the decline, probably into opex week.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1175
- bearish below 1150

The intraday charts is where this afternoon's spike down really screws things up and once again I'm ignoring it for now. I'm tempted to just say expect a retest of it before we get a bigger bounce but I'm not sure that will happen. So I'm showing what a more "normal" pattern (is there such a thing in this market anymore?) might look like. In my attempt to figure out where we are in the decline, using EW counts, I think we need to see a relatively brief consolidation (4th wave) before another new low to finish a 5-wave move down from the April 26th high, which would create a larger degree 1st wave down. As shown on the daily chart above, I think the 200-dma near 1095 makes for a good downside target.

S&P 500, SPX, 120-min chart

This of course raises the question about what I think will happen with the market due to the job reports tomorrow morning. I was hoping for a better setup into the end of the day today to help answer that question but the violent move kind of buggered that up. My best guess, again based on where I think we are in the wave count, is that we'll see some choppy and whipsaw price action tomorrow as we see the market consolidate recent losses. That should last a day or two, so into Monday, and work off some of the short-term oversold indicators. Then a new low accompanied by bullish divergences should set us up for a nice rally into opex. After opex, look out below.

The DOW sliced through every imaginable support level it has between yesterday's close and the February low, which is where it ultimately found support this afternoon. It quickly broke its 50-dma this morning and then proceeded to break its uptrend line from March 2009, its 50% retracement of the 2007-2009 decline and then its 200-dma. There was nothing stopping the stampede. The DOW made it back up through two levels of support but as with SPX I think we'll see a little bit of consolidation before heading at least back down to its 200-dma for a firmer test and bounce into opex.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 10970
- bearish below 10835

Different symbol, same pattern. The NDX could drop a lot further than I'm depicting but unfortunately it's too hard to tell. But like the others, I'm expecting a consolidation, followed by a new low and then a bounce into opex.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 2010
- bearish below 1957

The RUT's "probe" this afternoon was not quite as deep, relatively speaking. I see a better chance of its low just below 638 being retested sooner rather than later. But regardless, I think we'll see a higher bounce into opex week, maybe back up to the 690 area before heading much lower into June. You can on its chart below how it was able to close above its uptrend line from March 2009 so that's at least short-term bullish.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 720
- bearish below 700

Last week I showed the financial sector SPDR, XLF, and the bearish setup where it had bounced back up to its broken uptrend line from March 2009 last Thursday. It has since dropped down, leaving a bearish kiss goodbye against its broken uptrend line and confirmed the break by dropping below the April 27th low.

Financial SPDR, XLF, Daily chart

If today's big plunge was a result of a fat-fingered trade can someone explain to me why so many support levels were tagged and held? Even the BKX bank index--the plunge stopped at its uptrend line from March 2009. Pretty amazing coincidence. Today's close was unable to make it back above its 50-dma so that remains a plus in the bear's column. I think we'll see a break of the uptrend line and a test of the 200-dma before a bigger bounce.

KBW Bank index, BKX, Daily chart

On April 30th the home builders index made a double top near its price projection at 332.29 (for equality in an a-b-c bounce off the December low) and at the top of its parallel up-channel from December. It left a negative divergence at the test of the high, which helped confirm the bearish setup. It should now break multiple support levels at its 50 and 200-dma's and uptrend line from December.

U.S. Home Construction Index, DJUSHB, Daily chart

The choppy pattern in the Transports at the end of April was a good sign the top was near, especially with the bearish divergences developing at the new highs. The fact that it made a minor new high last Friday, and tested it Monday, without the DOW doing the same thing, it gave us a small bearish non-confirmation between the two. The breakdown from the high has been swift and it quickly broke support at its 20-dma (green) and uptrend line from February. Today it broke its 50-dma and was unable to recover back above it into the close. The same pattern as the others could play out into opex and then lower into June.

Transportation Index, TRAN, Daily chart

As I had mentioned earlier, the U.S. dollar has had quite a rally the past four days, let alone since November. Anyone shorting the dollar and using the proceeds to buy other assets is feeling some pain right now, especially if those assets are declining in value while the dollar rallies. It's not the kind of pair trade that one can feel good about. The dollar is in full bull mode as it punches above the top of its parallel up-channel from November. If it keeps heading higher above the channel that's one of the most bullish signs you'll see. Get long the dollar and stay there for a while if that happens. Otherwise the poke above the channel may have been a bit of an emotional overreaction to what's happening in Europe and the euro and we'll see a pullback/consolidation for a couple of weeks before heading higher again.

U.S. Dollar contract, DX, Daily chart

The rising dollar is putting pressure on most commodities and the commodities index, CRB, made an important move this week. It had been coiling since its January high and holding above its uptrend line from March 2009. If it was a bullish continuation pattern we would have seen the coil break to the upside but instead it has broken down. It has also broken it 200-dma. If it is unable to recover quickly, leaving a head-fake break of both its uptrend line and 200-dma, we should see at least a deeper retracement of the rally from March 2009. Based on the choppy overlapping and corrective rally for the year-long rally, it calls for a complete retracement.

Commodities index, CRB, Daily chart

Even though the dollar pushed higher today it didn't stop gold bugs from running into their favorite anti-calamity metal. Gold has clearly benefitted from a run from risky assets into the perceived safety of gold, especially when the risky assets are currencies. Gold rallied above the top of a rising wedge pattern and in fact did a brief throw-over above the top of its parallel up-channel from February. It's possible it's putting in the final touches to its rally (with negative divergences at the new highs). I see the potential for a pullback and then final high into next week where it could push back up to its high. Obviously a rally above its up-channel from February would be bullish so if it gets much above 1210 I would not be looking to short the shiny metal. But right now I think it's riskier to be long gold than short it.

Gold continuous contract, GC, Daily chart

With gold making a new high I want to see confirmation in the gold indexes (GDX, HUI and XAU). If a new high in a commodity is not met with new highs in the equity related to the commodity then that's bearish non-confirmation and so far that's what we have. For the gold/silver index, XAU, I show the possibility for a push higher into next week, like gold, but the current wave count looks good for the completion of the rally at last Friday's high. The rising wedge pattern for the bounce off the February low calls for a complete retracement and a drop below the February low.

Gold/Silver index, XAU, Daily chart

Another bearish non-confirmation of gold's rally, so far, is silver. Silver has been much weaker than gold and today's bounce was pitiful compared to gold. A lot of emotion (fear) is driving gold's price right now and emotion is a fickle thing. Silver looks ready to resume its decline once the bounce off trend line support runs out of buyers.

Silver continuous contract, SI, Daily chart

Oil is another commodity that's gotten whacked with the help of the dollar's rally. It made a pretty double top at Monday's high, clearly with a negative divergence, and the break below the April 19th low at 80.53 confirms the double-top sell signal. It held its 200-dma after spiking below it today and tagging its uptrend line from July 2009. A break below the uptrend line from July 2009 would be confirmation that the rising wedge pattern from July has finished and will likely get retraced quickly (so back to 58 in short order). In the meantime we could get at least a bounce to correct this week's decline.

Oil continuous contract, CL, Daily chart

The economic numbers that caught my attention this morning were the Productivity and Unit Labor costs. Productivity is on the rise and labor costs are declining for one reason only--employers continue to trim their payrolls and squeeze more blood from those lucky enough to have a job. I've been on both sides of the fence (laid off and left behind) and as a manager responsible for layoffs and as a worker getting laid off. I can speak from experience about all sides and I can tell you none of them are pleasant. Having a job of course pays the bills but sometimes the stress (which can literally be a killer) is more than the money is worth. I feel the situation is only going to get worse before it gets better, and it will get better. So for those suffering through this, keep your head held high, find things to laugh about and I know that you will come out fine on the other side (perhaps different and that's OK).

Economic reports, summary and Key Trading Levels

Friday morning we get the 800-lb gorilla of a report in the job numbers, primarily the nonfarm payrolls number. Estimates are all over the map and honestly I don't have a clue as to how the market is going to react, especially after today's "little" selloff. The price pattern would look best with a 1-2 day consolidation before heading lower again into early next week so perhaps that means we'll find a whippy response to tomorrow's numbers. Volatility is increasing, as measured by both the VIX and daily swings and we're seeing many signs of emotional angst. This will only aggravate market moves. Be very careful and be choosy with new trades.

I came across the chart below on Minyanville and thought it does an excellent job at showing the cycles of the market which are really cycles in social mood. Look at the cycles through the various stages of bullish enthusiasm and bearish despair. Recognize those symptoms in yourself because your goal as a trader is to flatten out that cycle. You've heard many say that trading needs to be unemotional. We of course are happier when making money but the point is to rid yourself of greed and fear and trade like a robot, perhaps like a quant (wink).

Emotional Cycles in the market

To summarize today and where I think we're going, I wish I had a clue. OK, I have a clue but today trampled my clues and I've been busy unraveling them after today's price action. I received one comment from a reader today that made me smile. Dave writes "Keene, my sentiments about the manipulation in the markets/economy/world largely parallel yours. Many days I have thought 'how can he just keep cranking out these "logical" wave patterns only to see them repeatedly shredded and tossed on the floor?' Thanks for your perseverance."

Thanks for recognizing that I'm getting trampled every day. Here I thought no one noticed (smile). The market will humble you like no other. It goes back to the cycles of emotions above. The sooner you stop feeling the need to be right and all the emotions that go with that, the sooner you can feel it's OK if the market tramples you. Just get up and keep at it, with new-found knowledge that what you thought was correct is something different. I use EW because it helps me think through the problem. It helps me identify where the market has been, in what kind of pattern, and therefore what I should expect.

When the market zigs when I thought it was going to zag, I try to get back on course with it. As we all know it's not an easy task. Many don't like EW because the wave count is constantly changing. My answer is well of course it's changing--with the market. If I stubbornly hold an opinion (been known to happen) that happens to be wrong, the market will quickly remind me with a loss in my account (been known to happen).

So the market may have done a big zig and I have to see what follows it to see if it will be followed by a zag or two zigs and then a zig. My wave counts will reflect my latest thoughts on what I think (clearly not what I know) will happen. As Bill Fleckenstein used to say (I'm paraphrasing), "I am often wrong but never in doubt."

Jim posted the following at the end of the day on the Market Monitor "NYSE CEO is saying they are expecting an ugly open on Friday as trading firms clean up after today's disaster. The intraday drop and the -347 Dow close will have created an entirely new set of margin calls for Friday morning. Traders, both retail and institutional, will be forced to sell something to raise money or the brokers will liquidate for them at 2:00 PM.

So that's an added risk for tomorrow. If there's any selling pressure, particularly from any reaction to the job numbers, selling could become intense at times if many are selling for margin reasons before the market drops even further. I'm sure the PPT will be right in there with the mix to help hold things up. Short-covering spikes followed by more selling followed by more spikes back up--it's another reason a consolidation (with potentially large swings) could be what we'll see over the next 1-2 days before we get another leg down that has much less selling pressure (as the 5th wave of the move down from April 26th) which then sets up the bigger bounce into opex.

Stay calm, prepare a trading plan for tomorrow and execute according to your plan. Don't get stuck in front of your monitor like a deer in the headlights. If at any point you start hoping for a move in order to get out of a position you need to exit immediately. Hope is a 4-letter word in the market. Good luck and I'll be back with you next Thursday. Remember, if you can, have fun.

Key Levels for SPX:
- cautiously bullish above 1175
- bearish below 1150

Key Levels for DOW:
- cautiously bullish above 10970
- bearish below 10835

Key Levels for NDX:
- cautiously bullish above 2010
- bearish below 1957

Key Levels for RUT:
- cautiously bullish above 720
- bearish below 700

Keene H. Little, CMT


New Plays

Keeping Powder Dry

by Scott Hawes

Click here to email Scott Hawes
We will be releasing several plays this weekend once we have a better sense of what exactly happened today. Guessing is not the smart thing to do. I have listed a couple trade set-ups below for those that are interested:

Long HP (not HPQ) - Came back to retest its broken downtrend line from January and has support at $36.00.

Long WFMI - Ascending triangle on dailies.



In Play Updates and Reviews

SINA & IMAX Perform, Stopped on HITK

by Scott Hawes

Click here to email Scott Hawes

Editor's Note:

Good evening traders. I'm not sure what exactly happened today in the market but it sure seemed manipulated. Chatter was that there was a bad tick in Procter & Gamble that caused some computer programs to sell, which started the cascade. I also heard that there were human errors in entering trades and that some trades may be cancelled as a result. Who really knows but I am sure we will find out. What I do know for sure is that it is almost impossible to manage swing trades in this environment. The bid/ask spreads on all securities widened to levels I don't think I've ever seen, not even in the fall of 2008.

In any event, SINA performed well for us while we were stopped out of HITK. The recent events have narrowed our portfolio immensely but keeping your powder dry at this juncture is probably not a bad idea. Staying on your toes is an understatement and taking profits off the table when the opportunity presents itself is a must.

NOTE: James will be filling in for me this weekend with new plays and updates. I will be back next week and we will have the portfolio ramped back up in no time.

Current Portfolio:


BULLISH Play Updates

IMAX Corporation - IMAX - close 18.90 change -0.15 stop 16.75

Why We Like It:
IMAX got pushed around today but held its own considering the shenanigans. The stock also created a bottoming tail candlestick on its daily chart which may indicate that sellers of the stock are waning. Buyers have been piling into the stock in recent months and IMAX reported earnings on 4/29 that beat expectations (.53 compared to .37 estimate). The company is experiencing a surge in earnings due to the onslaught of 3-D movies on the horizon. I suggest readers take advantage of the momentum and initiate positions if IMAX pulls back to $18.50. We will place our stop at $16.75 which is just below the 50-day SMA. Our target is $20.95 which is just below the stock's 52 week highs.

Current Position: Long IMAX stock at $18.50.

Option Traders:
Suggested Position: Buy JUNE $20.00 CALL

Entry on May 5 at $18.50
Earnings Date More than 2 months (unconfirmed)
Average Daily Volume: 1.9 million
Listed on May 4, 2010


BEARISH Play Updates

Moody's Corp. - MCO - close 24.46 change -0.77 stop 28.60

MCO just won't cooperate and rally to our trigger. We came within 20 cents today. I still want to take advantage of any bounces in MCO and am keeping the trigger at $25.25. If the stock trades to $25.25 I suggest readers short MCO (previously trigger was $25.45). This is near recent highs and if the stock trades to this level I expect more selling to continue. My comments from the weekend remain the same. I am essentially suggesting short positions on any relief bounce in MCO. There is strong resistance in the $26.00 to $26.50 area which I expect to hold if MCO can even make it back up there. MCO's chart is broken and a lot of damage has been done. The stock is forming bear flags on its daily chart and I believe conditions are ripe for the decline to continue. The stock was hanging on to a recent support level and its 200-day SMA (both in the $26.00 area) which was broken last week. I am bearish on MCO and if the market starts a significant pullback MCO could be a nice winner for us. Our initial stop is $28.60 but will be adjusted after our entry is triggered. There is plenty of resistance and congestion just overhead. Our target is $23.25, with a more aggressive target of $21.85 which could get hit if things get ugly. Our time frame is a couple of weeks.

Suggested Position: Short MCO at $25.65

Option Traders:
Suggested Position: Buy JUNE $25.00 PUT, current ask $1.58

Entry on April xx at $xx.xx
Earnings Date Over two months
Average Daily Volume: 3.5 million
Listed on April 26, 2010


Sina Corporation - SINA - close 33.00 change -1.50 stop 38.80 *NEW*

SINA hit our first target of $33.00 today and closed there as well. The stock has now broken all of its major daily and weekly SMA's except for the 100-week SMA, which it closed just above today. SINA is bound to get a relief bounce from here but I expect the overhead resistance and SMA's to hold. Our new stop is $38.80 but we will adjust it as the trade develops. Our first target is $33.25 which is a point where I would tighten stops to protect profits. A more aggressive 2nd target is $30.50. If the market correction continues I think SINA could easily trade down to this level. Our time frame is several weeks.

Current Position: Short SINA stock at $34.95

Option Traders:
Suggested Position: JUNE $35.00 PUT

Entry on May 4th at $34.95
Earnings Date June 9, 2010 (unconfirmed)
Average Daily Volume: 1.1 million
Listed on May 1, 2010


CLOSED BULLISH PLAYS

Hi-Tech Pharmacal Co. - HITK - close 23.09 change -1.51 stop 22.45

HITK got caught up in the nonsense today and we were stopped out. The stock recovered and is now above our stop, but we'll take the loss and look for better opportunities. This stock is still holding an upward trend line from 8/17 and looks poised to move higher. If readers still have positions you can use the same stop and targets listed on the charts potential exits.

Closed Position: Long HITK stock $25.25

Entry on May 4th at $25.25
Earnings Date July 5, 2010 (unconfirmed)
Average Daily Volume: 230,000
Listed on April 29, 2010