SPY Technical Analysis

Click on Chart to Enlarge

This post is kind of a technical follow-up to the trade recommendation earlier today. The chart above is a 10 minute chart of SPY which is an equity/ETF that mirrors the performance of the S&P 500.

The chart shows a bearish divergence on the MACD indicator during this afternoon's highs. Looking back at the chart, other bearish divergences above the zero line have resulted in significant pullbacks. This technical situation coupled with the overbought short-term model, indicate a pullback is likely soon. Another factor supporting a bearish short-term move is that this overbought signal is under resistance at 92.50 from highs earlier this month, so this is essentially a "lower high" indicating a potential downtrend.

In choppy overlapping corrections like the market is presently in, I find that the 127.2% and 141.4% extensions of the most recent move are often a solid resistance zone. Those levels would put SPY in the 83.00-84.00 range. If we get an oversold signal near those levels, I think it could be a good bullish trading opportunity.

Pete

New SDS Trade

As of this morning the short-term S&P 500 model is overbought. This is occuring at a lower level than the last true overbought signals which gives a high probability of success for bearish trades in the form of inverse ETFs (SH, SDS, BGZ, etc). Also volatility has declined so much that it is not taking huge moves to get these short-term signals now. Without further commentary......

Trade Recommendation:

Buy SDS today 12/31/08 with a market order. The current price is 71.68 which I will use to track the trade results.

Also, the last trade on QLD was stopped out if following the stop on this blog. However, I always try to post the exit purely according to the indicator as well for comparison. I would take this signal as an exit for that trade.

Pete

Gold, Grains, and General blah

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The chart above is of GLD which is an equity/ETF tracking gold prices. Today gold prices made new highs for the month modestly exceeding the highs from several sessions ago. However, the closing price was below those prior highs. For those wanting to see a continued advance in gold, this is a warning sign that buying interest at new short-term highs may be waning. Also, there is a strong RSI bearish divergence in the recent peaks. Watch the trendline of the RSI indicator over the next several sessions. Most times this trendline will break in advance of prices breaking the same trendline and can give another early warning that the trend is ending. I checked the continuous futures chart of gold prices and the analysis is the same as on the ETF. Also the MACD indicator is in a historically overbought region.

Click on Chart to Enlarge

This chart is DBA which is an ETF that is composed of soybeans, corn, sugar, and wheat. Like most commodities, it has fallen sharply this year. I have looked at the most recent commitment of traders data and the configuration for the underlying commodities is similar across the board and it shows the commercial traders (typically smart guys) buying these commodities to an extreme level. Also, speculators have greatly reduced their positions which is good from a contrarian point of view. I would interpret this as a bullish set-up for a trade on DBA. The problem now is that the short term technicals are overbought. Interested traders may be wise to wait for a pullback on short-term indicators before considering a trade.

Short-term models for the S&P and Nasdaq are basically neutral currently. It would be nice to get both those models to an extreme one way or another soon to set-up another index ETF trade. I am almost equally willing to take bullish or bearish trades at this juncture, with a slight bias toward bearish short-term trades due to many factors discussed in recent posts.

Pete

Sentiment Surveys and the VIX

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In recent posts, I have noted how put/call ratios, the VIX and VXV, and blogger opinions are getting to ranges that have had bearish implications in the past when looking ahead a couple months.

One piece of the sentiment puzzle that I have not mentioned here in a while is related to investor sentiment surveys, which can be extremely useful contrary indicators. There are several classic surveys followed by investors, but if I had to pick a favorite it would probably be the American Association of Individual Investors (AAII) survey. This survey tends to fluctuate quickly enough to make it very useful for intermediate term trading.

I find this survey to be most useful as a contrarian indicator used to trade in the direction of the 200 day moving average. Since the 200 day moving average is pointing lower now, this basically means that I would use a statistically high bullish % in the survey to initiate bearish trades. Since October the bullish opinion has been rising but us still not even 1.5 standard deviations away from the 1 year average. However another 1-2 weeks of rising prices and a break above the 920 level of the S&P 500 would likely raise this bullish % to statistically meaningful levels in my opinion. Most other surveys are still very neutral or are near pessimistic extremes, so I feel that there may not be enough of a sentiment shift back to the optimistic side to push the market lower just yet.

Another thing I watch closely for timing major market moves is the VIX. I look at the VIX in several different ways from oscillators to trendlines to bollinger bands to retracement % to Elliot Wave patterns and even a rather unique (I think) running tally of higher highs or higher lows since a significant market top or bottom.

Since the November market lows the VIX has made 8 lower lows. Anything beyond 12 and flags go up for a potential reversal. Based off this system, I think the VIX could drop a bit more and the market could rise more before we get into the danger zone.

Also I have noticed an almost uncanny tendency since the 2006 VIX lows for the VIX to retrace 78.6% (roughly 80%) of any major VIX advance. The chart at the top of the page shows the VIX with several retracements of this nature. A 78.6% retracement of the VIX advance from August 2008 lows to October 2008 highs would place the VIX at roughly 35. This happens to be the VIX level that repeatedly capped VIX advances in 2007 and early 2008. So we could have a case where old resistance becomes new support.

Peace, Love, and Merry Christmas to all!

Pete

A Number of Reliable Indicators Giving Warnings

In the last informational post I noted that the VIX (expectations for volatility the next 30 days) had dropped below the VXV (expectations for volatility the next 93 days) by about 10% as indicated by the VIX/VXV ratio dropping to about 0.90. That has been a reliable indicator of near term stock declines during this bear market. Because of the time frames of these volatility indexes, I would expect the next 1-3 months showing further stock declines. This might be a good time frame to look at for option traders (that is, Feb. or March expiration).

Now after this past week, a whole bunch of indicators are starting to give warnings that stocks are overextended to the upside. This is all occurring without the classic type of buying thrust that typically indicates a bear market is over.

In months past I have mentioned that a 10 day simple moving average of put/call ratio data is one of the most trustworthy yet simple ways to gauge market sentiment. Recently the total put/call ratio showed a reading that was stretched relative to standard deviation bands. Now after this week, the 21 day moving average is looking similarly stretched. This is a ratio that does not get stretched often, but when it does, it pays to pay attention. The last comparable readings were October of 2007 and May of 2008, both being major tops.

I won't go into every measure that is showing bearish warnings, because the tried and true ones (in my book) are telling enough. But there is another interesting piece of info that I thought I'd mention. The link below shows a chart and graph quantifying the outlook of the blog world's view on market expectations for the next 30 days.

http://tickersense.typepad.com/ticker_sense/

The interesting thing is that the data suggest a more prolonged period of net bullish blogger opinion than any time since the poll's inception a couple years ago. These blogs are well respected and influential blogs. Bloggers took a major bullish consenus the week of the crash into Oct. 10. Despite the blog world remaining very bullish since that time, stock prices have continued to basically drift sideways to down in volatile fashion since then. In my opinion, this bullish sentiment is out of sync with the reality of prices. This survey is not one that has been around for years, and it is something I only occasionally look at, but I would assume that it would be useful as a contrary indicator in the same manner of classic investment advisor surverys.

For longer term investors, I would think that waiting for a major break of the 2002 bear market lows in the Dow and S&P would be wise before making longer term purchases. Maybe the 5000 level on the Dow and 500 level on the S&P would be times to make major multi-year or multi-decade investments (assuming things actually fall that far).

Pete

QLD Trade Update - Stop Placement

Based off of the price pattern in QLD right now and due to the info in the last post, I suggest a stop placement on QLD which will allow it to move higher if it does, but for any one in it by my earlier recommendations, the potential loss will be minimal.

Recommendation:

Place a "stop loss" order of 26.30 on the open QLD trade.

Pete

Volatility Signaling that this Rally Is Running Out of Steam?

Click on Chart to Enlarge

The chart above is a chart of the VIX with standard Bollinger Bands around it. Also below the chart is a 10 period RSI of the VIX. I don't know how many people use traditional technical analysis on the VIX, but I have found some basic indicators to give timely warnings.

First, note that the VIX has touched its lower bollinger band. Since the VIX and the markets have strong inverse correlations, low VIX readings tend to correspond with market tops. The RSI is indicating a level of oversold VIX more so than any time since early May before the steady crush lower from mid May to mid July. I have a simple system for looking for VIX extremes that I have posted about before. That system is still a few lower VIX days away from really being in the danger zone, but I would heed the current VIX levels as a warning that this rally is long in the tooth.

Click on Chart to Enlarge

The chart above is a chart of closing VIX/VXV ratios with standard bollinger bands overlaid. Please follow the link below to the VixAndMore blog as that is where this indicator ratio originates.

http://vixandmore.blogspot.com/search/label/VIX%3AVXV

The chart above does not show intraday lows, but I wanted to show a smooth view of the data that is easy to identify extremes. This ratio is nearing the 0.90 level and its lower bollinger band which have proved outstanding warning signals for soon to be market declines.

Taken together these data certainly should tell us to be on the defensive, or start to get aggressive with bearish trades.

Because this data is raising red flags, I may arbitrarily suggest exiting the QLD trade initiated yesterday before any signal comes from the indicator, or I may suggest a stop loss to use to exit the trade if the market turns south. In the past, trusting the indicator has proven the best strategy, but for real life trading, risk management is the most important part of successful trading.

Pete

New QLD Trade

The short-term model of the Nasdaq is just a hair's width from oversold as I type. Based off of a few post-FOMC meeting studies and the gap support from Tuesday, I think this oversold signal has a good chance to work well.

Trade Recommendation:

Buy QLD before the close today or tomorrow morning with a limit order of 27.00. Current price is 26.74 which I will use to track the trade.

Pete

QLD Trade Exit

The short-term model for the S&P 500 just became overbought and I suggest exiting immediately the open QLD trade. The current price is 28.10 which I will use to track results. The was another nice trade.

Pete

New QLD Trade

The short-term model for the Nasdaq hit oversold levels yesterday, and with today's gap down in the markets, a bullish divergence was created. So I am going to recommend bullish ETF trade here.

Trade Recommendation:

Buy QLD today before the close. Current price is 26.75 which I will use to track the track results.

Pete

I Expect a Continued Trading Range Until Dec. Expiration

There are many ways that traders traditionally look at support and resistance in the markets. As I have mentioned in past posts, one of the main things I look at are gaps in the major index ETF's like SPY or QQQQ. As we stand today there are unfilled gap ups at 79.50, 88.00, and 89.50. These gaps I view as a support cushion below current prices. There are unfilled gap downs at 92.50 and 96.00 which are above current market prices and could be viewed as a short-term ceiling on a market advance. There is a large unfilled gap down at 110.00 from back in October in the midst of the dramatic waterfall decline in the first two weeks of that months. That gap did not get filled at all and should act as a longer term ceiling on prices should the market "breakout" of the current trading range.

Another concept that is more advanced in analyzing the market from both a technical and sentiment perspective is evaluating the open interest in option strikes in the index ETF's SPY and QQQQ. Options are typically used as hedging instruments and that will result in many puts held at strike prices below current market prices. Options can also be used for speculation in both directions. Call options above market prices can be a sign of speculation/expectation that prices will advance beyond those levels by expiration. Additionally there are complex option trading strategies that involve the purchase or sale of both put and call options simultaneously and may take advantage of range trading.

That is a very elementary view of options. The open interest is basically the amount of contracts held in that particular option. So how do you use this data? Looking at front month (current month) options can tell a lot, as that is where the heaviest open interest is.

Right now the peak call open interest for Dec 08 is at 90.00 on SPY. Peak put open interest is at 80.00 and a slightly lesser peak at 85.00. I would view these levels as market support for the rest of the month. It gets more interesting with the QQQQ options. Peak call open interest is at 35.00 in Dec 08. The amount of open interest here blows away the amount in any other strike price. Seeing as 35.00 is well above current prices, I view this level as a level of great speculation and anticipation for prices to move quickly higher in the next week and a half. History will tell us that usually these options will expire worthless. I would doubt that we make much progress to or beyond those levels by expiration.

Peak put open interest in Dec 08 QQQQ options is at 27.00, with heavy cumulative open interest from 27.00 to 29.00. According to the "maximum pain theory" areas of heavy open interest are often where the price will end up at expiration. This will make those options worth little or nothing typically and will inflict great pain on the holders.

Taking the front month data together, I believe it indicates a continued trading range until expiration. Also, I would place my bet on prices of SPY and QQQQ being near the current level or probably a bit lower at expiration. After expiration, when all those contracts are history, I think we will be likely (or more likely) to see a price breakout of the range.

One last interesting point comes up when looking at Jan 09 SPY open interest. There is huge call open interest at the 100.00 strike and is greater than corresponding put open interest by a 6 to 1 ratio. It seems that options players have an optimistic expectation for the beginning of the new year as SPY would have to rise well above 100 to really cash in on those options.

While I don't want to read too much into a single piece of data like that, I believe history would tell us to bet against points of optimistic or pessimistic extreme like that.

Pete

Stocks to Watch -- Bearish Trades

Click on Chart to Enlarge

Today's post is really an educational post that will cover a number of concepts relating to the kinds of patterns to look for in bear markets that will provide excellent short sale candidates or put option trades allowing you to make money as stocks decline in value.

The chart above is Verizon, ticker VZ.

The long term view is that the stock is below its 200 day moving average (MA), and the 200 day MA (red line) is pointed down. Also, the 50 day MA (green line) is below the 200 day MA. Since the October low, the stock has touched or crossed above the 50 day MA only to fall back below it 4 times. Now in the most recent advance the stock has moved back above the 50 day MA. Multiple failed rallies at the 50 day MA are classic for bear market rallies. A high volume close back below the 50 day MA would be very bearish.

Another key to look for on rally attempts is the volume. Notice how the peak volume on up days (the black bars at the bottom of the chart) was highest in October after the lows, then lower at the last week in November, and lower yet the last few days. Also today marked a new high coming off the October low, yet volume is not impressive. These are signs of waning demand at higher prices.

The stock has been somewhat range bound forming a rising wedge/triangle type pattern since the October lows. The bollinger bands overlaying the chart are the blue lines, and they provide a statistical range around price and should contain about 95% of all price on a closing basis. These bands tend to be a ceiling on rangebound market rallies. Price is pennies below the upper band right now, and the 200 day MA hovers in the same area. The 200 day MA is a typical resistance point for bear market rallies. A downtrendline is present at that level also.

An advanced concept to understand in technical analysis, particularly pertaining to short-selling is the idea of overhead supply. Basically, areas of previous consolidation or support that the stock has moved below provide a point where many shares were aquired by institutional investors (large funds, etc.). Since these investors are now at a loss, they will want to sell and "breakeven" when the stock comes back to that level from lower prices. Such is human nature. So any advance into prior consolidation levels will meet a plethora of sellers and keep pushing prices down. In reference to this chart, VZ traded in an extremely tight range from mid-June to mid September of this year. It is not often you see such a tight range. This occurred almost entirely between 33.00 and 35.00. Not totally visible on the chart is that there is a horizontal support line around 32.00 from prior significant lows. Price finally broke that level in September and is now coming back to that level. There is a saying that old support will become new resistance, and I have found that to be very true in a situation like this. Price is now just above 33.00 and should be meeting anxious sellers soon.

I did not include any technical indicators on this chart, but there is a major bearish divergence in momentum on this advance compared to the November advance. Also, the %K slow stochastics is overbought which tends to occur at significant price peaks both shorter and longer term.

Now the last and most key ingredient for a successful short sale is the state of the stock market in general. The market will need to show further declines to really drive this stock down. I believe that this will occur over the next several months, but any move below the November 20 market low will be good confirmation that the bear's appetite has not been fulfilled.

Now, I won't go into any detail on other stocks now, but I want to give a few stocks from different sectors that I think are going to go down for people to check out on their own.

The oil refiner group (XOM, CVX, SUN, SNP) look ripe to short-sell. Other stocks are GG (gold stock), WMT and PG (refer to prior posts).

If anyone wants more analysis on any of those stocks, please post a question or comment.

Pete

Levels to Watch on SPY

In the shortened week last week, the short-term model became extremely overbought. I was away visiting family and did not make any posts. I did not feel in a huge rush to suggest a bearish trade at that overbought signal because the market was able to hold up for a day or two after it became overbought. That can be a sign of underlying strength. We were also far enough off the lows of the previous week, that the market could become oversold above those lows. That is one thing I look for to determine what direction to trade--Is the market above or below the prices that it was at when the last signal registered? So I think the next signal here will be the one to act on.

Right now there is a large unfilled gap down overhead at 90.00ish on SPY. I view that as a major area of resistance. If the market is able to push through that level, then I think there is a good shot it makes it up to the 96.00ish level where there is another gap left unfilled.

If the market fails the next day or so, and goes below Monday's lows, then the next area of major support is an unfilled gap up at 79.65. If we get down to that level this week, then I think that would be a good short-term bullish trade entry point. If accompanied by an oversold reading, I would definitely consider recommending a trade there on SSO.

Pete

Waiting for The Next Move

The trade I suggested in the last post did not trigger because the market did not fall enough to fill the limit order. If anyone used that as a guideline to make a short-term purchase, I would STRONGLY suggest exiting that trade when I post the entry for a new bearish trade.

I expect this week. or possibly next week, to mark the highest prices that we will see for several more months. I view mid December as a time frame in which we will start to see the market pick up its trend to the downside. I expect a high volatility trading range until then.

If/when the market continues to move higher over the next couple days, and the short-term model becomes overbought, I will suggest a trade entry on SDS which is the double inverse ETF of the S&P 500. So it will gain value as the market declines. Also I may suggest trading BGZ which will move even more (3X) as the market falls.

For those interested, check out recent posts on VixAndMore blog that I have linked to the right of this site. There have been new 3X ETFs launched recently. BGU is the bullish fund and BGZ is the bearish fund. In an already high volatility environment, these will move at a heart-pounding pace, but they provide another avenue for speculators to make oversized profits without trading options or futures.

Sit tight for a few days, and wait for the next trade.

Pete

Market Update and New SSO Trade

Today was another ridiculously horrible day in the markets. However, I feel relatively certain that we will begin a large bounce up in the market tomorrow. With that said, there is an expanding type pattern forming right now that must go below 737 on the S&P 500 in order for me to consider it safe to enter a new trade. So I am going to recommend a trade here and use the short-term model as an exit signal, with a couple stipulations.......

Recommendation:

Buy SSO with a limit order of 17.60 tomorrow only (do not enter after Friday)

Exit the trade if it is not profitable at Monday's close. If Monday's close is profitable place a stop loss at breakeven and await exit via the short-term model signal.

Pete

Market Update

Today triggered several short-term extremes in the markets and the short-term model of the Nasdaq hit the oversold region. However, the methodolgy I use for trade recommendations on this blog is based around going with the prevailing trend (direction of 50 day moving average for simplicity). So I am not going to recommend a bullish trade here, because that is a counter trend trade, and I doubt the ability of the short-term model to clearly become overbought to signal the exit before we see new lows gain.

I do expect a strong bounce in the markets of 1-4 days starting tomorrow or Friday. The equity put/call ratio hit 1.16 today which is an extraordinarily high reading only matched a few times (3/14/08, 3/17/08, and 9/15/08). The reading was so high that it is beyond 3 standard deviations above the 20 day average reading.

The day after the March 14 incident the market had a large gap down that immediately reversed and the day closed well above its open. That day was the March 17 incident which is the highest reading that I am aware of. The market went on to make great gains over the next 4 sessions. The day after the Sept. 15 session there was a large gap down as well. Again the market reversed immediately and closed way above its open. The market went on to make great gains over the next 3 days though the two sessions after the 15th were very volatile.

So if we get a gap down tomorrow then I would consider that a buying opportunity for a very short-term trade of 1-4 days. If we gap up, then I would expect that a large up day is most likely, but I feel that the upside may not last as long if that happens.

This market is a very dangerous environment, so don't risk too much on any trade.

Pete

PG, WMT Technical Analysis

Click on Charts to Enlarge

The top chart above is Wal-Mart and the bottom chart is Proctor & Gamble. Both companies represent basic consumer spending and demand for everyday, non-luxury type products.

Looking at the charts of these companies you can see the extreme similarity in the price charts with respect to the timing of the highs and the rising wedge formation that has followed the recent severe price decline. What is not visible on the chart is the long-term context of the recent declines. PG has shown such a severe price correction that under cut the last major consolidation of the prior bull market, that it virtually gaurantees that this stock is headed substantially lower.

My analysis of the rising wedge pattern, which is actually a type of triangle pattern, is that there is likely to be one more high (likely this week) above the highs of Nov 4. Many of the same concepts that I mentioned in regards to NSC a week or so ago, apply to PG. There has been a high momentum rally (momentum indicator peak higher than any peak in years in this case) after the first obvious break of the bull market trend. The stock is rising underneath its 50 and 200 day moving averages which are likely "failed breakout" points over the coming days. I think there will soon be a great short-selling or put option trade entry point in this stock.

Almost all of the same comments apply on WMT technically though the long term context is a bit different.

Now is there any larger message that can be gleaned from looking at the charts? WMT is the biggest retailer in the world. The chart suggests future (long-term) weakness in the stock. I believe that this also tells us that consumer spending is going to be greatly slowing, even more than it already has, in the coming months/years. Stock prices are leading indicators of economic conditions as the future expectation/realization is very quickly priced into the stock, while it takes months or years of data to actually prove the point. With basic household goods companies showing severe weakness, we should expect a major downturn in the economy.

Pete

New SSO Trade

I don't have time for more details, but refer to the last several posts about this trade.

Trade Recommendation:

Buy SSO before today's close.

Current price is 27.28.

Pete

Market Update - VIX and S&P 500

Click on Chart to Enlarge

Click on Chart to Enlarge

The top chart above is of the S&P 500 ETF (SPY) and is a daily chart. The bollinger bands overlay the chart and a MACD is plotted below. In past posts I have mentioned that I always look at gaps as points of significance. There is an unfilled gap up in SPY at around 84.00. Other than major breakaway gaps, most gaps will get filled relatively soon. This is one reason I expect price to come back down at least to 84.00. Also, despite a historic decline in the markets, there has not been a classic divergence of technical indicators indicating a bottom. A move to new lows will likely show technical divergence and set up a better market rally.

I think the most likely scenario is a quick move under 84.00, lasting 1-2 days and then a reversal. I will look to aggressively trade any reversal and recommend a trade on SSO which will profit approximately twice the amount of the general market averages.

There are many seasonal and historical statistics suggesting the potential for a big move up in stocks, but my opinion is that the market has not inflicted enough pain and confusion just yet to stage that rally.

The lower chart above is the VIX. This is a gauge of investor fear and willingness to over-pay for options, which are commonly used to protect stock portfolios. If the decline in stock holds today, the VIX will close above the 20 day moving average. The traditional target would be the upper bollinger band if this occurs. So, I will look for the VIX to move near its upper band and the S&P to move below its lower band. At that point, I will just be waiting for a classic reversal pattern.

Pete

Trade Set-ups

The last 2 days of big selling pushed the short-term model into clear oversold territory. However, there has been no significant reversal that gives indication that the recent selling pressure has hit a short-term climax. Additionally, the only real technical support underneath current prices is the October lows around 840 on the S&P 500.

I would be willing to suggest a trade on SSO if the October lows are violated and there is clear indication of intra-day reversal or a bullish candlestick formation. Ideally the short-term model would be oversold and divergent at that point, but oversold with signs of reversal would be good enough to make the trade.

Based off of all the information I consider in recommending these trades, I think the best way to play this market in the next few weeks is to assume rather high volatility, with little directional bias. I would give more weight to overbought conditions than oversold, because the "keep it simple stupid" principle tells me that the market trend is clearly down, and it makes best sense to trade overbought signals in a downtrend. The high volatility may indeed present good set-ups in both directions though.

Pete

NSC Technical Analysis

Click on Chart to Enlarge

The chart above is of NSC which is a railroad company, Norfolk Southern.

I bought a few Dec 55 put option contracts on this today. There are a number of things I wanted to point out on this chart for the interested technical analyst.....

Not visible on this chart is the long term trend. The stock was in a bull market for several years and the recent decline obviously broke the uptrend channel and the speed and size of the decline is greater than the bull market corrections on the way up. If you remember anything from this post, remember that last sentence.....that is typically the nail in coffin after a bull market. It is a clear shift in long term trend.

So, this particular stock has obviously topped, and the general markets are obviously in a bear market. So now we look for a good point at which to short the stock or to buy put options.

Now to the technical analysis.......

The stock is rising and is just under the 50 day moving average on this advance. That moving average is a key average that everyone watches and where smart money will look to short the stock on its first bear market rally.

Second the bollinger bands overlying the chart show that the stock has come up and touched the bands. The 3 standard deviation bands are not on the chart, but price actually touched those bands too. This provides a great area to look to short from a statistical point of view as those bands will contain over 95% of price action and a touch of the upper band in a downtrend is often a reversal point.

Also, look at the rate of change indicator above the chart. Despite a short advance, that line has hit peaks only seen a few times the last couple years. These ROC peaks in bull markets often mark short-term tops, and in bear markets I have seen this initial high momentum thrust after the first leg down be the top before massive declines in the next leg down.

Underneath the chart is a fast stochastic chart showing the fast stochastic line is overbought. In bull markets I don't follow that line much, but in bear markets an overbought stochastic often immediately leads to weakness.

I don't use volume as a primary indicator, but when you see heavy volume declines, followed by overlapping upward prices on declining volume, that is hallmark for a corrective advance rather than new uptrend.

Today also formed a bearish engulfing pattern, though on low volume. But still, that rejection of higher prices is another clue that sellers are there to jump on this.

To sum up, I think this is a stellar opportunity to make a bearish trade on NSC. I am not going to track this on the blog, but for a swing style trader, I would view 63.00 as a stop loss and if stopped out look for the next bearish candle stick to re-enter. For someone who is willing to give some wiggle room on this stock, I think that the 69.00 is unlikely to be approached before another large decline in the stock.

Pete

SSO Trade Exit

Despite the last few days not triggering a true obvious extreme in the short-term model I use for timing these trades, I am suggesting an exit.

The first reason is based off the indicator itself in that it was a hair's width from overbought a few days ago, and then prices eased and started making new highs but without the indicator making more highs. This is a classic technical type of divergence, and I have seen that divergence is useful in this indicator as well.

The next reason is that the election tomorrow is a wild card, and at this junction I don't have a clear indication of what way stocks are likely to move in either scenario.

So, while I typically will not deviate much from the indicator signals in recommendations here, I am going to post the exit at the current price on SSO which is 32.20.

This is another nice gain of 13.5% up from 28.37 at entry on Oct. 23rd. Selective timing using this model has continued to give outstanding results.

Pete

SSO Trade Update

With Tuesday's big market advance the SSO trade is now in a profitable position. Most overseas markets are continuing the advance Wednesday.

Despite the monster day yesterday, the short term model is not overbought yet, so if the market continues higher for the next day or so and gets overbought, the SSO trade should be another big gainer.

A wild card today will be the Fed meeting which will determine interest rate changes. While I don't know what they will decide or how the market will respond, realize that the reaction to these types of changes can be violent. In this case, there is the chance that the violent reaction will be to the upside as there is lots of negativity that could potentially be "reversed" off a news item like a favorable rate change. Looking at historical declines and advances in bear markets, the expectation would be a 30-40% advance from the low point of this decline. The time frame would typically be 4 months or less, and I think that in this case it is likely to be less if we do get a bear market rally on par with historical rallies.

Based off of chart analysis I view the 1100 area in the S&P 500 as either a topping area for a bear market rally, or at least a ceiling on any intial thurst upwards above this month's highs around 1050.

For trade management purposes in the past I have said that my bottom line using the short-term model has been much better with out using a stop loss to get suckered out in this volatile market. But for money management purposes I would suggest quickly moving a stop loss to a breakeven position on any further market strength, especially if the market gaps up Wednesday morning. Certainly a stop loss could be in place around 26.00 on SSO now with little risk of getting stopped out of a (should be) successful trade.

I will post the exit when the time comes.

Trade Updates

Using today's opening price for SDS of 102.33 the trade made an 11.2% gain up form 92.04 entry price at the open on Oct 15. I have learned from past experience that the model serves me better when if I just wait for the signals and do not set a stop loss that would prematurely exit the trade.

In real life, someone should be advised to use a stop loss, but if you are trading this system with a smaller portion of your capital, I think it is best to not use a stop loss. I filter what signals to act on by going in the direction of the prevailing trend, and then also using candlestick patterns and market sentiment to act on occasional reversal points.

Also, the opening price for SSO was 28.37 and that is the price I will use to track this trade. For someone in the trade I would suggest a stop loss of 26.20 if you like to have a defined risk for money management purposes.

Pete

SDS Trade Exit, New SSO Trade

Today the short-term model neared the oversold region heading into the close. It is not quite there but is very close and I believe that it is close enough to recommend an exit in this environment.

Remember that I had suggested a stop loss when the trade was profitable and near oversold last time. That had resulted in a breakeven trade if following that suggestion. However I also said that I would post the exit when the short-term model actually got to oversold. So that is what I am doing now and would definitely suggest exiting if you have not done so already.

The closing price on SDS is 102.50 today. I will use tomorrow's opening price as the trade exit price to more accurately gauge the profit/loss of anyone following these updates.

Recommendation:

Sell SDS with a market order tomorrow morning (10/23/08) if you are currently holding SDS shares.

Now in this case I am suggesting using this oversold signal as an opportunity to buy SSO. SSO is the exact opposite of SDS. SSO will profit as the market rises and vice versa. I will use SSO's opening price tomorrow as the entry price for the trade.

Recommendation:

Buy SSO with a market order tomorrow morning (10/23/08).

Updates on SDS

Today, the 92.00 level was hit and should have resulted in a "breakeven" stop loss order triggered for anyone in the trade on SDS. This afternoon the short-term model once again hit overbought territory. Remember from the last post that it never actually got to the oversold extreme yet, so that is why I did not post an exit.

I personally was not in that trade. However, after today's overbought reading and reversal in the markets, I bought SDS at 94.80ish. I have a stop loss of 86.80 or today's low in SDS.

I think we are at a "breaking point" in the market right now. Price has been converging over the past week. So it is like a spring coiling. With high volatility, a price converging pattern I think sets up a ridiculously strong thrust in one direction.

The fact that I bought SDS reflects my belief that the market may have at least one more strong move down before a more lasting bottom. If that the gets stopped out, it is probably because the strong thrust is beginning to occur to the upside instead.

I'll keep you posted.

Pete

SDS Trade Update and Other Stuff Too

This morning the short-term model on the S&P 500 was nearly oversold around the time the the gap at 88.50 was filled that I mentioned last post. The trade was outstandingly profitable at that point. However, there was a huge reversal today in very high volume making the trade only slightly profitable.

My suggestion for anyone with actual money in this trade is to place a stop loss at 92.00 which was just above the opening price yesterday and should create a "breakeven" trade if the markets rise tomorrow. As for following the trade, I will continue to wait for the model to make its next oversold signal before posting the exit price.

This is a difficult market to make accurate judgements on a day like this. Normally a 4% up day in higher volume coming off a potential market bottom would be a clear "follow-through" day like I've mentioned in prior posts. However, 4% is a pretty average to low % gain considering recent up and down price swings in the market. Also, a potential follow-through day should usually show some stocks breaking out of consolidation patterns. That is not really the case right now as there is no real market leadership and stocks are broadly damaged with few forming any legitimate basing patterns.

If I had to pick one direction for the market over the next few weeks, from the price charts I would say up.......but I really don't trust buying right now. Again, if the market can make legitimate headway, and then make another oversold signal at a higher level, I would strongly consider recommending a bullish ETF trade.

Pete

New SDS Trade

The short-term model was overbought yesterday, but there was no clear resistance in sight until 110 on SPY that I saw, so I did not want to recommend an inverse ETF trade. Also, with many signs of bottoming behavior I didn't want to get caught in the middle of a larger trend shift. Today the model came back just out of overbought territory and is far from oversold currently.

Today has changed the picture some as for how I interpret likely scenarios from here. I see a likely target on SPY as 88.00. Also, today's exhaustion type gap and bearish candlestick gives a good stop loss point and sign of at least some likely market weakness to come.

Without all the details, here is the trade recommendation:

Buy SDS with a market order tomorrow morning (10/15/08).

Pete

XLE Morning Star Candle Stick

Click on the Chart to Enlarge

This chart is of XLE. XLE is an exchange traded fund that tracks energy stocks. It shows a morning star pattern which is a high reliability bottoming candlestick pattern.

There should be a large down day (dark candle) followed by a gap down and a candle that has a small fat part (called the "real body"). Then the next day should gap up and the white candle should close at least half way up the real body of the prior large dark candle.

The higher the volume and more technically oversold, the more significant this pattern. Also notice that the small "star" candle (the second to last one from the right) formed well outside the bollinger bands that overlay the chart. Those bands should contain 95% of all data in them, so whenever you see a classic reversal pattern happen at an extreme outlying point, that should add confidence as well.

I bought a call option on this yesterday.

Pete

SSO Trade Exit

With today's big market advance the short-term model has become overbought. The current price of SSO is 32.66 down from 35 and change at entry. So this was by far the worst trade since I have posted trades starting in April. There was massive intra-trade volatility and a significant loss though it pales in comparison to recent gains on other trades.

I think that it is likely that holding this trade will lead to further gains ove the next couple weeks, but to do that I would absolutely put a stop loss somewhere a few cents below Friday's low in case this vertical decline is not done yet.

If the short-term model becomes oversold in the next couple weeks while maintaining a price comfortably higher than Friday's close, then I will be likely to suggest a new trade at that point.

Pete

Piercing Line Candlestick - Russell 2000

Click on the Chart to Enlarge

The chart above is of the Russell 2000 index. Every chart tells a story. The charts and experiences you live through in real time so that you understand the emotion that accompanies them will have the greatest impression and learning value on you.

When the market is in freefall, certain price pattern consistently emerge at the turning points, some higher reliability, some with lower. A piercing line pattern happens when the market is downtrending, and then there is a gap down, but there is immediate buying and the close of the day closes well into the prior black(down day) candle. The rule is that the close of the piercing day should be at or above the halfway point of the prior black candle. The larger the gap down, the higher the volume, and the higher the close, the more bullish the interpretation. One interesting thing about the current candle is that it has a long lower shadow also. While this is not your typical piercing pattern candle, the rejection of lower prices should not logically be any more bearish than a classic candle that advances right from the open.

All the major indexes showed bullish candlesticks at the close Friday. This has not occurred in a couple weeks, so maybe we will finally see a bounce right now. In order to have a good confirmation that we may see some legitimate buying pressure for several days or weeks, we would want to see a large white candlestick tomorrow or a large gap up with at least some additional gains that hold into the close.

Pete

SSO Trade Update

I entered SSO today for an average price of 33 dollars and change on a limit order. The market blew past that a ways.

The only real consolation for this large intra-trade drawdown is that the upthrust after comparable historical periods tends to be very strong (about 10-15% on the SPY ETF) over the next week or two. There still exists a reasonable chance that the SSO trade will be profitable at the next overbought signal.

For someone who is not in the trade yet, I would still get into it. The model dipped back to oversold today. Despite palpable fear and perceived risk, these types of market moves have led to the biggest short-term gains historically.

I put about 25% of my account funds into SSO today. I would not advise putting a whole lot more than that. The time to starting increasing exposure is when the market has clearly turned, and then you get an oversold signal at a much higher bottom than is occurring now.

Doji Candlestick on SPY

Click the Chart to Enlarge

I have been waiting for a classic bottoming candle stick pattern to appear before starting to enter any bullish trades (expecting the market to rise). Finally today we got a truly classic candle pattern. The pattern is called a doji when the opening and closing price are the same or very close. This appears like a long line with a small cross hash mark on it.

The Japanese rice market traders who first discovered these patterns talked about how the market is in perfect balance when a doji is formed.

Stop and think about this..........the market moved wildly on almost the heaviest volume (most shares exchanged) in the history of the market. If you study price history you will know that huge volume days tend to have BIG price movements from open to close. Whenever a high volume, wide range doji happens something very rare is occuring.

I like to think of the Doji candle as an analogy to the apex point of a ball thrown high in the air. No matter with what force you launch that ball, at some time, at its highest point, the instantaneous velocity will be ZERO....momentary perfect balance. Then the ball will quickly change direction and fall down. The doji is the same. It is a point of momentary balance (no change from open to close) right at the apex, or turning point in the market.

Now it is certainly possible that today will not prove to be the lowest point before a major price advance, but I would heed the warning of the doji. I believe that based on many different factors, we are within hours to days of beginning a large advance in the market.

Pete

New Trade - SSO short-term Oversold

With the market in shambles it may seem crazy to recommend a trade that expects the market to rise. But that is the nature of the markets and the model I use for these trades. Most times I focus on buying low points in an uptrend. But ridiculously strong upthrust can form after the bottom of a down-trend, especially the expanding type that has been forming.

The short-term model for the S&P 500 is now both over sold and it is divergent with the prior oversold signal. Divergence is a term used in technical analysis that describes a situation where the indicator you are using is not following the same trend as price is. Divergence often happens before trend shifts.

Without further ado here is the recommendation:

Buy SSO with a market order today Oct 8th. or at the open tomorrow.

The current price is 35.25 which I will use to track the trade.

Pete

Thoughts on How to Use this Blog

My goal with this blog is to give any regular reader a way to take control of their investments and to be able to have steady growth with minimal drawdowns (periods of declining portfolio value), all despite the market going up or down.

In my opinion you should expect to have about $2500 or more to devote to trading/investing. If you have $2500 or greater and open a Zecco.com account you can trade with no commission for up to 10 trades a month. That is more than enough for following the trades on this blog. Since April I have averaged 2 recommendations a month (totaling 2 buys and 2 sells). I am not including any option trades or other more exotic stuff. I am just referencing the "short-term model" trades that I post.

I calculated the cumulative return on the recommended trades I've made since April. Assuming no commission, the return is about 77% since April on an initial investment.

Based off of a lot of information and historical comparison that I look at, I think that the markets will perform poorly for a the next few years (maybe 2-4 years) if holding typical stock investments or mutual funds. The positive side to this, is the in "bad" markets volatility is usually quite high, and the trades I recommend will be more frequent and more profitable in volatile environments. I truly think the next couple years will offer a far better profit opportunity than most typical investors could expect in very strong markets.

Always take some time to follow a methodology in theory before using real money. Also, do your best to educate yourself on concepts and terminology used so that you can be somewhat comfortable in using that methodology.

Please post any questions or ideas in the comment section.

Pete

SDS Trade Exit

With today's big decline the short-term model is within a hair's width of oversold. It could get worse, but I am able to post now, so my suggestion is to exit the trade. The current price is 87.30 up from 66.66 for a whopping 31% gain!!

With each passing day things are getting more volatile and more extreme. History tells us that a buying opportunity/market bottom is close at hand. The bigger question is how violently the market will move in a few days time. That will affect the risk-reward ratio of a trade and how good or bad of a price you get in retrospect.

I will wait on recommending a new trade till some of the smoke clears.

Pete

New Options Trade on CL

Click on the Chart to Enlarge

The chart above is CL which is Colgate-Palmolive. I have had a put option on this for a couple weeks now and it is somewhat profitable currently though far from its maximum gain.

The pattern here is that the stock broke down sharply from its early September high pretty much signaling that a larger corrective/decline is occurring. Now the stock has made a choppy advance back up to the 20 day moving average and formed a bearish engulfing pattern yesterday. Based off this pattern I think that another sharp decline is likely, and will take the stock below 72.00.

My recommendation is to buy an Oct. 75 Put on CL at a limit of 1.60.

The current price of the option is 1.50. If the stock gets to 72.00 before expiration on Oct. 17th, then that would be 100% gain or better because the option would be worth a little more than 3.00. In this case I would not suggest using a stop loss on the trade, so the risk is 100%. but the reward should also be 100% or better.

The exit strategy I would suggest is placing a limit order for 100% gain after entry or exit on expiration day if 100% is not achieved.

Pete

SDS Update

Today the House votes on the revised "bailout" plan. While speculation on these types of things isn't the norm for me, my guess is that it will not pass, or that the market will respond unfavorably to all the baggage in the bill.

There are a couple scenarios I think could play out here. As far as exiting the SDS trade from last week, the short-term model is not oversold yet. If today is a huge down day after all the news comes out, I would suggest exiting right before the close today. I'm sure the model will be oversold or very near it if that happens. I can't always immediately post when the model hits an extreme, so that is my suggestion. Also, because the potential exists of news sparking a positive market days of large proportions, I would suggest putting a breakeven stop loss order in on the trade early today for protection.

Looking ahead to the next few days, think a significant shift is going to occur in the market trend for at least several weeks. This is based off of past "post crash" market scenarios. Typically it results in upward biased choppy price movement, which should be great for the methodology of the trades I post on this blog.

Pete

SDS and General Market Update

The house of reps. did not pass the "bailout" bill. This has obviously created some panic in the market place.

This has been very beneficial to the SDS trade I posted a couple days ago. The short-term model is not oversold on that yet, so stay tight there.

Also, this break of the extreme panic low earlier this month creates a situation that I think could be very dramatic and cause a waterfall type (near vertical) decline in the stock indexes taking them down several more percent over the next few days. At that point, based off of price pattern form and current sentiment, I believe there will be a large reflex reaction in the market causing it to rise sharply, probably for a couple months or more. However, realize that this is still a bear market and this does not mean the worst is over.

For trading purposes I think this will be an excellent trading environment for making money due to extreme volatility in short-term swings. I would suggest anyone reading this blog follow the short-term trades I post on this blog as they will take advantage of these swings.

Pete

New SDS Trade

The short-term model for the S&P 500 has become overbought today. I'll admit a little hesitation on recommending a trade at this juncture, but the overbought signal at a lower high than the prior signal is one thing I look for in recommending an inverse ETF trade. I feel the downside risk to a disappointment in the "bailout" situation is more substantial than the upside potential for any agreement. But that is a wild card that is giving me hesitation right now, in addition to the fact that I believe we are very close to an intermediate term market bottom, or may have seen one already.
Nevertheless..........

Recommendation:

Buy SDS today before the close. The current price is 66.66 (a bad omen....or is that good in this case.....), and that is the price I will use to track this trade.

Pete

Follow Up on Gaps and Short-term Status

Click Chart to Enlarge

I made a post a few weeks ago about looking at gaps on price charts. The summary is that most significant gaps are retraced (meaning price comes back to the gap point) relatively soon. Also, there should be some expectation of pause or reversal at/around significant gaps.

The chart above shows a chart of SPY (S&P 500 ETF) and shows that the massive gap from last Friday has been retraced now. That coincided with short-term oversold conditions on the model I follow. So far it has led to a little bounce in prices which I would expect.

Now the thing to look for is if this gap holds the next couple days. The short-term model is currently nearing overbought peaks that marked reversal points the last couple weeks. No doubt news about "the bailout" will trump most other factors, but I will be looking to recommend a double inverse ETF trade if the model actually reaches overbought territory.

Realize that SPY has a long way to go before moving above the last short-term overbought high which was last Friday. If it gets overbought before that high is breached, my inclination is to stay bearish for at least one more move lower in the markets.

Looking Ahead (Gold and US Stocks)

Click chart to view a larger image

In this blog I have made frequent posts relating to stocks, but also to gold and oil. Oil is what drives our world, and gold is the money of the ages. Oil and gold prices have strong positive correlations, while the correlation between oil and stocks or gold and stocks is not consistent for long periods.

Right now my view is that stocks, oil, and gold are in bear markets. I think all are likely to go down further in the next several months and probably longer. In bear markets, the best opportunities to make money are when the price is falling, because that usually happens at a very fast rate.

Gold and stocks have had a relatively strong negative correlation this year, and I think that is likely to stay for a little while. Gold has made a massive price advance the last couple weeks that has made its momentum based indicators the highest they have been in years. These times tend to correspond with tops in gold prices. I am waiting for a good candlestick pattern to emerge to help recognize any peak in prices soon. I think a little patience will be necessary though. Then, I will advise on buying puts on gold related assets or shorting gold stocks.

I believe that based off of recent correlations that this peak in gold will correspond with a bottom in the stock market that should last several months and produce good price gains off the bottom.

I will be looking to make trades on GLD put options and SPY or QQQQ call options when I feel the market is ready to turn. I will keep you updated.


Pete

Update on Last Post- General Market Stuff

For those who read this consistently, I wanted to clarify and update a few things regarding my outlook and pass along some more information.


First, I don't think that this past week was the end of this bear market. In the last post I mentioned that I think we are near a major bottom in the markets though. In a bear market I would consider this to be a bottom that lasts several months and leads to a relatively large price advance (say....20-30%).


Now I wanted to pass along some information. I read a post on another site today looking at what has happened to markets in the past when they have had short-selling bans imposed by the government. The pattern that seemed to emerge was a severe sharp price gain followed by either some stagnation and then declines, or just gave way right to sharp declines from the end of the sharp price advance.


My thought for the last several months was that the market would go below the July lows, which it did. However, I had thought that this leg down would go deeper than it has so far. I was rethinking that after Thursday Friday (and still am to some degree), but the historical precedent of this type of situation now makes me think it is still possible, and probably somewhat likely that the market will go lower over the next several weeks yet.


Hopefully there will be another clear opportunity for me to recommend a short-term trade soon, so I will keep you posted.


Pete

General Market Update--Looking Ahead

As of Thursday and Friday, it appears most likely that the stock market has made a major bottom. One reason for hesitation is that the panic in the credit markets reached an unseen level, so we are in some sense in uncharted territory. However, form a contrarian perspective, unseen panic is what you look for to initiate a longer term investment. I suggest reading the recent posts from the Useful Trading Blogs section if you want to get further historical reference for the type of price move that has occurred in the last couple days.

The short-term model that I use to recommend index ETF trades on this blog is overbought indicating that the market may see some selling soon. Typically this is what I want to see to recommend an inverse ETF that will appreciate as the market falls. However, with the likelihood of a major trend change occurring, I am not going to recommend anything right now.

If you would have compounded all the gains from those trades I recommended using this model since April, then you would have about 30% gains or so since April. That is very good, and should give you plenty of patience to wait for a more clear market direction to make the next move.

Pete

Panic Building/Climaxing?

In timely response to my last post, all the major indexes broke the July lows and that certainly did send the put/call ratio to levels that could be considered very extreme. However, the 21 day moving average of the put/call ration has ample room to fall to match extremes seen earlier this year, so I think there still exits some argument that we can see lower prices still.

Sentimentrader.com posted some data showing a once in a century type panic in the credit markets occurring right now. Typically this has coincided with important market bottoms and created good investment opportunities. However, I would caution that crash type scenarios have happened before, and something truly extreme could happen gain. I would advise waiting this market out to give it a chance to prove itself to the upside before buying stocks again.

When markets enter climaxing downside moves, it typically occurs swiftly, with little pause, and can often end with a huge price decline unseen in recent days.

I am maintaining some put options but have exited a few losers to decrease exposure in case the market reverses sooner than I expect.

Pete

A Few Updates

A week or so ago, I had mentioned in a post that I bought a put option on UPS. The stop level that I had suggested has been surpassed. With that said, I am still in the trade. I only devoted a portion of my account to the trade, that I could stand to lose 100% and still be OK. I do not typically let a trade lose 100%, but there is always that risk. I am not convinced that the market will stay strong enough for this stock to hold up, but this coming week will more clearly answer that question for me.

Also, for anyone who followed the last post about the gold stocks showing reversal candle patterns, that proved true today. I mentioned that I traded AEM but did not specify the trade. I had Sept. 45 calls. I made a good profit and exited today, though in retrospect holding till close would have netted a much bigger profit. The bottom chart at top shows AEM. Today the stock gapped up strong, which I had mentioned in the last post is what I prefer to see after a reversal candle. When you see that in the pre-market for this specific pattern, it often pays to buy at the open, even if you are not in the trade already. I targeted the fill of the recent gap down as my exit, and that is basically where I got out today.

Now on to what's ahead.........................

I wanted to offer a perspective on the market, though only time will tell if it has merit. The sentiment right now is ripe for a reversal on some grounds. However, some of the tried and true data I follow suggest that there is at least potential for the market to fall substantially. The equity and/or total put/call ratio is one such piece of data. My perspective is this........

Look at the bottom that formed in March relative to January in the DIA chart above. Now look at the potential bottom right now. They look very similar to me. Looks like another classic retest of a significant low is occuring, and we should go higher from here........

However, the similarity is so striking that I can't help but feel that this market is going to fake us out. Everyone is hoping for and many expect a market rally. The market as a rule will alternate patterns of correction, and my feeling is that this retest will fail.

Then if the lows are substantially exceeded, I think that will set up some real extreme sentiment and give a more clear bottom. I think that would get the put/call ratio to rachet up again......a symptom we have not seen despite a pretty sick market since late May.

Pete

NEM (and many other gold stocks) Reversal Candles?

Click on Chart to Enlarge

The chart above is Newmont Mining (NEM). I am posting this chart because it shows what I consider one of my favorite candlestick patterns. I suggest clicking on the chart to view it more clearly.

The pattern forms when there is a large down day like Tuesday, then the next day price gaps up to the middle of that large black candlestick. Then price comes down to undercut the low of the large down day. However, there is a reversal and the price closes near where it opened. This forms a long lower shadow and a small real body. I view this as a harami/hammer/doji power packed reversal candle.

Here are other factors I want to see to take the trade:

1. Very high volume on the hammer candle (at least higher than the prior day)
2. Very oversold market conditions (this is present now as evidenced by the stochastic chart underneath the price chart)
3. Bullish technical divergence (price going lower, but indicators at higher lows)
4. Candle occurs around the lower bollinger band (this indicates that the reversal is occurring at a statistically extreme range, which is good)

I prefer the next day gaps up at least slightly. It did not do this today, and this trade may fail. However, I would take this candle pattern as a reversal warning in the near future, even if it is not a major trend reversal.

As an aside, I made a trade on AEM yesterday which is not going well today so far. I will have to exit if there is no sign of follow through later today. But these stocks are on my radar for a trade set-up even if today doesn't work out.

Pete

Looking at Gaps on SPY

One of the things I watch intently in analyzing a chart are gaps. A gap occurs when the opening price is much different from the previous closing price. This is often due to a news item....like the news about Freddie Mac and Fannie Mae this past weekend.



Most significant gaps are eventually filled, meaning that price will eventually come back to the origin point of the gap. I have seen statistics on this from sentimentrader.com, and as I recall most gaps are filled within 30 days. I always look for these gaps to be filled in order to set up a low risk entry point for a trade. That is because as soon as a gap is filled, the trend often continues.



So, as pertains to our current market and the chart of SPY.......we had a gap down last Thursday. That gap has now been filled by today's huge gap up this morning. In addition there has been an obvious bearish reaction to the gap up today. I pretty much expected this, and feel that price is unlikely to be able to make much headway in coming weeks. the question now is "how will the market respond if/when today's big gap gets filled?"



I expect maybe a short pause, but I would not look for a large upside reaction to that gap.



The take home message is that you should pay attention to those gaps if you trade DIA, SPY, QQQQ, etc. Look for reversal points shortly after the gap gets filled. Pay attention to how the market responds when the gap is filled. Does it blow right through? or do you get an almost immediate reversal?



As an aside, I bought DIA Oct. 114 puts this morning around 11:00 am ET, so I do have a bias here. I will not track that on the blog, but that trade reflects my views about the gaps mentioned above.



Pete

FRO Option Update

The Sept. 60 put that I recommended on FRO is trading for around 10.00 right now as of Friday's close. The entry price I used for the trade was 5.20 which was the open the day after I posted the trade. So that is close to 100% gain.

For beginning traders I think it is important to understand that every option you trade really has a risk of 100% loss. If you use a stop loss then you should not be losing 100% often, but realistically, most people hate to lose more than anything, and they move their stop order down or just don't use one. So it ends up that you could lose all the value if the trade goes against you.

For that reason, I think that beginning option traders should be using a system that will regularly result in winners of 100% or more when you are correct. Those big wins will counteract 100% losses at times. In fact if your winning percentage exceeds 50% and your average wins are 100% or more, you would still have an OK system even if you let all your losers go to zero or till whatever is left at expiration.

The flip side to selling at 100% gain is that the huge profit of an option really occurs when the delta rises to close to 1.00 and then the profit gains become more parabolic. To balance these factors, some recommend selling half your contracts for 100% gain to create a breakeven trade at worst. Then you are free to let the trade continue in hopes of catching a much bigger gain on the other half position. I think this is very reasonable for traders trading multiple contracts. If you are trading just one contract typically, then I think the best guideline to follow is to sell for either 100% gain or let it run till expiration. Pick one strategy and follow it consistently as the pros and cons will tend to balance out over time

Pete

UPS Put Option Trade

Click Chart to Enlarge

Today I bought an Oct. 65 put option on UPS. Looking at the chart you can see a couple sizeable gap downs in June around 67.00 and 66.00. Price has now come back to fill those gaps. In doing so, it made a classic shooting star/doji with a long upper shadow. At that same day, the high price touched against the 3 standard deviation upper bollinger band. Then with the market showing weakness, I feel that today was a good entry.

If selling short, I would exit on any close above 67.00. For the option trade, you could exit there as well, or if you only risk a small part of your trading capital, you could not set a stop loss, and just plan to hold it till either 100% gain or till expiration.

I may make a post soon showing a unique way to look at some put/call data that I have never seen in print anywhere else. It is not rocket science, but can be very helpful.

Pete

Market Update

I have been suggesting for the last week or so that I thought the market was weakening at that I am thinking we will start to accelerate to the downside. But enough of opinions, what are the facts I look at?

I look at a large number of studies and different sentiment indicators, but a few simple systems seem to work time and again.

1. The VIX has closed above the 21 day moving average and as of today the 5 day moving average is crossing the 21 day. This is a simple signal that works well on the VIX. Also the MACD of the VIX has made a cross signaling the VIX may rise (and markets fall).

2. 5 days of distribution the last few weeks. Heavier volume down days in the market are what Investor's Business Daily uses to track the market trend. Today was 5 distribution days for the NYSE.

3. Put/Call ratios (both equity and total) have recently made relative lows against standard deviation bands of the 10 day average. That indicates complacency and that is not good especially in a downtrending market.

I would again suggest bearish trades on BNI, DD, DIS. I would hold off on AZO until I see a more clear break down. However, most stocks follow the market, and if stocks start to come down hard, I think AZO is likely to as well.

Pete

SDS Trade Exit

The short-term model for the S&P 500 is now oversold. The current price of SDS is 66.90 for a nice gain up from 64.19 at entry. I recommend an exit on this. I would be for letting this trade ride for a while if the initial stop is maintained. But that will add more volatility to your portfolio.

Pete

Trade Updates

The SDS trade is doing well so far. The short-term model is back near oversold. Ayone in this could consider exiting tomorrow morning, but I will wait to post the exit until the short-term model does enter the oversold region. I will not be looking for a bullish trade at that point though. I feel that we may be close to a breakdown type of point in the market.

Also, the FRO put option trade made headway today. I will plan to hold that trade till expiration, but anyone in it may want to consider selling at 100% gain or 150% gain.

Trades I would make today include DD, DIS, AZO, BNI all for put option trades probably with October expiration and at-the-money or in-the-money strikes.

Pete

New SDS Trade

The short term model is very very close to overbought. It is close enough that I am going to suggest an inverse ETF trade. I suggest buying SDS the double inverse fund of the S&P 500. This will rise as the markets fall. For anyone trading this, for a risk management standpoint I would use a stop loss of 62.50. The current price is 64.19 and that is the price I will use for tracking the trade.

I had suggesting exiting the previous SSO trade already even though the short-term was not extremely overbought. I would definitely exit it now if you haven't already.

As an aside, I think ENER would be a good put option purchase right now. Also, I have puts on TEX which looks to be forming a triangle pattern that I would expect to break to the downside.

Trade Recommendation: Buy SDS with a market order today, 8/28/2008.

Pete

SSO Exit and Market Update

SSO opened at 61.60 today and that is what I will use as the exit price for this trade. The entry price was 61.66, so this is essentially a breakeven trade. The short-term model never made it to overbought, but everything I have been looking at had suggested that the market would move lower soon (as it has today), so I wanted to err on the side of caution this time.

If the market ends down today in higher volume, as it appears it will, that would be 5 distribution days since the recent follow through in July. Five higher volume selling days in the space of 4 weeks is what Investor's Business Daily suggests is almost always enough to send a market into a deeper correction. So, the volume pattern is another reason to be careful in the market now.

Pete

VIX Update and What I'm Watching

The VIX has made 12 lower lows since the July highs in the VIX. I consider anything 12 and over to be stretched and time to start expecting a reversal in the markets. Also, despite the large price gains today, the volume on QQQQ and SPY was very low, which does not convince me that this rally will last.

The short-term model is close to overbought, but not quite. I am going to suggest exiting it on Monday morning, as a bit of personal judgement on this one instead of waiting for it to get more extreme.

Three trades I would take immediately are STZ, DIS, and DD. All these would be short sales or put option trades.

Pete

Updates on Commitment of Traders Reports

I wanted to give some updates on current CoT data.

Right now the Commercials (smart traders) are net long (meaning they are buying) natural gas to a greater degree than any time in the last 5 years or more. Both the commercials and the large speculators net positions are at extreme levels that have corresponded with bottoming in the commodity the past several years. For non-commodity traders I would look at UNG which is an ETF that tracks natural gas.

Crude oil is also in a similar position to natural gas. Both commercials and large speculators are at extremes corresponding with past buying opportunities. However, I have discussed in past posts, that the commercials were in an extremely bullish position even before the huge sell off the last month or two. Also, I have discussed in past posts, that the price action of crude oil is more consistent with a decline off a major top and may have further to go down before a truly great buying opportunity exists. USO is an ETF that tracks oil for those interested. Also DIG is a leveraged oil and gas ETF that will move about double the amount of oil and gas.

The "smart" commercial traders are continuing to decrease exposure to the US dollar as it has made a dramatic rise the last 2 months. Large and small speculators are both upping there exposure greatly. All three groups are at extremes relative to standard deviation bands of the data. UUP is a relatively new ETF that will rise as the dollar rises. I do not have a lot of interest in this ETF because I would rather trade something more volatile like USO (which will generally go the opposite direction of UUP).

These data raise the possibility that we will see a return to a declining dollar and rising energy prices soon. I trust data over other conceptual arguments, but I think there is something to be said that our country may be moving into a deflationary time as consumer spending drops dramatically with the baby boomers passing their peak spending years. How this will balance out against still relatively strong Asian demographics for several more years I don't know yet.......that's why you always control your risk in any investment. Trust your data, but follow a good risk management plan in case it doesn't pan out.

Pete