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 I suggest reading the recent posts from the Useful Trading Blogs section if you want to get further historical reference for the type of price move that has occurred in the last couple days.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