Crude Oil Tests $100 and forms Range

Feb 20, 2008: 10:55 AM CST

I haven’t heard much about crude oil recently (other than it’s expensive) until today, when journalists are bemoaning another test of the $100 per barrel level. Let’s look at the recent history of this major global commodity and what it might mean for the markets:

Three times since November, Crude Oil futures have tested the psychologically significant area of $100 per barrel. Will the third time be the charm that breaks prices through the recent tight and clear channel?

Notice how major support and resistance has developed at the $85 and $100 levels. These areas have become fixed in traders’ minds as levels that have worked in the past and serve as clear targets for stops, entries, and exits.

Eventually, the force of supply or demand will overcome one of these areas, but until then, we can only observe the price action and horizontal channel consolidation.

Notice the recent rapid ascent of the commodity from $85 to $100 in approximately two weeks. This represents massive strength on the side of the bulls.

Now that price has hit resistance, the market faces a major turning point. Should oil break $100 per barrel, it could have massive psychological significance on the US Stock Market (as well as global markets), pushing them lower. It may even be enough to cause US Stock prices to eject from their recent triangle consolidation (indecision) pattern.

Before we get too excited or bearish (or bullish, from a contrarian’s perspective), let’s peek at oil’s weekly chart:

We see the same sort of consolidation pattern on the weekly chart, but we also see a momentum divergence. Momentum readings, as do all oscillators, lose a bit of their significance as price winds down to a low volatility, equilibrium point where swings have narrowed. The divergence is not as strong or telling as the divergence that occurred from October to December 2007, which presciently preceded the major high volatility price move from $52 to $100.

Could price be forming a bull flag style continuation pattern? Let’s hope not but we can’t overrule that possibility. It would seem highly unlikely, but anything can happen in the market.

Let’s continue to keep an eye on this commodity, and others, and focus on what strength here means for the US and global stock markets.

Check out MarketClub or INO.Com for more information and educational videos, including analysis by Adam Hewison on the current state of the gold and crude oil commodity markets.

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Market Still in Triangulation Zone

Feb 20, 2008: 10:42 AM CST

The US Stock Market still has failed to break its recent symmetrical triangle or coil pattern, and the pattern is still forming on the major indexes.

Let’s peek:

Most triangles resolve 66% to 75% of the way to the apex, and that is approximately where we are. Volatility has narrowed and typically price will eject into a trend move following these consolidation periods.

Triangles are mostly continuation patterns, meaning that the odds slightly favor resolution to the downside, but no pattern and no market prediction is ever 100% accurate, and this triangle could break to the upside as well.

Volume has also been declining as the triangle formed, which further confirms the pattern.

I drew the most recent triangle pattern, which occurred throughout the month of December. That particular triangle consolidation resolved to the downside. What will February’s consolidation do?

We’re currently in “wait and see” mode.

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Nasty but Interesting Intraday Action

Feb 19, 2008: 7:23 PM CST

The market action today was quite stellar, but ended lower after an amazing morning gap.

Let’s look at some of the set-ups and trades that you could have taken today:

First, “fade the gap” which occurred over the weekend. The gap actually filled halfway (which classifies as an official full gap morning failure) into moving average support, which set up the “Impulse Buy” momentum trade.

A second pullback in the upwards price trend occurred around 1:00, which exceeded its price target (the most recent swing high) and then price pulled back but failed into the final hours with a massive breakdown that took price down $1,40 (140 Dow points) in less than 30 minutes.

Morning traders who were excited at economic news were slammed today, and their expectations of bullishness were dashed.

Let’s look the NASDAQ ETF (QQQQ) which was even more bearish than the Dow Jones ETF (DIA) today:

The initial gap fade play went further than the 50% retracement the Dow experienced, but also found significant support at the rising 50 period moving average and also set-up an “Impulse Buy” trade. The second pullback trade worked (but barely exceeded its price projection) and then price began to fail.

Notice the super-trade that occurred as price rallied up to significant resistance from the crossing (and simultaneous price) of the 20 and 50 period moving averages.

The final hour showed a positive momentum divergence before a massive 5-minute up-bar was observed.

Today offered many clear-cut trading signals and low-risk opportunities. If only every day was as easy as today.

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A Look at Bonds, Stocks, and the Fed Rate Cuts

Feb 19, 2008: 10:09 AM CST

Continuing the thought from my last post asking whether Fed Rate Cuts are Actually Good for the Market, I thought I’d compare the 2 Year Treasury Note, 30 Year Treasury Bond, and the S&P 500 and overlay the recent Fed Rate Cuts on the comparison chart.

Let’s see what happened:

The chart begins in June, 2007, when the Fed announced that it would likely stop raising interest rates for a period, and in fact, may begin cutting soon.

The Fed cut rates .50 basis points on August 17th, and then cut five additional times which have been marked on the chart with black lines at the bottom.

Notice how the S&P 500 responded to the first rate hike – with a euphoric 7% rally (which also experienced another rate cut). Notice also how the market topped at this point and began its violent downward descent from October 2007.

Notice also the 2 Year Note (green) and the 30 Year Bond Price (blue) and how they both responded to the first rate cut.

Bond prices move inversely to bond yields, meaning that if you bought a bond ETF or actual treasury notes/bonds, then not only did you experience appreciation from the monthly yields, but also from the fact that the prices actually rose in your favor as well (as could be expected in a period of falling yields).

I mentioned previously that it seems like everyone on the Street gets euphoric when the Fed cuts rates, but I vehemently disagree. The fact that the Fed is cutting rates is often a sign that the Fed and economists fear weakening economic conditions more than they fear inflationary concerns, and so they’re willing to ease monetary policy in response to deteriorating economic conditions.

Does the Fed also respond to the market? Yes, as evidenced by the surprise .75 cut on January 22nd. But even that drastic of a cut had little relative effect on the market.

Nevertheless, the actual strategy appears to be exit the market when the Fed begins a campaign of lowering interest rates and buy bonds/notes. Aggressive traders could have even decided to short the US Market, but smaller investors would be better off buying bonds during a campaign of Fed Rate Cuts instead of jumping aggressively into the market as Wall Street would have you believe.

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Is Fed Easing Actually Good for the Market?

Feb 18, 2008: 10:40 AM CST

Is it really as simple as “When the Federal Reserve cuts rates, it’s great for the market” or “When the Fed raises rates, it’s bad for the stock market”?

Michael Panzer of Financial Armageddon recently asked this question, as well as provided an excellent graph detailing stock market returns and Federal Funds rate at his post “Is Aggressive Fed Easing Really Bullish for Stocks?

This is a concept I’ve been at odds with the financial media for quite some time, but I felt alone in my view.

Traditional thinking goes like this:

“When the Fed raises rates, it chokes off money supply through higher interest rates and decreases capital expansion, so it’s bad for the market. However, when the Fed lowers rates, it’s great for the market for the opposite reason. With lower cost of carry rates and lower interest payments, companies can take on more loans and expand their business, as well as the consumer can purchase more items (including bigger purchases like houses and cars) on credit or loans (or mortgages).”

That’s absolutely true, but what does it mean when the Fed raises or lowers rates?

Typically, the Federal Reserve raises interest rates to prevent rampant inflation from runaway expansions caused by ‘easy money.’ If the Fed kept rates at 1%, then so many businesses would be expanding and consumers would be spending that inflation (through higher demand) will cause everyday prices to skyrocket as well.

The Federal Reserve lowers interest rates to stimulate a weakening economy to encourage businesses to expand and consumers to spend. If weak economic conditions are present, or predicted through fundamental forecasts, then the Fed typically will choose to reduce rates to stimulate expansion.

That’s excellent, but let’s look at some of the underlying facts behind this:

The Fed raises rates when business conditions are “too good” and the economy is expanding or is expected to expand.

The Fed lowers rates when business conditions are “too bad” and the economy is contracting or is expected to contract.

How does that relate to the market?

The Stock Market generally rises when businesses conditions are good and the economy is expanding.

The Stock Market generally falls when business conditions are poor or deteriorating.

Keep in mind that the stock market anticipates economic conditions (discounts them) by a factor of three to six months in advance.

So what might it actually mean (in simplified terms) when the Fed raises or lowers rates?

When the Fed raises rates, it means economic conditions are good, and the stock market is expected to rise.

When the Fed lowers rates, it means economic conditions are poor (or becoming so), and the stock market is expected to fall.

Before you scream “foul,” let’s look at the excellent 10 year chart from Michael Panzer that expressed this sentiment far better than any words could:

(Image Credit: Financial Armageddon)

Notice that the market (S&P 500) was rising into 2000, and interest rates were rising as well.

Notice that the market began to stumble in 2000, and then fall, and Interest Rates fell right alongside the market.

Notice how the market bottomed in 2002/2003, and as the market rose through 2004-2006, the Federal Funds rate rose as well.

Finally, notice how the market fell in 2007/2008, and the Federal Funds rate fell as well.

Also, notice the flatline periods in the target rate. This indicates likely turning points in the campaign by the Federal Reserve, but also indicates long-term investment shifting points from into the market and out of the market.

A simple strategy (that flies in the face of conventional wisdom) might be buy stocks when the Federal Reserve is in a campaign of raising rates and be in bonds (which rise as rates fall) when the Federal Reserve is in a campaign of lowering interest rates.

The next time you hear a Wall Street pundit scream because the Fed raised rates, or jump with jubilation because the Fed lowered rates, think back to this chart and what that actually means.


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