US Steel Melts Resistance

Jun 23, 2008: 11:39 AM CST

US Steel (X) broke a resistance level today, which could signal higher prices yet to come for this basic materials sector stock.

Daily chart:

Although momentum seemed to be diverging, the indicator broke a trendline just ahead of the eventual price break above the $185 resistance zone.  The stock has had an impressive run over the previous three sessions, and bulls were finally able to drive price through this zone with little resistance.  Volume increased on the prior two sessions, hinting that the upper resistance level had higher odds of ‘melting away’ than holding.

The stock could find resistance at the $200 (round number) per share level, but otherwise there seems to be a clear pathway to that level now that overhead supply has (apparently) been resolved.

Note:  The Blue arrow in the middle of the chart represents a high probability swing or position trade, in that the stock had performed a momentum trend move (evidenced by the new momentum high) and then retraced back to the rising 20 period moving average.  With a stop just beneath this average, an entry close to the average, and a target well beyond (or, in the case of a position trade, exiting when price does break this average convincingly), this would be a good example of a high probability trade with potential edge over time.

Basic Materials/Industrials have been strong through 2008.  Will they continue to be so?

US Steel (X) is the top metals fabrication company by market cap, at $22.22 billion.

Other stocks in the Metals Fabrication Industry – ranked by market cap – include:

Precision Cast Parts (PCP)
Reliance Steel (RS)
Valmont Industries (VMI) – profiled recently on the blog
Matthews International (MATW)

Source:  Yahoo Finance


The AAPL Retracement

Jun 23, 2008: 9:50 AM CST

Apple Inc (AAPL) is a highly publicized stock which has exhibited a smooth trend recently.  Is the most recent action in AAPL a steady retracement or a full-blown reversal?

Let’s look to the charts for some clues:

On the weekly structure, price has just completed a large run-up in price on declining volume (throughout 2008).  Price is currently in a retracement mode, and appears to be finding temporary support at the $170 range, which corresponds with the weekly 20 period EMA.

Should this area fail, the next ‘line of support’ could be the rising 50 EMA, which is near $150 per share.  Those desiring to be ‘long’ AAPL may find the $170 zone offers a potential support zone with a tight stop for entry.  There are many other factors to consider, as well.

In terms of the swing ’structure’ of the weekly chart, price made a new swing low at $120 in early 2008 and has now made a lower high at $190, and some would argue the stock is now in a confirmed downtrend, an argument which would be strengthened via the break of the 20 and 50 period EMA.  Until then, we still assume the structural uptrend.

What might the daily chart say to us?

I overlaid the Fibonacci retracement grid on the chart, as well as provided the lower panel “3/10″ MACD oscillator.

On this chart, $165 appears to be very strong support.  This area corresponds with the rising 200 period moving average, and the 38% Fibonacci retracement, which is the first line of potential support during a normal retracement.

One concerning factor is the decline in price as it has made both lower lows and lower highs in price.  Another factor to consider is the negative momentum divergence which preceded the price ‘rollover,’ or smooth transition from buyers (demand) to sellers (supply).  I actually drew the arc to highlight this transition.

Key points to take away:

If you are wanting to get long Apple, there could be strong potential support around the $165 zone, should price retest this level.  A strong penetration of this level would call the bullish arguments (from a chart standpoint) into question, and traders would need to hedge or cover losses at that point, as momentum could carry the stock even lower.

Risk could be higher now than it was previously, as well.

This analysis is for short-term trading tactics only, and make no reference or assumption to longer term investments or company fundamentals.


Monthly Overview of the Major Indexes

Jun 22, 2008: 2:13 PM CST

Have you been keeping track of what the larger picture is on the charts of the major US Stock Market Indexes?  If not, let’s take a moment to see what the Dow, NASDAQ, and S&P look like on their monthly charts.

S&P 500:

The S&P is beneath its peak in 2000, and appears to be forming a similar pattern as it did before the 50% market drop (caveat – I am NOT forecasting such a drop).

Price is trapped between its key 20 and 50 period EMAs, and just a few more points lower would officially break its moving average support line, and would cause a major long-term sell signal.  With one more trading week to go in June, a monthly close beneath this zone is certainly possible, and if that happens, it would be difficult to envision many bullish scenarios that could add comfort to investors.

Although price could still find support at this level and ‘bounce’ back up, be prepared to consider shifting long-term investments should this level be definitively broken.

Also, notice the momentum divergences that preceded the turns in the market.  Volume is surging to the upside as  investors are more uncertain about what to do.  Notice also, that volume has declined on the recent upswing in price, which will likely be defined officially as a “true bear market rally”.

The chart of the Dow shows a very similar picture, only that price is actually higher than its 2000 peak.

Dow Jones:

Price is testing its key rising 50 period EMA, but a monthly close beneath this level would potentially be a significant long-term sell signal.

NASDAQ (logarithmic scale):

The NASDAQ chart looks different than the others due to the stratospheric rise of the technology stocks and the euphoria that occurred in 1999/2000.  Price is just shy of 50% of the all time closing high, and extremely unlikely to take out that level anytime soon (as in, within the next few years).

Price sits above its 50 period moving average, which has served as support ever since 2004.  Price appears likely to retest this level which is over 100 points away.

Keep in mind that I’m using a logarithmic chart for this index, so the height of the actual peak is much taller than the chart would convey.  Without using a log scale, the bottom prices looked extremely small and insignificant for comparison purposes.

A large juncture in the market is just around the corner, so be prepared to alter your strategies should the market take a turn for the worse in the near future.  It could be a harbinger of things yet to come if the charts indeed are similar to their counterparts around the year 2000.

On a promotional note, the free trial window to sign up for 2 weeks of unlimited, full access to the Market Club services ends Monday night, so sign up and test drive all the Market Club has to offer if you have any interest to do so before it’s too late.

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Probability of a String of Profits or Losses

Jun 21, 2008: 2:15 PM CST

How does flipping a coin relate to trading probabilities?  Simple, we can look at different probabilities of trading outcomes based on the distribution that results from a pure 50/50 chance outcome.

What do I mean?

Although the odds of a successful trade are rarely exactly 50/50, let’s assume that – for the moment – they are.  Let’s say you take ten trades in a row.  What can you expect to happen?

You can expect that 5 out of the 10 trades (or coin tosses) will ‘win’ (or, come up heads).  What is the actual distribution like, though?

Did you know that the odds of having exactly 5 of the 10 trades (or coin flips) win is only 24.61%?  That means that roughly 75% of the time, you’ll have a different result than what you expect!

To be fair, the probability of having 4, 5, or 6 winning trades (plus or minus 1 from the expected value) is 65%, which is in line with the standard “bell curve.”

What is the probability of having a run of 10 out of 10 trades be winners (or losers)?  It’s only 0.10%.  Rare, but it can happen.

Let’s look at the results from a randomized study I completed in Excel, based on flipping a fair coin 10 times, for 10,000 trials (something that might take months in the real world) and count the number of times ‘heads’ comes up in each of the 10 series of trials.

This will be similar to what you can expect if you took say 100 sets of 10 trades each and asked “how many trades can be expected to be winners?”

Let’s look at the distribution:

Remember, with odds of 50%, we would expect 5 throws out of 10 to come up heads.

We would expect the next most common values to be 4 or 6 throws out of ten to come up heads.

We would not expect many at all to turn up a series of 10 heads in a row (or 10 tails in a row).

Despite that, out of 10,000 series of 10 tosses, we had 10 runs of 10 tails in a row and 11 runs of 10 heads in a row.

What does this mean for trading?

If you can expect to win 50% of your trades, this would be similar to the distribution of possible outcomes, and their respective probabilities based on a series of winners or losers.  Most of the time, you’ll fall one or two values away from the expected value (exactly 5 out of 10), but sometimes, you’ll get a string of losers or winners, just through probability alone.

What will happen to the distribution when I shift the odds up to having higher odds of a winning trade than losers?  Recall that few situations produce exactly a 50/50 chance of producing a win over a loss.

Check back!


The Arc of Opportunity is Almost Complete

Jun 20, 2008: 6:33 PM CST

What is the Arc of Opportunity, you might ask?  It’s reflective of the smooth, even transition that’s occurred recently in the Dow Jones Index.   You could name it whatever you like, actually, such as the “Arc of Shame,” “Arc of Buying and Selling,” “Arc of Transition” or whatever seems catchy to you.  Let’s look at it in its full glory.

This is a unique pattern that probably isn’t discussed in any textbooks, but the underlying logic is sound.

This represents an orderly shift from buyers to sellers in a clean, systematic way, as demand overcame supply, momentum decreased, and supply overcame demand in a rhythmic, almost ‘mirror image’ pattern.

I have been quite bearish on the short term because the potential of this situation occurring, which has played out according to expectation, but the up-days gave me difficulty in intraday trading – my bias was too strong to see how the market could go up, and that resulted in missed opportunities and small stop-outs.

We all need to learn that, even though the short term trend may be down, there is no such thing as “straight up” or “straight down.”

Nevertheless, this pattern (as I see it) is just about complete, and will terminate when price tests or breaks through the March lows.  I’m not sure what – if anything – the Federal Reserve has up its sleeve to save the market again.

In January, it was the .75 rate cut.  In March, it was the Bear Stearns bail-out and rescue.  In June, it was….

Be very careful in the upcoming weeks, and remember that volume can be lighter during the summer and moves can sometimes be more erratic.

Nevertheless, I thought this pattern was very interesting and offered a clear pathway for price, which provided good trading opportunities, once you got the overall short-term direction correct.

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