Where we Are in the Indexes

Feb 4, 2008: 10:20 AM CST

Let’s take a rapid look at the major US Indexes as we start the new week:

First, the NASDAQ Daily:

  • Bullish Divergence preceded the recent 200 point rally (divergence is now complete)
  • Price rests at the falling 20 period MA – bearish
  • Price is in a confirmed downtrend
  • Volume has accelerated majorly and has made new monthly highs
  • Price could be forming a daily bear flag pattern

Next, to the NASDAQ Weekly for an interesting pattern:

  • The mid-line of the triangle represents the support/resistance barrier the market has faced since 2007.
  • The 2,550 level represents significant resistance that would be very difficult to overcome
  • Price inflected (bounced) nicely off the 200 period weekly MA, which should serve as support
  • Price is in “no-man’s-land” right now, as it is virtually equidistant from the three key moving averages
  • The weekly chart is also in a freshly confirmed downtrend
  • Price made a new weekly momentum low (not seen for years) – bearish

The S&P 500 is showing a near identical pattern, as is the Dow Jones:

Where do we go from here?

If the bear flag setup plays out on the daily chart, then the major Indexes could test recent market lows.

If the bear flag fails, then price could travel higher to test 2008’s highs (which are a distance away).

The structure hints at more bearish news on the charts than bullish, but we know the sentiment out there (extremely bearish) and realize that the market often acts against the opinions of the majority, but recall that sometimes the majority is right, especially at the ‘middle’ of the move when everyone begins to catch on.

It will be difficult to forecast which scenario is correct.

Either way, trade intelligently and don’t get carried away if possible.  Check out videos at INO TV for more thoughts and trading tips, or check out a “sneak peek” video at your convenience.

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Pulte Homes – A Massive Recovery

Feb 3, 2008: 10:26 AM CST

Pulte Homes (PHM) was one of the major homebuilder stocks to suffer major losses during 2007, but 2008 has shown a dramatically different picture for this homebuilder stock.

On the shorter daily time frame, notice the discreet momentum divergence that proceeded the major rally.

Recall that at the birth of a new trend after a long trend has been established, the first momentum impulse is often caused by traders who are massively short, as they buy back large quantities of stock to cover their short positions. This increased momentum (and price) move also attracts “bottom fishers” who believe they are buying the stock as close to the absolute bottom as possible.

Pulte Homes above shows a classic technical set-up that describes this pattern very well.

Let’s view the weekly picture now:

Notice that there are clear signs of capitulation on the side of the sellers as we moved into 2008. Notice the massive volume numbers as the stock made newer and newer price lows.

Also, notice the massive momentum divergence with price that began occurring in September 2007 and has now been resolved with a new momentum high on the weekly chart as price has risen above the falling 20 period moving average to make new highs not seen since September.

Again, a certain percentage of the recent move is likely due to short-covering, and this could be described accurately as part of a “short-squeeze,” but I see something else going on.

According to the Sector Rotation model, Financials and Consumer Discretion (including homebuilders) have seen the most significant increase in funds over all other sectors recently, which occurs at or near potential market bottoms.

With all the bad news out in the market, it’s reassuring to see that sectors once thought destroyed are making a potential bullish recovery, which is absolutely due to the environment of lower interest rates.

How long this recovery in these sectors will last is anyone’s guess, but for now, this is a welcome bit of bullishness in a sea of overwhelming bearishness.

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Is a Bullish Sector Rotation Occurring?

Feb 2, 2008: 9:44 PM CST

According to the Sector Rotation model, a bit of bullishness may be underlying the recent market moves.

Let’s see:

As of early January 2008, funds have been taking money out of Energy and Technology stocks (which were major winners of 2007) and are pouring it into the beaten down Financial and Consumer Discretionary Spending Sectors, which are early beneficiaries of lower interest rates and often bottom first when a recovery is expected.

Recall that the above performance is relative to the S&P 500 index, and do not represent absolute returns. If so, then all sectors listed above would be negative. But what’s crucial to see is the reverse in flow and the direct correlation of relative performance between these four key sectors of the market.

Let’s actually look at the absolute sector returns for the last two weeks:

The Financial Sector beat all others with a 16% appreciation! Consumer Discretionary Spending was not far behind, with an 11% gain. These signals often occur just after, or around a market bottom according to the theory, as big money begins to bet on a recovery and takes positions in these sectors which have been beaten down significantly by investors. Are they now recovering?

If so, this could be a very bullish sign for the overall market. While the absolute bottom may or may not have formed, the sector rotation model is providing potentially bullish information to those open to listen.

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Yahoo and Google Spike but in Different Directions

Feb 1, 2008: 1:23 PM CST

The technology world is abuzz with headlines today! Yahoo Inc (YHOO) may be acquired by Microsoft (MSFT), which sent shares soaring, while Google Inc (GOOG) missed earnings expectations and plummeted.

Before looking at the charts, let’s look at the headlines:

From Yahoo Finance: Microsoft makes $44.6 Billion Bid for Yahoo

Yahoo’s stock, like the up arrow in their logo shown here, is headed up, up, up (this morning at least).

Also, from Fortune Magazine this morning: “Putting Yahoo and Microsoft Together… Some Pieces Won’t Fit.”

As if this wasn’t enough to keep the technology world buzzing this morning, search engine giant Google announced yesterday that it missed earnings, but would have hit them if employee stock bonuses/options were not included.

From The Street.com: “Google, Microsoft, and Yahoo… Oh, My!

Also from Fortune.com: “Google Misplaces $72 Billion” Oops! That’s what the author estimates was the loss from the earnings miss and the decline from the all time price high. An excerpt:

“Fortune’s Philip Elmer-DeWitt notes that Google stock has now dropped more than 230 points from its November high of $747 a share – wiping out more than $72 billion in market value. That’s more than half again as much as Microsoft (MSFT) is offering for Yahoo (YHOO), for instance.”

That really puts things into perspective, or at least tries to.

Now that you have the headlines, let’s glance at the charts:

Microsoft (MSFT):

Oops. Investors were not pleased. This is the traditional reaction, in that the offering company takes a hit to their stock price when the news is announced while the company being acquired experiences an expected stock pop.

Like what happened in Yahoo (YHOO):

Wow is the word of the day. The day is not finished yet, and already over 365 million shares have traded today. That is some massive volume! Notice the slight volume pick-up on the days prior to the announcement. Did someone know this was going to happen? I’ll look at the options later to see if there were clues.

Yahoo’s share price has appreciated 47% or just over $9.00 as of 2:30 EST.

Unfortunately, the news was not all good today. Google investors woke up to a massive decline which was exacerbated to the downside as the day continued:

As of 2:30 EST, Google’s share price has taken a 7.86% decline, which is $44.36.

For trivia’s sake, the 14 period (day) Average True Range (ATR) for Google is actually near $28, meaning that in one day, a $28 price fluctuation up or down would be normal.

With wild swings up and down like this in the stock charts, is anyone safe?

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Gap Fade Stats for January

Feb 1, 2008: 6:24 AM CST

As per reader request, I conducted a quick summary of all gaps in the DIA (Dow Jones ETF) for the month of January to see what would have happened if a trader faded all gaps.

The question is the following:

How many days in January had overnight gaps in the DIA (Dow Jones index), and second how many (and what percent) of those gaps filled.

I also added a very quick, very unscientific calculation of returns had a trader attempted to fade a gap.

Let’s start with the hard facts:

13 of the 20 trading days in January experienced some sort of gap greater than 10 Dow Points ($0.10 DIA points); thus 65% of trading days in January experienced an overnight market gap.

Of these 13 overnight gaps, 9 of the 13 experienced a complete and total gap fill, representing 70% of all gaps filled.

Let’s view this in a quick table:


The following days resulted in some sort of overnight gap greater than 10 Dow Points in January, 2008:


Legend:

BLACK: Not a Trading Day
GREEN: Successful Gap Fade
RED: Failed Gap Fade
WHITE: No Gap Fade

Now, onto the subjective material:

I took each gap fade day and tried to assess visually the potential profit or loss for each day. For successful gaps, I took the intraday low and counted price to yesterday’s close only.

For failed gap fade trades, I took the maximum stop-loss size of $0.50 (50 Dow Points) for an arbitrary stop-loss, assuming that entry took place at or near the gap open. The losing gaps were all at or near 100 Dow points (or $1.00 DIA).

Here are the non-scientific statistics based on my analysis only: (no representation that these numbers are perfect or near perfect, but only represent possibilities designed to give you an idea of a gap-fade strategy that does not include commissions):

January

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Total Wins: $14.40

Total Losses: $2.00

Total Outcome: $12.20

Recall that $1.00 for the DIA (Diamonds ETF) is equivalent to 100 points on the Dow Jones Index.

SUMMARY:

Of the 20 trading days in January, 13 (65%) of those days produced gaps in the DIA, and of those 9 (70%) of those gaps filled for a profit using the classic “fade the gap” strategy.

Based on crude and unscientific statistics, traders using this strategy had the potentiall to gain $12.20 from all trades (13) taken!

Thoughts:

How would volume confirm? What about other indicators? What about morning news report? What about size of the initial gap? How would you place stops?

All of these questions could help us filter out gap trades, but would complicate the simplicity of the classic “fade the gap” strategy.

While nothing is ever 100% in trading, the classic “fade the gap” strategy produced an edge both in percentage and potential dollar profit in the month of January, 2008.

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