A Brief Look at Financials

Apr 2, 2008: 8:33 AM CST

The Financials Sector (XLF) has received considerable attention as of late, but let’s look at the chart for a few more insights:

The small horizontal hash-marks represent the series of lower lows and lower highs which have defined the prominent downtrend, and this structure has not been broken yet.

Price recently formed a higher low, but the pattern appears to be forming a consolidation pattern – perhaps a symmetrical triangle in development. After the large volatility move down in this sector, a period of consolidation is welcome.

Recall that there has been a relationship between the Financials Sector and the overall Stock Market, so if we see any signs of strength here, that would be an excellent (bullish) sign for the overall market.

What would look encouraging? A solid break above the declining 50 period moving average and a decisive break above the developing triangle consolidation formation. In fact, if we saw price stay above $28, that would be a rather bullish development.

The weekly chart supports this thesis that the $28 level is quite critical to overcome:

There is a significant down-trending channel that has been in place since October, 2007.

$27.00 seems to be a critical level to overcome, as it is the price where the declining 20 weekly moving average appears, as well as the top of the declining channel. Taking out this level with force and stabilizing above $28 would trigger significant technical (chart) significance and could cause funds (and traders) to act in concert, whether they initiate new buying or buy back old short-sale positions.

To help the bull’s case, there is a positive momentum divergence forming on the last two price swings.

Also, volume has surged through 2008, which could indicate the potential for a capitulatory bottom (where everyone sells indiscriminately, leaving few traders left to sell).

Keep an eye on this sector, for I believe a significant break of the $27 or $28 level could change the calculus for the broader stock market.

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Gap Fill Probability Study

Apr 1, 2008: 10:47 PM CST

I just discovered this interesting graph from Finviz.com (under the Services section) regarding probabilities of a daily gap filling.

While they don’t discuss their methods or the period observed, the main idea of the study is two points:

The probability of an overnight gap being filled increases as days progress;

The larger the gap, the lower the probability that it will fill.

Let’s look at their chart (courtesy Finviz.com Services):

Therefore, the probability of a gap being filled is a function of the size of the gap and the time after the gap occurs.

To show the extremes in the data, a gap of size 5-10% move has a 70% chance of filling within 5 days, but a near 90% chance of filling after 50 days.

A gap size of 35-40% has a 15% chance of filling within 5 days and a 40% chance of filling after 50 days.

Again, please be aware of the caveats of this study:

We do not know which stocks (or groups of stocks) were used; we do not know if these were upside or downside gaps; we do not know when the study was created; we do not know the number of occurrences per each percentage range; and other concerns.

This chart may be enough to get you thinking about how to view a gap, but I would encourage you to test your own data for a more accurate probability of the gap filling strategy.

I assume this graph is used to get you familiar with the kind of service or research this company does, and is just a sample only. As such, don’t take this chart as absolute certainty – but only as a foundation to build ideas and test your own strategy.

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Where Does Today’s Action Leave Us?

Apr 1, 2008: 5:13 PM CST

First of all, today’s action came as a surprise to so many traders, myself included. Let’s look at some key facts to discover what may have changed due to today’s action:

First, the DIA (Dow Jones ETF) Daily:

Price aggressively violated its 20 and 50 period moving average, giving no respect to these levels. Recall that during consolidation phases, oscillators trump moving averages for trading support/decisions. This fact is a confirmation that we are currently experiencing a ‘trading range’ environment which spans from near $120 (Dow 12,000) to $127 (Dow 12,700). Unless the bullish action of today’s movement can push price beyond the $127 consolidation zone, we could expect price to return back to the ‘value area’ which has established. It wouldn’t surprise me a bit to see the bulls push price above this critical level on the daily charts.

Short-sellers – take note. Those funds who have been pushing down the market with selling pressure could cover their positions quickly and aggressively should the market rise enough to trigger their stop-loss levels (exiting a short-sale requires you to buy the shares to ‘cover’).

The market sits at a precipice, but I would imagine most people thought the market would be sitting near the $120 level or lower to be on the edge of a precipice. Instead, the market has tested the upper range of the consolidation period. Perhaps that’s a major reason today’s action was so strong after all.

Let’s peek at the weekly chart of the S&P 500:

Two critical components to highlight:

First, a positive momentum divergence preceded the last 3 weeks’ upward movement.

Second, price has two levels of overhead resistance to overcome

– the 1,375 level corresponds with the falling 20 period moving average
–1,400 corresponds with a resistance/support level in the past

While commentators are calling this a ‘major bottom,’ (and that may be), it’s generally a good idea to wait for confirmation rather than being hasty and jumping in because the news told you it might be time to buy. Although the market is likely to experience higher prices due to short-covering and bottom fisher activity, you may be better served to let the market shatter these levels before you get super-bullish yourself.

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Gold and Oil Pull Back Hard

Apr 1, 2008: 4:55 PM CST

Over the last few weeks, both gold and crude oil prices have become more volatile, both rising quickly and falling quicker. Let’s take a peek at some of the charts and what it might mean for the stock market:

Crude Oil Prices:

Recall that Crude Oil prices are quoted in US Dollars, and the dollar has been strengthening lately. Also, oil recently shot from $86 per barrel to over $110 – a massive increase without a pullback or consolidation in between. Some sort of ‘reaction’ against this move was almost certain.

However, what actually has formed appears to be a potential early reversal signal, which will be confirmed if price falls beneath $100 which will alert many funds and traders (and the national news) to this development. There may even be significant stops placed beneath that level which will trigger quickly.

Notice that price has made a lower high and is threatening to make a lower low, which would shift price into a downtrend on the daily chart. Significant support exists around $100, so traders need not get ultra bearish for oil until that development occurs. I would imagine that declining oil prices would be viewed quite favorably to stock market participants for what it means for the economy.

On to Gold Prices (per ounce):

Unlike oil prices, gold price have actually turned over into a confirmed downtrend on the daily chart (trends are relative to their time frames).

Gold prices increase when investors/traders fear that inflationary concerns are invading the economy, and often place longer term investments here when they feel economic uncertainty is ahead.

Prices have been increasing rapidly, and again a pullback (or reaction) is not a surprise to most traders. Unfortunately, this development may come to a surprise to the general public, some of whom have been melting gold artifacts to take advantage of higher prices.

Trend changes can precede large moves, and often trends end in euphoria (which is synonymous with continuity of thought, and when this occurs, no one is left to buy – such things are puzzling to new traders).

Keep an eye on these two ‘key commodities’ because their direction can often send signals to the broader stock market.

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Market Rockets into Second Quarter

Apr 1, 2008: 9:21 AM CST

How were your trading results for the first quarter? The S&P lost 10% last quarter (and year to date), and the following chart shows the returns in Q1 for the major US Market Indexes:

That was actually the worst quarter in five years!

How did the market begin the 2nd quarter? So far (intraday), the S&P has surged over 2% and looks to be headed for a strong close.

The strength (intraday) has originated from the Financials and Consumer Discretionary Sectors – this is an excellent sign for the overall market if the trend continues.

The Financials Sector (XLF) was up over 5%, while the Consumer Discretionary Sector appreciated over 3% (both intraday).

Commodities have been retracing, and could be forming potential tops, which will boost the overall stock market (lower oil prices and lower commodity prices in this environment validates the Fed’s claim that a slowing economy will curb inflation).

Will this large (relative) rally be a perverse April Fool’s joke played on us by the market?

Let’s keep an eye on these developments and see if new trends emerge!

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