Sunday, April 30, 2006

Weekly Forex Market Outlook


THE WEEK AHEAD IN THE FOREX MARKETS

Recently, we have seen a lot of positive economic data out of the US, but following the harsh comments from the G7 this past weekend, the question ahead of us is Will Good Data Matter? Federal Reserve Chairman Ben Bernanke was surprisingly dovish in his comments to the market on Thursday, raising the possibility of a pause in the Fed cycle. The cards are stacking higher and higher against the dollar and the latest shift in stance by Bernanke may be the straw that breaks that camels back because the Federal Reserves persistent interest rate hikes was the primary reason the dollar was able to maintain strength throughout the past few months. With that gone, dollar bulls may have nothing left to hold onto, but the real worry is that the latest G7 meeting was eerily reminiscent of the 2003 G7 meeting in Dubai. If you recall, back in 2003, the G7 finance ministers called for more flexibility in exchange rates. At that time, the change to the statement was the first significant move by the committee in 3 years. It resulted in a 150 pip knee-jerk rally in the EUR/USD, but over the next four months, the dollar fell another 11 percent against the Euro which amounted to 1100 pips, 9 percent against the British pound and 7 percent against the Japanese Yen. The long term impact was far more substantial than the markets knee jerk reaction, which is the risk that the market faces today. Over the weekend, we had another major shift to the G7 statement. For the very first time ever, China has been mentioned directly by the G7, reflecting their increased concern over the past few months. This raises the question of whether the US Treasurys FX report due in two weeks would also brand China as a currency manipulator. The G7 report could have paved the way for the Treasury to also take a harsher stance which given the G7 statement, would probably have less of an impact on the market. More importantly, the G7 statement is basically advocating appreciation in the Asian currencies and as a byproduct, depreciation in the US dollar. This is a key point since it comes at a pretty important juncture. The Federal Reserve is nearing the end of its tightening cycle while reserve diversification has picked up steam. Oil prices have consolidated this week but they are still at extremely lofty levels and in the words of President Bush, it will be a tough summer for US consumers. Yet, we have a lot of data ahead of us in the next week including GDP, non-farm payrolls, ISM and construction spending. But at this point, it seems that even good data may not save the dollar.

TECHNICAL OUTLOOK

EUR/USD

Market Recap: The euro rally continued as the pair holds above the 1.2400 figure and challenges a long term trendline from December 2004.

Short-Term: The dealer chart shows massive negative divergence with RSI and the 4/24 and 4/25 highs were rejected by the long term trendline that begins at the 1.3666 high on 12/30/2004. However, the pair closed a hair above (or right at) the downward sloping line yesterday, depending upon the thickness of your line. This is certainly disconcerting to shorts, but still, the proximity of the line certainly skews risk to the downside for a test of the 23.6% fibo of 1.1826-1.2472 at 1.2320.

Long-Term: The 20 day SMA still holds above the 200 day SMA and the massive 11 month head and shoulders suggests that any weakness going forward should be limited. A sustained break beyond the mentioned trendline exposes the 9/2 high at 1.2588.

EUR/USD WEEKLY CHART

Euro Weekly Chart

GBP/USD

Market Recap: Cable strength has been countered at the 1.25 and 4/19 highs of 17934 and the pair has traded within a range bound by 1.7750 and 1.7940.

Short-Term: The longer term double top at 1.7934 produced from the 1/25 and 4/19 highs has thwarted attempts by bulls to reach the psychological 1.8000 figure and yesterday’s brief break of the low combined with oscillator divergence on the hourly may be a sign of weakness to come. Still though, a break of the 1.7934 figure gives scope for a move towards the 38.2% fibo of 1.9546-1.7041 at the psychological 1.8000.

Long-Term: 1.8000 should prove tough to break as it is not only psychological but also the 38.2% fibo of 1.9548-1.7046), and a failure to break that figure would send the pair back to the bottom of a weekly channel near 1.7100-1.7200.

GBP/USD WEEKLY CHART

Cable Weekly Chart

USD/JPY

Market Recap: USD/JPY broke its long term trendine from May 2005 and subsequently are through supports before finding support near the 1/23 low at 114.13.

Short-Term: Resistance sits just above at the 23.6% fibo of 118.82-114.23 at 115.31 with the 200 day SMA at 115.50. A daily close below the 4/24 low at 114.24 is required to confirm a continuation of weakness towards the 1/12 low at 113.41.

Long-Term: The break of the mentioned trendline is significant in that it ends the consolidation that had persisted for much of 2006 and the path of least resistance is down.

USD/JPY WEEKLY CHART

Dollar Yen Weekly Chart

Key Events from Last Week

G7 Calls for More Revaluation from China
Talk of Reserve Diversification Resurfaces
Bank of Canada Raises Interest Rates to 4.00 Percent
G7 Calls for More Revaluation from China

The US dollar has succumbed to significant selling pressure over the past week as the G7 harshened its stance on China, calling for exchange rate flexibility specifically from the Asian giant. The Japanese Yen has been the weeks biggest mover. After having range traded for 2.5 months, the currency has finally broken out and is dictating overall market activity. As the proxy for Asia, the yen is most sensitive to any developments in China and at the moment, the big question is how China will respond. In the worst case scenario that China is also branded a currency manipulator by the US Treasury, will that be enough to force them to change their currency regime? China has proven to not be one to succumb to international pressure and each move that they have made in the past has been very politically astute. Just take the Chinese Presidents visit to the US. Even though there was widespread speculation that the Chinese President could make a major foreign exchange related announcement – he did not. Yet ahead of the US Treasurys report, China may very well make a minor but symbolically important shift that if branded as a currency manipulator, they could use as rebuttal. A major shift however will be unlikely since China has already downplayed the G7’s criticism. In addition, as indicated by Stephen Roach of Morgan Stanley, China does not want to be the scapegoat for the US self created problem. He argues that Americas unprecedented savings deficiency is what got the current account balances to where it is now. More interestingly though, he adds that back in the 1980s, when the US had its first major current account deficit, it screamed unfair value and pressured Japan, the country that it had the biggest gap with back then the same way it is pressuring China now to let the yen rise so that the gap would be closed. Japan agreed and let USD/JPY slide but sadly the strong yen was what fueled the major asset bubble that eventually led to the Asian Financial crisis. Roach says that China is far weaker economically now than Japan was then and in such a sensitive time, they probably have no interest in making the same mistakes that Japan did. These are fascinating comments by Roach that are well worth noting.

Talk of Reserve Diversification Resurfaces

A fresh wave of diversification talk has swept the markets, exacerbating the pressure on the US dollar. The latest central bank to talk of their demand for Euros was the governor of Qatars central bank, who said that they have recently been buying Euros for reserve purposes and although their current reserve makeup is confidential, up to 40 percent of its currency reserves could be moved to Euros. The UAE is also considering shifting another 10 percent of their reserves to Euros next month, which follows Swedens announcement on Friday that they have increased the Euro share of their reserves from 37 percent to 50 percent. On top of that, after talking down the dollars status as the absolute reserve currency on Friday, Russia announced today that they would allow their $61 billion oil fund to invest in bonds issued not only by the US and Britain, but also by Eurozone countries. Meanwhile Switzerland also indicated that their central bank has reduced the share of dollars in its reserves and instead has increased its share of yen reserves. This comes on the heels of comments by Iceland on Wednesday about their possibility of abandoning the volatile Krona in favor of the more stable Euro. With the breakdown of the EU Constitution well behind us, the market has feels that reserve diversification is a theme that is here to stay.

Bank of Canada Raises Interest Rates to 4.00 Percent

Even though oil prices has stabilized since hitting an all time high, the loonie is gaining momentum as the Bank of Canada raised interest rates for the sixth consecutive time by 25 basis points to 4.00 percent. Despite modest concern for the strong currencys impact on some sectors and the possibility for weaker growth in 2008, the Bank of Canada still believes that some modest further increase in the policy rate may be required. The central bank could not have offered clearer comments on the path for interest rates. After seeing weaker retail and wholesale sales figures for the month of February, the market was expecting more neutral comments from the Bank of Canada. Now however, the prospect of higher rates could easily tempt Canadian dollar bulls to take the currency even higher, for a test of the 14 year high.

Thursday, April 27, 2006

We Only Trade our Beliefs About the Markets - Dr. Van Tharp


If you are a regular student of Dr. Van Tharp's work or reader of this blog you hear this a lot: You can't trade the markets, you can only trade your beliefs about the market. Let's explore what this really means.

As a long time modeler of what makes great traders great, Van understands that to model effectively you have to find out what highly accomplished people do in common. Once you get the common tasks that produce excellent behavior, you need to get the ingredients of those tasks. Those ingredients include the beliefs, the mental states, and the mental strategies necessary to carry out those tasks.

Lets look at some statements and see what you believe about them:

The market is a dangerous place to invest. (You are right.)

The market is a safe place to invest. (You are right.)

Wall Street controls the markets and it is hard for the little guy. (You are right.)

You can easily make money in the markets. (You are right.)

It is hard to make money in the markets. (You are right.)

You need to have lots of information before you can trade profitably. (You are right.)

Do you notice the theme?

You are right about every one of these beliefs (whether you said yes or no to any of them). If you do not believe in any of these statements, what do you believe instead? You are right about that too! However, there is no real right/wrong answer. Some people will have the same beliefs and agree with you and others will not.

Therefore, whatever your beliefs about the markets are, they will direct your thinking and your subsequent actions.

What is a Belief?

Beliefs are a primary way to filter information from the world. Beliefs are judgments, categorizations, meanings or comparisons. They determine how we perceive reality and relationships in reality. What you expect (i.e. your reality) depends upon your beliefs and they are largely unconscious. Every sentence in this document represents one or two beliefs, including this one.

One of the beliefs that is most productive for good trading is the belief that you are totally responsible for your own results as a trader. When you adopt this belief, then you can learn from your mistakes. However, if you tend to blame someone else (your broker, your spouse, the person giving you tips) or even the market for the results that you get, then you will tend to repeat the same mistakes over and over again.

When traders own their problems and assume responsibility for the results produced, then they discover that their results come from some sort of mental state that either allowed them to 1) follow their rules, 2) not follow their rules, or 3) trade without having any rules.

When traders take the time to write down all their beliefs (about themselves, the markets, money, etc.), then they can establish a much better idea of what they want to trade, and how they want to trade. They can also see flaws in their thinking much easier. It is valuable to know which beliefs support you as a trader, and which ones hinder your progress.

What is a Mental State?

Every task has an optimal mental state that will allow you to accomplish it effortlessly. For example, to execute a trade you benefit from courage and total commitment. Fear, in contrast, is a big disadvantage as a mental state for executing trades.

Mental states are primarily what most people call discipline or emotional control. Examples include: being impatient with the markets, being afraid of the markets or being too optimistic about the markets.

Controlling your mental states is just part of the answer, but when you can see that you are the creator of your own results as a trader, then you can really make progress.

What is a Mental Strategy?

To understand mental strategies, you have to understand how people think. People think in their five sensory modalities (that is, in terms of visual images, sounds, feelings, taste and smell).

A mental strategy is the step by step way in which you use these modalities; it is the specific sequence of your thinking. For example, the most effective strategy for the action step of executing a trade is to 1) see the signal, 2) recognize internally that this is the signal you decided you should take, 3) feel good about it, and 4) take action. If you do anything else, you probably will not be able to take action or it will be very slow.

The Psychology of Trading

Once you have a clear understanding of which beliefs, mental states and mental strategies are the core factors in top trading performance, you can then teach the same skills to others and have them perform well too. And when you can see this success duplicated in others, which we have been able to do in most aspects of trading, then you know you have a workable model.

The key psychological traits of top traders are

1. Personal Responsibility

2. Commitment

3. Their psychological profile

4. Working on personal issues (e.g., self sabotage)

Trading fundamentals include the Ten Tasks of Trading.

1. Self Analysis

2. Mental Rehearsal

3. Low-Risk Idea Development

4. Stalking

5. Action

6. Monitoring

7. Abort

8. Take Profits

9. Daily Debriefing

10. Periodic Review

Traders need to be reminded of these tasks and to eliminate any self-sabotage that keeps them from following the tasks. Van teaches all of these steps in detail in his various products and workshops.

Van Tharp believes that everything revolves around your beliefs, mental states and mental strategies, so with that in mind, everything about trading is 100% psychological, including why and how you trade and which system you will follow or build.

Many traders have a hard time believing this and it is almost the antithesis of what people learn in academic finance. So only you can decide whether it is worth the time to learn more about yourself and the psychological aspects of trading.

People get exactly what they want out of the markets. Most people are afraid of success or failure. As a result, they tend to resist change and continue to follow their natural biases and lose in the markets. When you get rid of the fear, you tend to get rid of the biases ~ Van K. Tharp, Ph.D.

About Dr. Van Tharp: Trading coach, and author Dr. Van K Tharp, is widely recognized for his best-selling book Trade Your Way to Financial Freedom and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors. Click the "We Only Trade our Beliefs About the Markets" header link above for more information on Dr. Van K Tharp.

Wednesday, April 26, 2006

Stock Market MidWeek Outlook


NASDAQ Outlook

Don't get fooled by the NASDAQ's slight gain today. We're still at breakeven levels for the week, and the month, and three months for that matter. The current reading of 2333.20 basically matches the close at 2331.33 from January 11th. Since then, never has the index traded above 2375, and never under 2232. That 143 point span is only about 6 percent of the composite's current value, which is a pretty narrow range for a three-month period......by anybody's standards.

As such, there's just not a lot to look at in the MidWeek Update. The edges of that range are still support and resistance levels, and the NASDAQ is still dancing all around its 10 day (red) and 20 day (blue) moving average lines. It's a very choppy - and almost unusual - environment for traders to deal with. Even the VXN has been mostly inconclusive.

The best tool throughout all of this has been our stochastics chart, as it has spotted most of the short-term tops and bottoms. As it stands right now, it's leaning towards bearishness, so we are too. The actual sell signal was triggered in early April (the 7th), yet the NASDAQ managed to climb back up to the same high where the sell signal was first made (2375). Seeing that double top, though, only makes the scenario that much more bearish, in that traders drew a firm line in the sand at that point.

As for where it might stop, we'll only go as far as 2300 right now. Not only is that a big psychological support area, it's also where the NASDAQ bounced twice earlier in the month. If that support line fails, then 2240 would be the next potential landing spot.

Nasdaq Daily Chart

Daily Chart

S&P 500 Outlook

The S&P 500 is actually outperforming the NASDAQ today, but it doesn't mean a whole lot. For the week, the SPX is down by 4.2 points (-0.32%), and is still unable to keep hitting new highs with any continuity. That said, the S&P 500 still hot those new highs when it reached 1318.15 last Thursday. The current reading of 1307.10 is well under that mark, but falling back after hitting new highs has pretty much become the norm here. The SPX is still above the 10 and 20 day averages, so technically speaking, the trend remains bullish.

That said, like the NASDAQ, we still expect to see this large-cap index fall back from that recent by a little more that the current 11 point dip. There's an intermediate-term support line currently at 1287 (dashed) that seems to be a much more likely target. That line is sandwiched under the 50 day line, and above the 100 day average. Normally we might look to the 50 day line as a bounce point, but it hasn't been since February. So, we'll lower the bar for the time being, so to speak.

The ultimate bull/bear line, though, is the 100 day moving average at 1282. Only a break under that mark would move us to a bigger-picture bearish stance. However, given the time of year that we're in (when things slow down), that's a distinct possibility. Despite the fact that we just went through the most positive first quarters we've seen in years, traders are getting a little frustrated with a very ineffective market. That's a potential catalyst for a lethargic bearish environment over the next few weeks; the 100 day line is the key signal line for that possibility.

S&P 500 Daily Chart

Daily Chart

Dow Jones Industrial Average Outlook

The Dow's 68 point gain for the day (so far) still leaves it right at break-even levels for the week. And more than that, the blue-chip index is still under resistance at the recent high of 11468, yet above support at 11,179, where the 50 day line is resting. In other words, we're stuck in neutral here too.

Just for the sake of variety, we'll look at the Dow's weekly chart. Clearly it's bullish, supported by a trend lien that goes all the way back to October. Interestingly, the Dow showed us a high degree of bullish volume last week. In terms of the bigger picture, the volume and the relative strength is consistent with the idea that investors are rotating out of the speculative and smaller companies, and into these more established stocks. However, we'll also caution you that if a bearish turn gets bad enough, the Dow won't be immune to it. It would still be the better place to be in terms of smallest losses, but there would still be losses.

If instead the coming weeks are only neutral or even mildly bearish, the Dow may well be the best place to look for buy-and-holders.

What's the make-or-break point? Use the 100 day line at 11,000. If the Dow falls under that line, that could be a moderate problem for the bulls.

And on that note, we'll just say to the traders, the coming weeks are typically choppy and involatile. Reversal-based tools and scalping tend to do better in that environment. It's not likely that the market (or any index) will make a major move in any direction. We do, however, expect some sectors decisively lead or lag. Just be sure that your strategy, style, and timeframe make sense for the environment we're going to be in.

Dow Jones Industrial Average Daily Chart

Daily Chart

Traders Behavior


In trading as in life, how you think determines the results you achieve. Read on below for six key behaviors that you should on your checklist for trading success.

Check to see if you possess the traits and beliefs of winning traders, including:

1. My trading objectives are perfectly clear, and I truly believe I will achieve these goals. If you have the belief that you will win, you increase your chances of trading to win. In order to have this level of conviction, you must have a thoroughly-tested plan. You also must have a clear vision of how you will proceed with your plan to reach your goal. The more detailed you can visualize your goals being achieved, the more you will strengthen your internal belief and confidence that you will reach your goals.

2. I have created a plan to achieve my trading goals. I'm sure you've heard the saying "I didn't plan to fail; I failed to plan." Without a plan, your results will tend to be mixed and uninspiring. Commit to writing down your trading plan, and make sure you can answer the questions found in a recent TrendWatch on creating your trading plan.

3. I prepare my plan before the trading day starts. If you don't have a plan of action once the trading bell rings, you are moving from the proactive mentality into a reactive approach. I contend that the more reactive you become, the more you will get in late to market moves and dramatically diminish your reward-to-risk ratio. I prepare after the close for the next day's trading, seeking to stay proactive and a step ahead of the rest of the crowd.

4. I regularly monitor my trading results to measure my progress toward my goals. Trading results tend to follow a zig-zag approach similar to how a plane is guided to its destination. At periodic steps along the way, if a pilot is off course, they will set a new course towards the target. This is called course correction. Once you have defined your trading target, your periodic evaluation should lead you to assess what is taking you off course and encourage you to make the necessary corrections to get you back on target.

5. I quickly discard negative emotions that can hurt my trading results. When you lose, you want to learn from the experience, then put it behind you. You cannot afford to dwell on a loss once the trade is complete. You have to have total focus on the new moment and forget about the past, save for the time you allocate to evaluating past trades (which should be done outside market hours).

6. I am focused on the market during the trading day, and not easily distracted by non-market activities during trading hours. This can be a tough one for many traders who have many responsibilities. If this is the case, define the time you will be focused on the market and make arrangements not to be interrupted. For more information on this topic of successful trading behaviors, click the Traders Behavior header link above to obtain a successful traders mind.

Sunday, April 23, 2006

Weekly Stock Market Outlook


NASDAQ Outlook

It was a wild ride, but the NASDAQ ended the week with a respectable gain of 0.72%. The close at 2342.86 was a 16.75 point improvement from the end of the prior week, although it's wasn't necessarily a bullish sign of things to come. The NASDAQ basically matched its previous 52-week high of 2375 (from early April) and was sent tumbling again. At the same time, support lines are squeezing the index from the bottom up. Something's got to give soon.

Based on all we see right now, it looks like the NASDAQ is headed lower at least to some degree. That double-top at 2375 is pretty telling, but that's not the only reason we're looking for a dip. The VXN has put in a reversal pattern over the last three days, and if it follows through to the upside like we think it will, then stocks will have to fal proportionally. Keep in mind, however, that expiration week was last week, which taints the VXN readings a litte bit. The stochastic lines are approaching 'overbought' levels, although timing the stochastic-based pulbacks has been tough to do lately. Any single one of those sins wouldn't alone be a bearish pattern. But to see them all simultaneously is a strong clue.

Of all the bearish hints, volume is the biggest. Friday was a distribution day, which we've seen more than a few of lately. The Chaikin line is pointed lower, although it has yet to cross under the zero line - the official sell signal.

That said, we've been down this road before. The composite has been - and still is - range bound. So even the signals we do see are questionable. Until the NASDAQ can actually break out of this range, we don't see many bearish of bullish opportunities. The resistance is at 2375, but we're going to plot support at 2300. That's the spot where the index hit lows a few days ago, and it's also the mid-point beween the 50 day and 100 day moving average lines. Be patient here.

Weekly Chart

S&P 500 Outlook

While the NASDAQ made decent gains, the S&P 500 left the NASDAQ in the dust (a bearish concern in itself). The SPX gained 1.72% (+22.2 points) to end Friday's session at 1311.20. Along the way, a new multi-year high was hit this one at 1318.15. However, those moves into 'new high' territory have had little to no follow thorugh over the last four months. So, despite the big gain for the week and the relative strength on Friday, we're still a little suspicious of the S&P 500's apparent bullishness.

The pressure of being stochasticaly overbought is really starting to weigh in on the SPX. The last three times we were here are marked on the chart - all three resulted in weakness. In fact, the stochastiic lines and the trading channel the SPX has been stuck in has been the only reliable trading patterns to speak of. And as of right now, the pattern is telling us that we're at a short-term top, and we should expect a pullback.

The entries into stochastic 'overbought' levels are marked with red arrows, while the 'oversold' periods are marked with green arrows. You can also see that, simultaneously, the S&P 500 has pretty much defined straight-line support and resistance (dashed lines), forming the generally bullish channel we see going back to January. Until we have a clear reason not to think so, we have to expect this pattern to keep repeating itself. We hit the resistance at 1318; now we're looking for the move back to the lower edge of the channel, currently at 1282. That's only about a 30 point dip though.

What about the bigger picture? We know that periods of low volatility are followed by periods of high volatility. So, eventually, the S&P 500 will have to break out of this rut and start moving again (bullishly or bearishly). However, a cople of things will need to happen first. The first is (obviously) a break ouside of the range. The second is that the ADX line will have to start rising again. It's been stuck under 20 for weeks now, verifying that the chart truly is trendless (which is why stochastics has been so effective). So, we are indeed ripe for a big move of some sort. The probem is, the month of May kicks off the most lethargic period of the year. So, we may not get a reprieve anytime soon. Just keep that in mind as we progress through Q2. If the environement starts to change, we'll look at that here.

And by the way, we expect to see a neutral-to-bearsh environment in Q2, so odds are that the support line will break before the resistance lines do. The 100 day moving average (which we rarely look at) is going to be the line in the sand. It's currently at 1280 - just a hair under that support line. A close under that mark should signal the transition into a mldly bearish mode.

Weekly Chart

Dow Jones Industrial Average Commentary

Lo and behold, the Dow took top honors this week, gaining 209 points to close out at 11,347. That's a 1.88% gain, which barely edges out the S&P 500's return. Like the S&P 500, a new 52-week high of 11,406 was reached. However, that was also where we plotted a major resistance line going back to highs hit several years ago. That's also where the intermediate-term resistance line is currently resting, so we see the Dow as - literally - right at its realistic ceiling. And as such, we're looking for this blue-chip index to sink in the near-term.

The likely landing point is somewhere around 11,000. That's where straight-line support is right now, squared between the 50 day and 100 day moving average lines.

Despite the fact that the Dow is setting up a pullback, notice the bullish MACD crossover, and the solid bullish volume last week. On a relative basis, the Dow may survive any pullback better than any other index. However, it's stil going to give ground if a correction occurs. In fact, that relative strenght indicates that a pullback is likely. Traders are moving pout of the more speculative and small cap names, and into the safer blue chips. That's usually an omen.

In terms of the biiger picture, despite the 'Sell in May and go away' rule, we're not going to adopt any major bearish stances unless the 100 day line at 10,990 is breached. The mini-correction we're looking for next is only toward the lower 11,000 area.

Weekly Chart

Friday, April 21, 2006

Weekly Forex Market Outlook


The Coming Week In The Forex Market

In the week ahead, light US data should put the focus on more key releases from around the world. The US is only due to report consumer confidence, existing home sales, durable goods and new home sales, but the Beige Book report may be worth watching since it was the perspective of the Fed that shifted market expectations this week. In contrast, the Eurozone will be reporting the region’s trade balance, German retail sales, German industrial production, the IFO report and Industrial production. The UK will be releasing retail sales, GDP, consumer lending figures and the Nationwide house price report. Even little Switzerland has their trade numbers due for release. Over in Japan, the calendar is also light, but in other parts of the Asia Pacific, we do have important data that could induce volatility in the Asian trading session. Australia will be releasing their consumer and producer price indices while New Zealand will be having their Intra-Quarter monetary policy review. Canada also has a monetary policy announcement where interest rates are expected to be brought higher, but before that, they are due to release their retail sales figures. Globally, we have the G7 Spring meeting in Washington this weekend along with the IMF and World Bank meetings, which means that traders should pay particular attention to the news wires for comments from policy officials. Overall, with the major breakouts over the past week, dollar weakness should continue to be a predominant theme unless we see the Fed shift stance once again or if Iran backs off from their nuclear program – neither of which is very likely at this point.

Forex Technical Outlooks

EUR/USD

Market Recap: The euro rallies against the US dollar and makes 2006 highs before stalling just shy of the 1.2400 figure.

Short-Term: Short term prospects favor consolidation / pullback as hourly oscillators show negative divergence on the last two highs at 1.2368 and 1.2393. Since the 1.3667 top in December 2004, there have been 3 major euro counter rallies with this one being the fourth. The past three were rallies of 613, 724, and 683 pips each. Placing the low at 1.1825 and assuming anywhere from a 600 to 700 pips rally, we can predict a possible top within the 1.2425-1.2525 zone, which is fortified by the 8/12/05 and 9/2/05 highs of 1.2485 and 1.2588 and the intersection of time and a line from the 1.3667 high and 3/14 high at 1.3477.

Long-Term: The 20 day SMA still holds above the 200 day SMA and the massive 11 month head and shoulders suggests that any weakness going forward should be limited.

Weekly Chart

GBP/USD

Market Recap: Cable skyrockets through 1.7600, 1.7700, and 1.7800 before being rejected at the January 25th high of 1.7934.

Short-Term: The extremity of the recent rally is such that the April 19th candle spent nearly its entire day above the upper Bollinger band. A correction / consolidation of recent gains is thus likely. Initial support comes in at the 23.6% fibo of 1.7373-1.7933 at 1.7800 with sustained weakness targeting the breakout / 3/6 high at 1.7624.

Long-Term: Longer term Elliott wave analysis would say that we are currently in a large corrective wave. 1.8000 should prove tough to break as it is not only psychological but also the 38.2% fibo of 1.9548-1.7046), and a failure to break that figure would send the pair back to the bottom of a weekly channel near 1.7100-1.7200 that would ultimately complete the corrective wave.

Weekly Chart

USD/JPY

Market Recap: USD/JPY has traded to and held its supporting trendline from May 2005, which currently sits at the 116.73 low made this week.

Short-Term: Key levels remain the long term supporting trendline and the flat resisting line from the ascending triangle near the 4/11 high of 118.87. The ability of the pair to hold the supporting trendline certainly lends a bullish appearance to the chart but conditions remain range bound until a daily close below/above one of these levels.

Long-Term: With the pair holding above the mentioned long term trendline, the possibility that the ascending triangle plays out favorable for bulls remains.

Weekly Chart

Key Events from Last Week

Dollar Turns on Weak Housing Data and Dovish Fed Minutes
M&A Flow Continues to Boost the Pound
Commodity Prices Skyrocket Sending AUD, NZD, CAD Higher
BoJ and Japanese Government at it Again
Dollar Turns on Weak Housing Data and Dovish Fed Minutes

Over the past week, we have seen a strong breakout in the currency market that was brought on by a fresh dose of weaker economic data and surprisingly dovish Federal Reserve meeting minutes. To the surprise of the market, in sharp contrast to the more hawkish FOMC statement released last month, the minutes from the latest Fed meeting show that FOMC members were actually more dovish. Their lengthy discussion of the housing market slowdown indicates that aside from many analysts, policy officials are also concerned about the potential impact of housing on the economy. This past week’s report of a 7.8 percent drop in housing starts, a 12 percent drop in single family homes to 16 month lows and a 5.5 percent drop in building permits are solid signs of a sector that is beginning to falter. However, most worrisome to dollar bulls was the fact that Fed members felt that an end of rate rises was probably near and some even warned against tightening too much. This is definitely more dovish than the market was expecting and should give analysts that were calling for 5.5 to 6 percent rates a good reason to back down. Yet, broadly speaking, inflation is still a big concern given the new record high in energy prices, so we should still see at least one or two more rate hikes, making 5 or 5.25 percent rates the most likely top.

M&A Flow Continues to Boost the Pound

Over the past few weeks, the British pound has benefited significantly from strong M&A flow. Most recently, US based Nasdaq announced that it bought a 15 percent stake in the London Stock Exchange in a deal worth $780 million dollars. This comes on the heels of acquisition mania back in March and highlights the growing attractiveness of the UK as an investment destination due to their business friendly regulations. The London Stock Exchange announced that they are also entertaining bidders for more stakes in the exchange. The NYSE has also expressed interest in partnering up with the LSE. Previously, Spain’s Banco Santander acquired Abbey National making a presence in the U.K. lending arena while Japan’s Toshiba picked up Westinghouse. All in all, the current merger wave, rising to levels not seen for six years, has boosted the value of deals that is currently running at $10 billion a day. The effects have underpinned benchmark equities which are higher by 7.3 percent on the year.

Commodity Prices Skyrocket Sending AUD, NZD, CAD Higher

One of the biggest stories of the week is the incredible rise in commodity prices. Oil hit a new record high above $72 while gold prices hit fresh 25 year highs above $640. This has led to sharp rallies in the commodity currencies, or specifically AUD, NZD and CAD. The relationship between commodity prices and commodity currencies has been particularly strong as of late and is expected to continue to be in the week ahead. We have already seen retracements in the commodity currencies off of Thursday’s retracement in commodity prices. If this continues, so should the latest currency movement.

BoJ and Japanese Government at it Again

Even though the dollar is capturing the headlines, over the past week the Japanese Yen has really been the weakest currency of the lot. The yen has sold off once again against all of the majors and this time, even against the US dollar. In some pairs like GBP/JPY and CHF/JPY, we are on our seventh day of consecutive yen weakness. Where does this bearishness come from? The answer is the government’s discomfort with the rise in long term yields. Finance Minister Tanigaki has been vocal about his concern for the recent rise in bond yields and has even asked the Bank of Japan to explain to the market their intention of keeping rates low. Instead of doing so, BoJ Governor Fukui on the other hand said that he feels inflation is improving and that rates should reflect economic fundamentals. The conflicting stances raises the worry that we may find ourselves right back where we were last year, which is in the heat of debate between the Bank of Japan and the Japanese government on what to do with monetary policy.

Thursday, April 20, 2006

The Trade Plan Process


Traders and investors must have an edge.

Ever notice that the market seems to zig just when it's completely obvious that it should zag? The market's direction typically defies conventional logic about half of the time. There's nothing wrong with using assumptions and logic to make market forecasts. However, you must absolutely concede to the fact that an assumption or a logical conclusion may be wrong. We're human, and as such, we're going to be swayed by fear and greed. That fear and greed, though, can warp our logic so much that we'll rationalize anything - even the wrong thing. When that happens, our logic becomes flawed and we become less profitable traders.

So how does one get around the problems that fear and greed can create? A trading system! Most readers may be assuming that by 'system', we're saying that you need a highly complicated piece of software that can test certain trade signals, and dozens of charts on your computer screen. These things are nice if you're a highly active investor, but you don't really need them. All you really need is a method that you know works for you. These may be moving average crossovers, momentum signals, or sector-based strength signals. It doesn't matter which one you use - you just have to become proficient at one of them and trade it consistently. In fact, one of the most famous trading systems is Bill O'Neil's "CANSLIM" method. You don't even need a computer to use that one, and it's a very passive method.

The point is, logic can be flawed, but a trading methodology can overcome flawed logic.

Traders and investors must be able to receive a trade signal from their systems.

If you only remember one thing today, remember this - most charts are ambiguous. It's especially critical that the pure technical traders understand this. These market technicians are completely reliant on chart data. This can be a problem, since at any given time, about 90 percent of charts are neither bullish nor bearish.

How many times have been looking for trades, and started to hunt just by looking at individual charts? You start with the symbols you know, then you go to the news to see if anything looks hot or cold to the media. After you look at twenty or thirty stocks, boredom and frustration set in, and you just start picking ones that look like they'll do. That's a mistake - you softened on your trade criteria and may have bought or sold a stock for a poor reason. You want to limit your trades to those 10 percent of stocks that are actually doing something. So how does one do this?

You have to have some method of receiving trade signals from your proven system. It's extremely inefficient to look for stocks that fit your criteria. Rather, you want these stocks to present themselves to you. This will not only save you time and frustration, but will provide you with opportunities you may have never seen on your own. There are plenty of ways of getting the data, but the point is this - give yourself an efficient way to actually get the data you need.

Bottom Line Trading

Systematic signals and signal scans go hand-in-hand. By taking fear and greed out of your selection process, you won't suffer from the problems of flawed logic. And by freeing up your time and focus spent on hunting for trades, you can focus on trade management.

Sunday, April 16, 2006

Weekly Stock Market Outlook


NASDAQ Outlook

The NASDAQ Composite actually had a pretty decent gain on Thursday, gaining 11.43 points to end the shortened week at 2326.11. That's still a net loss of 12.91 points (-0.55%) for the week though, largely thanks to a disastrous Tuesday.

But, as we mentioned in the MidWeek Update, the losses taken between Friday of two weeks ago and Tuesday of last week really pushed the limits, so to speak. Traders have generally stayed in bullish mode for the better part of 2006, meeting each big dip with an even bigger buyback. The 51 point loss over those three trading days pretty much matches the 'average' dip we've seen all this year, and each of those was met with some pretty solid buying. So, we basically expect to see a repeat of that this time around.

The most immediate question mark for the NASDAQ is the 10 day moving average line, currently at 2329. The composite managed to trade above that mark for a while on Thursday, but couldn't stay above it when the closing bell rang. Although the chart is setting up a bullish move, we'd be hesitant to dig in too deep until we closed above the 10 day line. That could happen as early as Monday though.

As for where it might end if the bulls finally do get some traction, set your first target at the recent 52-week high of 2375. If the NASDAQ manages to get past that, a move closer to 2400 or higher isn't completely out of the question.

As for support, the 50 day line at 2296 is a starting point. However, it hasn't been all that precise as support, so that's a loose support level at best. The lows at 2240 make a better support line, despite the fact that they're 86 points under the current level.

As for 'bigger picture', and rally the market manages to make now may be the last big one for a while. The spring/summer period is typically slow, and stocks have a hard time going anywhere. Pair that up with the fact that we're sitting on some pretty good-sized gains already, we wouldn't be surprised if the bulls yielded to the bears after this one last rush.

Nasdaq Weekly Chart

Weekly Chart

S&P 500 Outlook

The S&P 500's close at 1289.12 on Thursday was the result of a 6.38 point loss for the four day week (-0.5%). However, most of that loss was inflicted on Tuesday, while the last two days of the week were actually mildly bullish. The index still closed under the 10 and 20 day lines, which is technically bearish. However, we've seen the SPX fall under the 10 day line four different times this year, and none of those times really turned into a significant selloff. So, that's why we're not even going to entertain the bearish idea this time around. If anything, we have better reasons to be bullish.

Thursday's close (and Tuesday's and Wednesday's for that matter) were all right at the 50 day line. While it's not been a perfect support line this year, it's been pretty darn close, sending the S&P 500 chart higher each time it's been hit. It looks like the bulls are working to make that happen again, with the major selloff being abruptly halted there. But that's not all.

The CBOE Volatility Index (VIX) has indeed peaked as of Wednesday. It opened lower, reached a high of 13.90, then closed at 13.06. The bar shape is an upside-down hammer - the first sign of a reversal. The next day (Thursday), the VIX fell al the way to 12.38. Stock obliged by starting to head higher, although not with quite as much conviction. We think the SPX will keep heading higher now that the VIX is pointed lower when regular trading restarts on Monday.

By the way, we now have a third bullish catalyst in play in the stochastic lines. They became officially 'oversold' on Thursday, priming the S&P 500 for a rebound, as they did on January 3rd and February 8th. Those rallies were good for a 25 to 35 point gain, which is about the same size move we'd expect this time around. From Thursday's close, that would put the SPX around 1310.....right where the index topped out a couple of times in the last three weeks. That said, each of the recent surges has also pushed the index into new highs, so there's certainly the potential for a little more than the 1310 level. However, we can't say it would be a gain of a whole lot more than that. We're entering into the slower period of the year soon, and that will make it tough to sustain a rally.

S&P Weekly Chart

Weekly Chart

Dow Jones Industrial Average Outlook

The scenario is about the same for the Dow as it was for the NASDAQ and the S&P 500, so we won't over-describe what we see on the Dow's chart. Basically, we think the selling pressure has subsided, and the bulls are gearing up for a decent upward move.

The one thing we'll highlight here is that the 50 day line has been near-perfect as support for the DJIA. plotted in purple below, the 50 day line has been the precise bounce point on three separate occasions over the last few months. Granted, it wasn't the bounce point in late January, but the odds still favor viewing it as one now. Plus, being stochastically oversold is making this chart ripe for an upside move, like we saw in late January and early March.

Like the NASDAQ, we'd feel a lot better about being bullish once we saw a close above the 10 day line. It's currently at 11,152. And really, a close above the 20 day line at 11,198 would be better. As for hoe far the Dow could go once unleashed, the last few bullish moves have been on the order of 200 to 400 points. That means the blue-chip index could see 11,400 or so within a couple of weeks. Yes, that's a new 52-week high, and should be tough to do. However, we'll remind you that the last three big bullish legs have al taken the Dow to new multi-year highs. So, it's not as big of a barrier as you might think.

That said, keep a close eye on things when-and-if we get to 11,300. That's the most recent high spot.

As for support, the 50 day line at 11,086 is the line in the sand.

Dow Jones Weekly Chart

Weekly Chart

Friday, April 14, 2006

More Option Trading Education


Option Exercise / Assignment

As we discussed in previous columns, most people who trade options want to take advantage of leverage. Their objective is to pay little to control an asset and then, if the asset moves in the desired direction, to sell the option and make a magnified percentage on the option. They're betting on the movement of the asset. They really have no desire to own the asset itself. The terms "exercise" and "assignment" both mean essentially the same thing. It just depends on which side of the transaction you're on.

Remember, when you buy a call, you have purchased the right to buy shares at a particular price. If, for some reason, the trader actually wants to buy the stock, he notifies his broker that he wants to "exercise" his option and to purchase the stock.

The person who originally sold the option has therefore been "assigned." He has to live up to the obligation he took on when he sold the option. In the case of the call option, he has contracted to provide a certain number of shares at the specified strike price.

When you buy an option, and the stock moves well beyond the strike price, it will require an action on your part prior to expiration. Likely, you will simply sell the option back to the market and take a nice healthy profit. However, if no action is taken, your broker will assume you want to exercise your option - and will do so. You may not have sufficient funds in your account to purchase the stock. You can get into some deep _ _ _ _ (trouble)! So, it's important that you have a good understanding of exercising and the assignment of options.

Some traders play the very dangerous game of "selling" uncovered (naked) options. These traders are taking on substantial, and often unlimited, risk because the sold options are not hedged in any way. When a trader sells an uncovered call, he is betting that the underlying asset will finish (at expiration) below a specific strike price. Conversely, when a trader sells an uncovered put, he is betting the underlying asset will finish above a specific strike price.

Example A: XYZ stock is trading at $38. The trader believes XYZ will finish below $40 and sells the $40 strike price and takes in a premium of $1.50. If XYZ, at expiration, closes below $40, the short (sold) call will expire worthless and the trader will retain his $1.50 profit. But, what if XYZ rallies to finish at $46? The trader has an obligation to provide shares to the option buyer at $40. That means he has to go out into the open market and purchase shares at $46 to satisfy his obligation. He bought the shares at $46 and sold those shares at $40 - a $6.00 deficit. He had taken in $1.50, so he has incurred a loss of $4.50.

Example B: ABC stock is trading at $52. The trader believes ABC will close above $50 and sells the $50 put, taking in a $2.10 premium. If ABC, at expiration, closes above $50, all is right with the world, the short put expires worthless and the trader keeps the $2.00. However, if ABC falls to $39, the option seller has to satisfy his obligation to buy shares of ABC at $50. That represents an $11 deficit. He took in $2.00 of premium. That translates into a net loss of $9/share.

Trading uncovered options requires meeting certain experience, and often account-size, criteria. Don't even think about it. At this point, this is for informational purposes only.

Option Cycles

Stocks that are optionable will always have options available for the current month and then for the very next month - no exceptions. If it's April 1st, there will always be options available to trade for the April cycle and the May cycle. Once the April cycle is over (after the third Friday in April), May becomes the current cycle and June options will be available.

What additional option months are available to trade beyond the current and subsequent months? That depends on the underlying's option cycle.

Every optionable stock is assigned an option cycle. Each option cycle consists of four option months spread out over the year -- the "January Cycle," "February Cycle," and "March Cycle."

The January Cycle includes the months of January, April, July, and October. That means that, regardless of the date, those option months will be available to be traded. Similarly, the February Cycle includes the months of February, May, August, and November. The March Cycle includes March, June, September, and December.

So, when you look at a complete (all months) option chain, you will be able to immediately recognize which option cycle has been assigned to a particular asset.

An Exception: Many optionable stocks (but not all), especially the more liquid ones, will have what are called LEAPS options. LEAPS is an acronym that stands for Long-Term Equity Anticipation Securities. LEAPS are just long term options - up to about 2 ½ years out - that are available for trading - all with January as their expiration month.

At this writing (April, 2006), some stocks have LEAPS going all the way out to January of 2008. In June, some stocks will be offering LEAPS going out to January of 2009. The point is, on all stocks having LEAPS, there will be January options offered for those years - regardless of the option cycle assigned to that particular stock.

Monday, April 10, 2006

17 Steps to Becoming a Great Trader

Dr. Van Tharp - International Institute of Trading Mastery

What ARE the 17 Steps? by Dr. Van Tharp

Dr. Tharp offers unique learning strategies, and his trading education techniques for producing great traders are some of the most effective in the field.

I have worked closely with traders and the markets for over 20 years. I have seen the good and the bad, which has given me experience and insights into what works and what does not work in the trading game. The same questions, fears and lessons continue to rear their heads year in and year out.

I believe that there are a series of steps and important questions that any trader must address to work consistently and long term in the markets. Through my many years of coaching I've managed to evolve this information into a series of 17 steps.

Lets take a look at the 17 steps one by one, with the first of the eight steps involving the development of a sound business plan.

First, assess your beliefs about trading and about yourself. Although it is difficult to grasp, did you know that nobody actually trades the market? Instead, you always trade your beliefs about the market

Second, determine your objectives for trading. System experts know that understanding your objectives thoroughly is half the battle in developing a system but most people have never taken the time to even consider what their objectives might be.

Third, understand the big picture. What is the market doing overall and how can you measure it for yourself? It is important that you know how to determine the big picture for yourself and how to measure it.

Fourth, include three strategies that are compatible with the big picture in your business plan. Although there are thousands of systems out there, there are not many types of strategies. Know the essence of ten key strategies that you could use, the general picture of how they work and how you can adapt them for yourself.

Fifth, understand what your personal edges might be and how they set you off from the crowd. Having an edge in the markets is not just a slight advantage. It could be the pivotal difference in your success. So it is very important to list your edges in your business plan and be able to capitalize on them. You need to know the key edges that almost any investor has over market makers or institutional investors. Or if you are a CTA, hedge fund, or portfolio manager, you need to know what your key edges might be.

Sixth, understand the key systems that almost every business must understand and start to think about developing structures for those systems. From marketing to cash flow, to back office and clients, trading is a business and should be regarded as such. More importantly, developing the right structures and systems is crucial for business success. For example, if you are a private trader, you must deal with clients, even if those clients are you and your family.

Seventh, develop a worst-case contingency plan. Most people don not even consider this crucial component until it is too late, but the key to a successful business plan is to be able to overcome disaster.

Eighth, select your trading market based upon two key factors. Learn what you need to know so that you can determine the following: Are you going to trade stocks? Are you going to trade futures? Are you going to trade mini-forex or real forex through the big banks? Are you going to do options on any of these? What market will you trade? Whatever you select must take into account the big picture and what is likely to happen in the next five to ten years.

Ninth, know about strategy preparation. There are several key sub steps that you should take before you think about trading. You need to know what you should do to get ready and how to follow up.

Tenth, know the key steps in strategy development and how to test for each. You will need to understand how to test exit signals, determine what your initial risk will be, and select and test your profit taking exits.

Eleventh, properly evaluate your system. Know what information you will need to gather to really test and compare your system with any other system. It's good to have a formula that will allow you to compare your system with any other system in the world and rank that system. Thus, you will know whether your system is weak, average, good, excellent, or superb.

Twelfth, master a simple way to get to know your system well without a lot of cost. You need a method to understand if your back testing is accurate. And, to understand what the worst-case scenarios will be for your system. Through this testing, you will be able to develop a simple position sizing model to fit your objectives.

Thirteenth, work on your objectives to actually develop position sizing models. This step is one of the keys to developing a system that fits you.

Fourteenth, know how to do a complete self-assessment. A successful trader needs to know the answer to these questions: How does my personality type impact trading? What is the most important attitude that I must have as a trader and how can I assess if I have it? What are my beliefs and values and how can I assess them? How do I begin to assess my key issues so that I know what could happen that might really interfere with my trading?

Fifteenth, commitment to do what it takes. There are many things you can do on a regular basis to really improve yourself. And if you have the commitment to really doing them, you will be unstoppable.

Sixteenth, how to develop a top down approach to discipline. Few traders have the kind of discipline needed for successful trading, but if you combine top-down discipline with regular self-work, you will be amazed at the difference in your trading.

Seventeenth, put what you know into action. Learning and studying are very important factors in any endeavor, however the only true way to be successful as a trader is to take action. Getting in there and learning from your experiences.

These 17 steps are explored in full detail by clicking the 17 Steps to Becoming a Great Trader title header link above.

Dr. Van Tharp - International Institute of Trading Mastery

Sunday, April 09, 2006

Weekly Stock Market Outlook


NASDAQ Weekly Outlook

Everything was just fine for the bulls until Friday, when the NASDAQ Composite lost 22.15 points (-0.94%) to close at 2339.02. That meant a tiny loss for the week, of 0.77 points......we'll call it a breakeven. Interestingly, the big reversal came after the composite hit a new multi-year high of 2375.45 in the opening minutes of trading.

As for what's next, that close at 2339 was suspiciously close to the 10 day moving average line. In fact, it's right on top of it. So the question is one of whether or not the 10 day line will hold as support. Given the overall scenario and chart, we have to say that it's already proven itself as a support line, which suggests that the market is likely to stage a recovery after Friday's fiasco, and keep pushing into new-high territory.

While it didn't do such a great job of it early in the year, the 10 day average became the support line of choice with this latest runup. On March 24th, 29th, April 4th, and now the 7th (for the most part), the 10 day moving average (red) halted the NASDAQ's decline and prepped it for the next move higher. We're going to assume it will continue to do so until it clearly stops acting as support.

At the same time, we see something a little more ambiguous on the NASDAQ's chart. Between mid-January and late March, the composite was moving sideways, stuck in a range. The 10, 20, and 50 day lines were pretty well entwined, as the index went nowhere. But now, we could be seeing a case where the consolidation phase is over, and stocks are back on the move.

The problem with that scenario, however, is that the Dow and the S&P 500 didn't go through that same consolidation period. Both of those indices were going pretty much higher while the NASDAQ flopped around.

For that reason, along with the fact that it's still too soon to tell, we can't quite say that the NASDAQ has really broken out of its range and is ready to make the next move higher. However, we do see that as a distinct possibility. As for how far things might go if this is indeed a real breakout, we'd have to say not too far. The coming months are the slowest time of the year for stocks, and investor optimism is still unsafely high. However, we might see a little more upside before we actually run into those two headwinds.

Our bottom line support is at the 50 day line, or 2300.

NASDAQ WEEKLY CHART

Weekly Chart

S&P 500 Outlook

The S&P 500 managed to squeeze out a tiny gain of 0.65 points for the week despite the 13.55 point (-1.04%) pullback on Friday. As with the NASDAQ, a gain that small may as well be called a breakeven, as it sure wasn't impressively bullish. The S&P 500 closed at 1295.50, and under some key short-term moving averages.

Those short-term lines were the 10 and 20 day lines, which had been holding up as support until then. Are we concerned for the bulls? Yes, and no. Anytime you're under the 10 or 20 day average, the short-term trend is clearly not all that positive. However, we also have to keep in mind that we've made several short-term trips under the 10 and 20 day lines since December, yet the SPX has more than recovered from all of them. So no, the bulls don't need to panic yet. The bulls really only need to get worried when-and-if the S&P 500 falls under the support line traced by this year's lows. It's currently at 1280, which leaves some room for a little more selling.

In fact, any recovery may not even need to start from that point - it could start as early as Monday, fueled by Friday's sudden plunge. There are two things setting up that possibility. The first one is that the S&P 500 is very near its 10 day low. Some of the ongoing testing we do here at BigTrends has revealed that in a choppy environment like this one, 10 days is about as far as the market can go in one general direction before switching gears and turning the other way.

The other reason we wouldn't be surprised to see a rally early next week is the CBOE Volatility Index, or VIX. You may recall in our prior Weekly Market Outlook that the one thing the bulls should fear the most is a steady, smooth climb in the VIX chart. In fact, we specifically stated that a volatile VIX spike would possibly spark a rally, rather then send stocks lower. As you can tell with the VIX chart on the bottom part of the image, we got such a spike. The last three times we got a VIX spike like this was at a short-term bottom (see the green arrows), so we have to wonder if the market will make it a fourth. Odds are good that it will, so we're actually thinking like bulls here. Just note that it might take a day or two for any rally to gain some traction.

The key support line from here is 1280. Unless we fall under that, we're probably not going to be able to find much reason to be bearish now that the VIX has moved away from its recent lows near 11.

S&P 500 WEEKLY CHART

Weekly Chart

Dow Jones Industrial Average Outlook

The Dow's 97 point loss (-0.86%) on Friday left it at 11,120 for the week. And like all the indices, that basically meant a breakeven for the blue-chip index. It closed 11 points (+0.10%) above the prior Friday's close.....not much to discuss there.

Despite the fact that the Dow Jones Industrial Average also closed under its 10 and 20 day lines, it's clear that the bigger-picture support line is still in play. It, as well as the 50 day line, is right around 11,080, so we're very close to finding a bounce point here. We'll just point out that this kind of micro-correction has become commonplace for the Dow, so we're not going to flinch with this one. The bigger trend remains bullish until that support line is breached.

DOW JONES WEEKLY CHART

Weekly Chart

Friday, April 07, 2006

Options Trading - Part 3 of 3


In our last column, we began to explore the wealth of information hiding in the Option Chain. We defined the columns and we went through the information to be had from the "symbol," "last," "change," and began the "bid" and "ask." Now, let's move ahead. I duplicated the option chain we used in our last column for the sake of consistency.

Options Table

Bid & Ask

Remember, if someone is looking to purchase the IBM April $80 call option, to find the posted price for that option they would look at the "ask" price - in our example: $5.20. If you already owned the $80 call option and wanted to sell it, you'd look at the "bid" price ($5.10) to see what you can get.

Notice that there is a $.10 difference between the bid and the ask prices. That is known as the "bid/ask spread." Where does that money go? Into the pocket of the market makers. That's how they get paid for making a market in that option. The amount they will ask for may vary from stock to stock and from option to option, but they will be there. Bid/ask spreads on some stocks can be as low as $.05 and as high $1.60 on others.

Being Represented

Now, look at the chain again - check out the IBM $75 April call. You'll see that the bid price is $9.70 and the ask price is $9.90. The bid/ask spread in this instance is $.20. Remember the definitions of the "bid" and "ask" prices. The "bid" is the most that someone (including the market maker) may be bidding to BUY the option. The "ask" is the most that someone (including the market maker) is ASKING FOR as they try to sell that option.

Just because in the IBM $75 call the current "ask" is $9.90, it doesn't mean you HAVE TO pay $9.90. You can offer less and see what happens. You can offer $9.80 for that option. The $.10 may not seem like a lot. However, if you're trading 10 contracts (equivalent of 1,000 shares), that $.10 represents $100. Is it worth it? Maybe. Maybe not.

When you offer the $9.80, the market maker now has a choice - he can compromise by $.10 and fill your order. The other choice is that he DOESN'T fill your order. He can simply "represent" your order to the market. He would do this by changing the bid/ask price to $9.70 (bid) by $9.80 (ask).

By trying to negotiate with the market maker, you are taking a chance. What if, while you're waiting to possibly get filled, IBM starts to move up? As IBM moves up, the $75 call option will get more expensive. So, if you were bidding $9.80 for the option before, the ask price might now have increased to $10.10 - without your order being filled. You would have missed purchasing the option in the hope of saving $.10. It's a calculated risk. Option buyers (speculators) are taking a shot in the dark to begin with. Taking that extra risk for $.10 is consistent with the gambling mentality, but not necessarily the wisest thing to do. But "wise" and "traders" don't often appear in the same sentence.

Another example: Look at the option chain again. This time, let's look at the put (right) side of the chain. Notice the IBM April $90 puts are bidding $5.30 and asking $5.60. Assume for a moment that you previously purchased the $90 put and now you want to sell it. Currently, the market maker has posted $5.30 as the price he would pay you for that option. However, you might want to receive $5.40 for the option, so you place your order for $5.40. Again, the market maker has two choices - FILL your order or REPRESENT your order to the market. If he doesn't fill your order, he will have to show a new bid and ask price. It would change to $5.30 bid price and $5.40 ask price. You assume the same risk that we discussed in the previous example. IBM could move up. As IBM moves up, the value of the put option will go down and you may miss the chance to sell your $90 put option at a good price. IBM may come back down later or tomorrow, but, then again, it might not.

Just keep in mind that the market is constantly changing - especially stocks that are liquid and are regularly in the news. Will IBM move up or will it move down when you're ready to buy or sell? You have a 50% chance of being right. You might as well be flipping coins. Want to take that chance? Regardless of how foolish that sounds, there is a bottomless pit of people who think they can outsmart the market. They think they can look at a chart and determine where a stock may go. As the saying goes, a trader and his money are soon parted - except the original word "fool" has been replaced by "trader."

You may or may not choose to use certain strategies. However, it's important that you know and understand the concepts so you can make educated decisions. You probably worked hard for your money. I'm just trying to help you keep as much as possible and possibly make some more along the way.

Volume

This one is easy and can be useful. "Volume" represents the number of option contracts that have been traded on that particular trading day. We don't know, at that time, if the options were purchases or sales. All we know is that the options were traded.

Look at the IBM $85 call. According to our option chain, 1,074 contracts were traded that day. Maybe 750 of them were purchases and 324 were sales - we just DON'T KNOW! It could be any combination. All we know is that there is interest in the $85 call. It's no big surprise because the option strikes closest to where the stock (IBM) is trading are usually the most active.

Open Interest

This is an interesting number. "Open Interest" represents the total number of open contracts that are in existence since the option was opened for trading. An open contract means a position that has been initiated and not closed. When you purchase 10 contracts of the IBM $85 call, that translates into 10 "open" contracts - and those 10 contracts will be added to the Open Interest number. When you sell those 10 contracts, whether for a profit or a loss, that will be become "closed" and deducted from the Open Interest number.

Open interest numbers are calculated and available for the opening of the next trading day. If you open a new position by buying 10 contracts on a Thursday, these 10 contracts will appear in the "Volume" column, but they will not be represented in the Open Interest number until Friday.

Next Time

We'll discuss more about Option Chains, bid/ask spreads, option cycles, and more.

Wednesday, April 05, 2006

Options Trading Education & Training

Options Trading - Part 2 of 3

Option chains have a ton of information. Much of this information you will need when making your decision of whether or not you want to trade a particular option. Look at the option chain graphic below. It's an option chain for IBM options for the month of April. This snapshot was taken on March 21, 2006.

This is not the only month options are offered for IBM. Similar chains are available for May, July, and October of 2006 - plus longer term options (called LEAPS) for January, 2007 and January, 2008. For now, we'll be focusing on the April, 2006 option chain.

As you can probably see, the chain is divided into two sections. Information on the pricing of "call" options is on the left while the "put" option pricing is on the right. Separating these two sides is a column labeled "Strike." This column has a list of the different strike prices that are available for IBM. Each stock will have its own list of available strike prices, depending on where the stock is trading.

Let's check out the column headings so you'll have an idea of what you're looking at. Much of this information is important, while some is not. Let's go from left to right.

Options Table

Option Symbol (Symbol)

Every single option has a specific symbol. These symbols are important and are used when placing your trade orders. Most symbols consist of five letters - the root, the expiration month and the strike price. The first three letters represent the "root" of the option. They identify the underlying security (in this example "IBM").

The fourth letter in the symbol represents the month. In our example, "D" is used for call options for the month of April. January calls are "A"; February calls are "B"; March calls are "C"; April calls are "D"; and so on, up to "L" for December calls.

The fifth letter in the symbol represents the strike price. They begin with "A" representing $5, "B" = $10, "C" = $15, "D" = $20, etc. Now, if you remember, there are 2 ½ point strike price increments under $25. The "U" = $7.50, "V" = $12.50, "W" = $17.50, and "X" = $22.50.

Look at our graphic. Go down to the $80 strike price on the call side. Look at the symbol in the first column on the left - IBMDP

IBM = root for IBM

D = month of April

M = $80 strike price

Last Price (Last)

This number reflects the last price at which this option was traded. Is this price important? NO. Why not? Because it's not necessarily an accurate representation of the value of the option. One doesn't know when the last trade took place. The last trade could have been two minutes ago or two hours ago. As you know, the price of an option moves up or down in relation to the movement of the stock.

Look again at our graphic. The $80 call shows the last trade as being at $4.70. When was that trade made? We don't know. You can get a clue by looking at the "Volume" (Vol) column. That tells you that there were absolutely none of the $80 calls traded this day. So, the $4.70 "last trade" must have taken place sometime earlier. And, we have no idea where IBM was trading when that trade was made. It could have been trading at $82 or $83 or $84. We simply don't know.

So, how do you know the true value of an option? You look at the current "bid" and "ask."

Change (Chg)

This is another bit of useless information - at least I haven't found any use for it in the last 12 years. Why? It's old news and based on the change of the last trade from the previous last trade. I suppose they wouldn't bother calculating it unless it meant something to somebody, but it escapes me. If you can find a use for it, good for you. There are more important things to think about - like food, love, and sports (not necessarily in that order).

Bid Price (Bid)

OK. Now we're getting to the good stuff. Those of you who have traded stocks before know that the "bid" price is what you can expect to get if you want to sell your shares. It's the same with options. If you owned a contract of the $80 IBM calls, you could sell it immediately at $5.10/share ($510 per contract). The "bid" price reflects an accurate reading of the value of the $80 call at that particular point in time. Remember, if IBM goes up $.30, the "bid" price will likely change. So, when you pull up a snapshot quote (like our graphic), the price is valid for that moment in time.

Ask Price (Ask)

The "ask" price is simply how much the market is currently asking for should you want to purchase the option. In our example, you would pay $5.20/share ($520 per contract) to purchase the April $80 IBM option. Again, this is a snapshot in time and the $5.20 price will move up or down as IBM stock moves up and down.

Since the "bid" and "ask" prices are constantly changing with the upward and downward movement of the stock, it's nice to have a data source that provides you with streaming quotes. Many brokerage firms offer real time streaming quotes as part of their trading platform - and it should be FREE!!

Streaming quotes will instantly change and make your trading life easier. Why? Because you don't want to have to keep requesting snapshot quotes every 30 seconds to get an accurate reading on the value of the option you're considering trading.

A key phrase here is "real time." Many data services offer you free "15 minute delayed" quotes - a perfect example of more useless information. Who knows where the heck IBM was trading 15 minutes ago? Not me. And it's certainly not worth the effort to try and figure it out - because we're only concerned with the CURRENT value when we're making our trading decisions.

Next Time

We'll dig further into the "option chain" in next week's article.

This Is Good Stuff

Just a reminder that, if you're new to options, these basic articles are valuable. Print these articles out so you can reference them at your leisure. This is your bible for the options basics. It's information you need to know before you risk your hard earned dead presidents - and it may very well become a collector's item. What better reasons can there be?

Monday, April 03, 2006

Weekly Market Outlook

NASDAQ Weekly Outlook

The NASDAQ's flat close on Friday still left it at 2339.79 for the week, which was a 26.97 point improvement from the previous Friday. And although a 1.17% rally for the week isn't red-hot, it's still a gain. Plus, a key resistance level was broken that should make it easier for the bulls to start getting traction now. So, we'll at least concede that the uptrend has a renewed fighting chance.

The key item on the chart this week is the move above the resistance line at 2333. We had seen this mark send the composite lower a couple of times, but the third time really was the charm. As a result, we now have a bullish divergence on the MACD chart, and a bullish volume trend as well. We're going to take those at face value for the time being, but also with a grain of salt.

Simultaneously, we're still skeptical too. The NASDAQ has hit 'new highs' before.....twice in the last few months. The first time was in November, which actually led to some decent short-term gains, but the index also stalled, then dipped slightly. The second instance was the move to 2333 in January, but again, the rally faded quickly, and the index got stuck in the mud for a few weeks. So while we'd normally encourage buying on a breakout such as this, we're concerned that this is just bait. It just happens to be pretty smart bait......the recent trading levels were just slightly above recent highs - just enough to provide a sense of a true breakout. The problem is the VXN is starting to drift higher again, although very quietly. Those two ideas are at odds with each other.

What we'd really like (ok, need) to see is a true breakout bar. The big outside reversal bar from January 3rd is an ideal example (lower low, higher high, higher close, rising volume) of what really needs to happen to spark a rally. We'd also settle from what we saw on November 2nd (open at low, close at high, rising volume. big gain) as evidence. We just haven't seen one of those big decisive days that usually jump starts big moves. (Those two example days are marked on the chart.)

Full Size Chart

Dow Jones Industrial Average Weekly Outlook

The Dow's 171 point selloff last week left it at 11,109, and it's 1.52% drop was the most bearish of the three major indices. Seeing that disparity, though, has become common. The thing is, we still wouldn't say the Dow's exactly in trouble - this kind of loss following a big gain is par for the course for these blue chips. From a bigger picture perspective, the fact that the Dow is still above long-term support and still above the 50 day line means even the Dow's uptrend is still pretty well alive.

In the short run, the lower and lower closes under the 10 and 20 day moving averages along with a MACD and stochastic sell signal has pretty much yielded the results you'd expect....bearish ones. However, with the 50 day line and that support line both at 11,000 now, we have to think that the Dow is actually poised to find support soon. A tumble under the 50 day line shouldn't be a big worry for the bulls, but if that support line (dashed) breaks, that will change the complexion of things quite a bit.

In any case, this truly is a tale of two markets. Some of the best opportunities that traders may be able to take advantage of as long as things stay choppy is the fact that the indices seem to rise and fall at the expense of one another. As for position and swing traders, just take that as a warning that not all stocks and indices are moving in tandem.

Full Size Chart