Patterns and Sticks in their time, Opera too

I thought I'd make a quick point about candlesticks and patterns in the context of a time frame. I know that candlesticks have been somewhat of a focus lately and we've talked about double tops and bottoms recently, so I thought I'd point out an observation I made this week.
Candlesticks, like chart patterns, are applicable to all time frames and have increasing signficance the larger the time frame. Take a look at this double top formation on the SPX this week. This chart of the SPY shows each candle representing 15 minutes. There is a Double Top reversal pattern that would have worked out nicely as a clear and clean entry point for a bearish intra day trade. There is even a confirmed Hanging Man candle pattern on the second top. One might even consider playing a downward break of the symmetrical triangle in the most recent day for a bearish continuation on an intraday basis.
(Click the image to see it larger)

But would this bearish entry make sense for an intermediate or long term entry? Looking at the daily chart, probably not. Of course, there are plenty of signs that the chart is weakening. My uptrending support line from March was broken and then acted as resistance. The incline of the trend is becoming less steep. This week shows three days with topside shadows followed by a big red candle on Thursday. One could look at this cluster like an evening star formation. It's not textbook, but it tells the same story. With the Investools study set, you will even find that the chart now shows 2 red arrows on the MACD and Stochastic. Nevertheless, the SPX is still in an uptrend and has now found support for the second time in recent weeks at the 20 MA. Though many things may be pointing us to look for a reversal, it is a bit early to call it a top here, particularly when the recent months have repeatedly shown us drastic down days followed by days and weeks of upward movement.

Finally, the weekly chart shows just how the candlesticks and patterns can be used to simplify everything in the bigger picture. It is really quite amazing when you think about the amount of information, news and action that is represented in that one simple candle. This image shows the SPX, DJX, Nasdaq composote, and Russel 2000. The SPX and Dow show very strong weekly candles with the most recent week resulting in a harami, which is a potential reversal. According to Steve Nisson, the Japanese will say that with a harmai the market is "losing its breath." I would say, though, before seriously worrying about a drastic bearish move, we should like to at least see this weekly pattern confirmed with a lower close at the end of this week. For now we must look at these markets in a strong uptrend as taking a very natural breather and perhaps a very healthy pullback.
The Russel and Nasdaq, on the other hand, are looking a bit more ominous. Neither have participated in the strength of the SPX and Dow in the last month and look to be more setup to roll over. The Russell small caps, in particular, have barely found life above the resistance level from late February. Of the "Gravestone Doji" which is seen on the Nasdaq, Nisson says that the Japanese call it this because it "represents the gravestone of the bulls that have died defending their territory."

I hope this is of some use to you. I just want to reiterate that the use of candlesticks and patterns are fantastic but must be appropriately applied to the time frame you are looking at.
On the subject of watching for a reversal, it is worth noting that the VIX has established a very clear level to watch for. Remember, "When the VIX is low(and starts to rise), it's time to go." 14.50 or so seems to be the magic signal for the moment.


So in addition to the ideas from the last post on REITs, Retail may be a good place to look for potential bearish setups if the market does continue to show weakness. We know that our COH has been taking it a bit on the chin lately. But this weekly chart of the $RLX shows a symmetrical triangle that could have big potential to the downside. Having shown relative weakness to the Dow and SPX recently, and with consumers being pinched by the high costs of gas going into the summer season, it would make sense that this sector might take a hit. As is noted in "Week Ahead" found in the strategies tab on the Investools site, Dell, Costco and Sears report this Thursday.


And now for a shameless plug:

As you may know, I am an opera singer.

In case you are looking for a little culture in the coming months, I thought I’d share the information on my performances this summer.
I will be singing in three different operas in June and July. In June, I sing the role of Basil Howard in The Picture of Dorian Gray, a setting of the Oscar Wilde novel by composer Lowell Lieberman . The music is quite impressive and the cast is a very good group of singers. This is being done with Center City Opera at the Kimmel Center in Philadelphia.

There are four performances but it is double cast, so make sure you buy tickets for one of these two dates when I’ll be singing. For more info on the company and these performances, go to their website.

My performances:
Wednesday, June 6, 8 PM
Sunday, June 10, 2:30 PM

In July I will sing two roles with the New Jersey Opera Theater, performing at the Berlind Theater at McCarter in Princeton. In Mozart’s Die Zauberflöte (The Magic Flute) I will sing Sarastro, the high priest of the temple of Isis. In Gounod’s Romeo and Juliet, I will sing Frere Laurent, the provider of poison. For information on tickets, go to their web site.
This is one of my favorite pictures from past performances with that company.

The dates for those shows:

Die Zauberflöte (The Magic Flute), Sarastro

Friday, July 13,8pm
Sunday, July 15, 2pm
Saturday, July 21, 8pm
Saturday, July 28, 1pm

Roméo et Juliette, Frère Laurent

Friday, July 20, 8pm
Sunday, July 22, 2pm
Saturday, July 28, 8pm

Both of the theaters where these performances will take place are ideal for seeing and hearing opera in a more intimate environment. I think they seat somewhere around 600 people. The casts are all young, up and coming talent. So there will be no old, tired, park-and-bark singing here. So come on out to the opera!

For a few last laughs, here's a picture of me as Sarastro in a children's production of The Magic Flute in Zurich. The costume was all mirrors from head to tow. By far the heaviest costume I've ever worn. Not very mobile, but it made quite an affect under the lights on stage.

Here's a picture of me as one of the waiters in Rosenkavalier. Baron Ochs refers to them as Maikäfer, a type of bug that comes out in Spring, so the designers decided to have us painted up as bugs in very nice, linen servant outfits. They do some crazy stuff in the German speaking countries. I won't show you the picture of me as an "old servant" dressed in tight, white boxer briefs and a pink, silk ladies bathrobe with a choker around my neck!


The opera world is a strange and wondrous place.
I do recommend coming out to see any of the productions I'm involved with this summer, even if you've never been to the opera before. They're all good shows, and seeing opera up close is quite impressive. And for those worried about language, they will all have super-titles projected above the stage. I would recommend buying tickets very soon. Almost all of the performances for New Jersey Opera Theater sold out last year and I would expect them to do the same this year. And don't worry, there's not a bad seat in the house, so just buy whatever is available. Ideally, I'd recommend somewhere in the middle of the house and no closer than the first 3 or 4 rows. That way, there's a little room for the sound of the voices to come out and blend with that of the orchestra.

Market Posture and a close eye on CTSH

Because I won't be able to attend the meeting this week, I thought I would take my stab at identifying the trends of the market. In our last meeting we did a market posture that I recounted on the blog here. The end result of a very measured walk through all the angles was a bearish stance. It kind of stinks to do all that work and see the market rally in the next week. But should our stance on the market change?

Remember that this exercise is done with an emphasis on choosing an intermediate term stance on the market. That means a time frame of the coming 1-6 months.

• Long term, still bullish. Higher highs and higher lows.

• Short term, still bullish. Higher highs and higher lows. New high made this past week for this shorter trend. When we looked at it at the meeting, the higher low we had was just barely a higher low. It is now unquestionably a bullish short term trend.
  

• Intermediate term, I'd say we've changed from Neutral/Bearish to Neutral. We discussed that the former long uptrend of higher highs and higher lows was clearly broken. We appeared to have put in a lower high, but now that has been taken out and we're waiting to see if we put in a new lower high or if we power back up to and through the former high.

Look at these three views of the SPY, which I used for the reference of volume. It seems significant that though the recent high that we spoke about last week was broken this week, it was done with very low and decreasing volume before the holiday weekend.
(Click it for a bigger view)


The Market forecast shows the green intermediate term line heading up with room to go along with the longer term sentiment line having turned upward. These are bullish signs. This chart even shows that the 20 MA is headed upward toward the 50, which the index has reclaimed.


The VIX has moved lower to the bottom of its recent range, but I see it sitting right on support. My reading of it is that it would be more likely to bounce up from here than move down. This has a bearish implication, but until that happens and even if it does move lower, I will read this as Neutral. Here is a weekly chart.


Putting all this together, I would read the result of this market posture exercise as cautiously bullish. But because the intermediate trend of the SPX was broken and is now still is in question, I'm reluctant to fully embrace this rally. Though I may put on bullish trades, I will keep them on a short leash and I will continue to watch for bearish trades.

Back on January 28, I did a post suggesting potential for a sideways market. Perhaps it was a bit premature and wrong to think of some nice and orderly sideways market. But I may have also been on to something. Given the look of things now, it would not surprise me to see the market stuck in a range between 1375 and 1460 or 137.5 and 146 on the SPY. That's plenty of room for daily and weekly turbulence.

In a recent post I included a potential bearish setup on CTSH. (it's toward the end of that post) The support line hasn't broken yet, but after an attempted bounce the stock has now bounced down from the 30 MA. Thursday's candle was a dragon-fly doji star, much like hammer in its implications, though it has yet to be confirmed with a higher close. But, as always, the primary consideration is support and resistance. Watch for that support line to break on big volume.


Have a great week!

Updating/weeding out the list

Today the market had very respectable and possibly encouraging gains. But judging from the volume on the major index ETFs, trading was not heavy enough to look at the day's action as a convincing change of sentiment in the market. This images shows a daily chart of the three majors since November with a 30 day Moving average. All of them have areas of likely resistance to overcome before any serious bullish posture could be entertained again. In addition to resistance levels from price action, the descending 30 MAs might just might provide another influential nudge to the down side.
It should be noted that they all are in a double bottom reversal pattern, but there are a few things to consider. 1) The pattern is meaningless until the resistance from the high between the two bottoms is broken. 2) A bullish reversal should come at the bottom of a bearish trend. The recent bearishness is really just the first breakdown of a very bullish trend and not yet a trend with lower highs and lower lows(I'm looking at SPY on a daily closing basis). So, looking for an upward "reversal" seems a bit premature.
(Click for a larger view.)


While the market is sorting itself out, this is an ideal time to rebalance our lists. Everyone should be working on a bearish watchlist. Despite the current state of things, I think we should always focus on the primary watchlist for the group as a bullish watchlist. After all, that direction is the ultra long term bias and nature of the market. Besides, many people may not be interested in or comfortable with shorting the market or trading bearish. When the market does resume its strength, we want to be ready with a list of well chosen stocks that are likely to be among the first and strong participants of a new rally. But first we've got to get rid of the current stocks that are less attractive at this point.
I mentioned a few thoughts about trimming down our list a few posts ago. Here's a complete run down on what I think should go and what should stay.
First: here's a look at the list and how it scores in the Investools Phase 1 and Phase 2 analyzer.


The simplest way to start is by getting rid of KBH, UNT and ZMH because they have a combined F/E score of less than 3.25. I'm a bit sad to see ZMH go, particularly as it continues to work on a new 52 week high. But the growth estimates is less than our ideal 20% and it is estimated to grow at a pace slower than its group this year and also in the next 5 years.

Also, because the Estimates score is forward looking, we'd prefer for that score to be the stronger of the two, if possible. For that reason, I'd also like to see CRDN, WCC, and BHI leave our list.
CRDN - Growth estimates are a low 7.5%. Also estimated to under perform its group this year and next. Set an alert on this one for when it breaks 62.50 and forget it.
WCC - Growth estimate is less than 20% and it is estimated to under perform its group this year and next. It's been in a range between 55 and 70 for about 9 months. Set an alert to notify you if it goes above 70 and forget it.
BHI - It is actually very attractive from a valuation standpoint. PEG is .45 with a P/E well under its group. But the most recent earnings miss and the current and next year's estimates for earnings growth well below the group look like red flags. The chart is a mess with the gap down on the recent earnings announcement. It has also not participated in the latest rally attempt in the Oil Services.

The others:
ICE - Has had an incredible run and the trend has broken. PEG of 2.19 looks a bit overpriced. I'll be looking for potential bearish entries on this on a bounce down from 135 or a break of 125.

NTAP - It had a strong reaction to the recent earnings announcement in February but couldn't follow through and with the market selloff on the 27th, it gave back all the gains from the earnings jump. 36 remains important support, recently confirmed by a nice hammer formation. But once that breaks, things don't look good. Again, this has a high PEG of 2.24. Institutions own 87% of the shares outstanding on this stock. Once they start selling, look out below.


HWAY - This stock has just been boring! The fundamentals are still quite good, but I'd like to get rid of it if or no other reason than that it trades well below an average 1 million shares a day. As a result, there's not a lot of open interest throughout the options chain.

VSEA still looks to be a reasonable valuation with strong fundamentals. So I don't see great fundamental reasons to take it off the list. But I'm nervous about the chart. It has seen great gains in the last 8 months. More impressive is the strength of its chart compared to the SOX index in the last 4 months and it is now working breaking recent resistance to an all time high. But the chart looks like it could be ready to roll over. It broke a long term trendline in January and rallied back up to find resistance on the underside of that line. It now looks to be in an ascending wedge, which tends to resolve to the down side. With a big bearish engulfing candle strengthening resistance at 50, a reversal could be at play here.


CWTR - Though the fundamental scores are still pretty good and the valuation is actually quite attractive, I think this industry comparison chart says it all. GONG!

RIMM is pretty expensive, but it has held up impressively in the recent market selling. We should wait to see what happens at the earnings announcement on April 4. Or maybe we should not include stocks over $100. Thoughts?

In Summary, here is my recommendation for the list:
KBH Cut
UNT Cut
ZMH Cut
CRDN Cut
WCC Cut
BHI Cut
ICE Cut
NTAP Cut
HWAY Cut
CWTR Cut

Keepers(for now)
VSEA Give it the benefit of the doubt until it breaks down
RIMM Hold 'til earnings, at least
COH This actually has 3 green arrows right now
AAPL Apple rolls out a bright iFuture
CTSH Just ranked 15th in the Businessweek 50 best performing companies. Setting up for a new batch of green arrows.

So how does that strike you? Please let me know if this assessment of things is agreeable or if you see certain stocks differently than I and would like to take different action. Once we agree on the stocks to get rid of, we can begin to find replacements. We still have over a week until our next meeting, but perhaps we can get some ideas flowing between now and then. If you respond with ideas, I'll try to respond and include charts. If you want to mock up a chart with what you're seeing, I'd be happy to post that too on that blog.

Credit Spreads for a weakening market

If I had to make a prediction, I would say that this channel on the SPX is about to be broken. MACD and Stochastic are clearly rolling over. After a week of trying to hang onto the 1450 level, the market gave up and retreated south. The 1430 level now represents the convergence of the 30 day MA, the rising support line from the Channel since November, and potential horizontal support from a recent line of resistance. Breaking that area and the recent channel would be a major red flag. Breaking below the 1420 area would be an official lower low.

The Nasdaq isn't any prettier with what looks already like a lower high.


This weekly chart of the VIX isn't all that scarey looking. 12.50 remains the level beyond which we know there is a major change in progress. (I'm setting an alert for my own personal, instant newsflash.) The last week of action on the VIX doesn't look too bad, but it is noteworthy that the entire range of this weekly bar, shadows included, was made on Friday.


So it seems that at the very least, the uptrend is in jeopardy. If we are going to be headed generally sideways if not down, selling calls and doing credit spreads will be more suitable than going long stock and calls. In addition, if the market does begin to break down and VIX begins to rise, this will be accompanied by a rise in implied volatility which factors into the time value of options, making them more expensive. If they become more expensive, it is more advantageous to be an option seller.
If you have stock positions that look to be peaking or going sideways, consider selling March calls on them. Right now we're right in that window of 20 to 40 days before expiration. This time period is where we want to be selling calls in order to capitalize on the last month and more rapid decay of their time premium. (Of course, the proper analysis must be done for each individual position and you must be comfortable with getting called out of the stock or buying back the short call early.)
But let's talk credit spreads. In short, a credit spread is a position made of selling one option and buying another creating a hedged, defined risk position in which the net cost of the two "legs" brings in a credit. Let's use the SPY.

If we owned the SPY, we could sell calls at 145 for $1.40. As long as the stock is not at or higher than $146.40 at March expiration, we will make more money on the position than we would on just the stock. (Note the January post in which I mentioned selling Feb 144 calls.) But what if we don't own the stock? Sell the 145 calls naked? We could do that, but it would require a lot of margin and would theoretically have unlimited risk because the the SPY could take off like a rocket and never stop. Let's make a credit spread out of it.

We can sell the March 145 Call $1.40 and take on the obligation to sell shares of SPY at 145 if "called out." In order to limit our loss and define our risk, we can buy a higher strike price as a form of insurance. Since those calls at a higher strike price will cost less than the ones we sell, the net position will be a credit. I'll choose the March 147 call which we can buy for .65.
The total position then would be a "vertical" spread, March 145/147 for a total credit of .75. It is often referred to as a "Bear-Call" Spread, because it is a bearish position that benefits from the stock going down and it is made of calls. (Bull-Put Spread is the other type over Vertical credit spread.) In the worst case scenario, the stock would fly higher than both sides of our position. In order to fulfill our obligation to sell someone the stock at 145 we could use our right from the purchased call to buy the stock at 147 no matter how high the actual stock price. This makes for a max risk of $2. But with the credit that we took in on the position, we actually are only risking $1.25. The potential return on risk here is .75/1.25=60%.

I should note that I am not going to trade this position. As the name implies, it is a bearish position(even if it makes money in a sideways market too). I am not yet bearish on the market. I think the position is actually not such a bad idea and could work out very nicely. But it's more a matter of what kind of trader you are and how you will manage your risk and where this fits into your portfolio.

The example is more for the purpose of at least attempting to introduce the concept of a credit spread before refering to them further. I have mentioned a trade on BHI that I intend to recount for you, but felt the need to do a general intro to what a credit spread is first. Also, because people seem to be more comfortable with calls than puts, I figured it'd be best to use a call spread as an example.

What I will get into on the next post is the prospect of reversing a trade. In short, if you put on a Bear-Call Spread and then the stock or index moves very aggressively bullish, you can close the short side of the spread by buying back the 145 calls for a loss. But by keeping the 147 long calls, you would then be in a position with unlimited profit potential. In doing this, we switch our position from a bearish one to a bullish one. This should not be done flippantly. I'll discuss further in my coming post on the BHI trade. (Sorry, I know I've mentioned it a number of times already and haven't done it yet. I just don't want to write any more at the moment.)

Be carefully out there. Choppy waters.

Sideways Market?

The market has shown amazing resilience in recent months. But it continues to show chinks in its armor. Most notably this week, the SPX had a nice breakout day demolished by a bearish engulfing day to follow it. That leaves the index kissing the MA and heading toward a likely third red arrow. If it does break the MA, it will also likely break the support line from the channel since November. Nevertheless, the tracks for a downtrend will not begin to be laid until the last significant low at support in the 1410 area is broken. Until that time, we have to assume we're still moving at least sideways, if not up.


The Nasdaq already has older red arrows on the MACD and Stochastic and a relatively fresh red arrow on the MA. Its breakout failed two weeks ago already, but what's most amazing is that the big bearish engulfing on Thursday of this week happened right at the old resistance line. It's just weird the way this stuff works out sometimes. In any case, sideways action seems even more likely on the Nasdaq, even if this 70 pt. wide channel is likely to be broken in the near future. The biggest message is that the uptrend is very much in question for the near future.


So this brings me to one of the basic principles taught by Investools. We should adapt our trading to the market. Though it may take time to become proficient and confident in such a variety of strategies, eventually we want to be able to make money in all markets, up, down or sideways. Here is the general application of strategies:

• Uptrending market- Long stocks(buying), long call options

• Sideways market - Covered calls, advanced options strategies(spreads, protective puts, etc.)

• Downtrending market - Short stocks(selling), long put options

Of course, advanced options strategies can be applied to all markets, but this is the simple ideal. Theoretically, the best way to take the most money out of the market if you know what you're doing.

With the assumption that we're moving sideways, let's explore what we might do if we were long shares of SPY. Assuming we're using the Investools method, the 3 red arrows are a sell signal. However, for the purpose of not getting whipsawed in an intermediate term trade every time we show 3 red arrows, we might use the "3 and 3 rule." This guides us to move our stop loss order up when we receive 3 red arrows to 3% below recent support or the MA. Using the MA currently at 142, that would put our stop at 137.74. (To find the level of 3% below support, just multiply the support level by .97)
Realize that because the SPY trades at 1/10 the size of the SPX this distance of over 4 points here is over 40 SPX points, seemingly quite a swing. If we're in a longer term position, that would be a fairly normal occurrence to ride out. But who likes to ride out a 40 point down swing? Perhaps the seller of covered calls wouldn't mind.

With the market showing signs of a sideways inclination but not yet a full blown down turn, three red arrows would be a good time to think about selling calls on our spy position.
Looking at resistance from the failed breakout being at 144, I would probably be most inclined to sell that strike price in case there is something of a bounce off the MA. This way, I'd still have some room to profit from the rise in the underlying shares owned.


Looking at the options chain as it is over the weekend(but will change somewhat at market open on Monday) we can get .60 for the Feb 144 call with 19 calendar days (15 trading days) left in its contract. With a credit of .60 taken in from the covered call, if we get called out upon the stock closing above 144 at expiration, our selling price will be essentially 144.60. One could also opt to sell the 143 for a higher credit, but the likelihood of being called out of the stock would be higher as you can tell from the Probability of Expiring (in the money) column.

One might even decide to sell the further out month to bring in more premium. Under 20 days out seems to be the recommended cut off for selling options, but 19 or 18 is probably okay if all the analysis is there. This is just getting into the rapid acceleration of time decay. Notice that the Theta is higher on the February options than on the March options. Ideally, as the stock moves sideways, we'll burn down most of the time value on the Feb call and then roll it(buy back the Feb call for cheap and sell the March call at the same strike price).

While the downside of doing covered calls is capping your potential profits, sometimes it is still quite attractive to squeeze out a little more juice from a holding. Though it is certainly possible that the SPX would rally more than 24 pts. to beyond 14,460 in the next 3 weeks, judging from the analysis above, it seems unlikely. So in this case, though we'd be very happy to see the stock move above 144 and call us out for this profit, the strategy is being employed to "generate income" on our holding as some people say, or better yet, reduce our cost basis on the shares owned.

Another interesting strategy taught by the people at Thinkorswim would be to do a virtual covered call on your entire retirement account, assuming it's in broad market funds. If you're in Mutual funds that roughly track the SPX, you could sell calls of SPY just like we did here. But since you don't own shares of SPY, they would be considered naked and you'd have unlimited risk since the index could shoot up to the moon. To cover the risk and keep it at a nice defined risk level, you would buy calls further out of the money than the ones you sold. You would then have the right to buy the stock just higher than where you'd obliged yourself to sell them to someone else. You could think about the bought calls as insurance. But being further OTM, they'll cost less than the ones you're selling. This creates a credit spread, in this case a Bear Call spread.
Using the quotes right now, it looks like a SPY Feb 144/145 call spread could bring in a credit of .30 or so, assuming we can fill somewhere between the bid and the mid price. Even if the market rallied hard and we lost the full .70 at risk in that spread, if the position were sized proportionally appropriate to your fund holdings, the profit in your funds would still compensate for the loss of this smaller position. Seems like a win/win situation. One could also do a bear call spread on the SPY even without mutual fund holdings, but you're then risking betting against an essentially bullish market without the benefit of an underlying component picking up profits if the market rallies.

Of course, selling calls or credit spreads does not negate the damage done when the market turns south. When the blatant sell signals are given to get out of the market, simply buy back any short calls or call spreads. Then, sell the underlying stock.

In closing, though I used the SPY as the model for selling covered calls on warning signs of an uptrend in trouble, this can of course be applied to stock holdings as they waver before either breaking down or resuming their uptrend.

On another subject, as if the whole risk factor hasn't been beaten to death lately by yours truly, here's an article from IBD on cutting losses short. Jeff Kohler has also recently done a blog posting about Position Sizing. Like mine, his postings are sometimes a bit on the casual side and less than definitive, but he gives good insights that are worth reading.

I will try in the next few posts to look at some of our stocks with an eye toward strategies for a sideways market.