General Observations

I have been reading a lot of comments by Fed officials that are leading me to believe that an increase in the money supply in the economy is on the way.   Fed officials are more afraid of deflation than inflation at this time.  An easy way to ward off deflation is to print more money.  The Fed can potentially add a lot more money to this economy by firing up the printing presses.  There is an old conventional wisdom in the stock market - don't fight the Fed.  If the Fed starts to increase the money supply a lot, more money may flood into the stock market leading to another run up in the stock prices.

Just looking at charts, I am inclined to believe that we are likely to spend some time oscillating between 9500 and 11,800 (DOW) with a possible revisit to the 7000 range in the long run.  In short, don't expect the markets to bust out into new highs anytime soon. 

Another example of Flag Pattern

Here is a chart of Ford (F) that has made a successful follow up to the flag pattern and is now, in what appears to be, yet another flag. Just remember, they cannot keep on going forever. 

The market has retracted back to its trend line now.  So the moment to truth approaches.  Will the market be able to find support and rally to test the overhead resistance or will it breach its uptrend line? So far the trend line is holding.  

Market / Position Update

Even though short term indicators are signaling an over bought condition, this market is acting very strong.  After a strong week, we are still barely retracting from the highs.  I would expect with this kind of market action that we could finally see a break to the upside where it will test the resistance around 10700 for the DOW (and may actually try to test 11,000 or so).   

I noticed a nice pattern on Goldman Sachs (flag pattern) earlier in the week.  Planned to buy some options but got too busy and forgot to buy.  GS broke out of the flag formation today to the upside.  I just saw it and jumped in with Aug 155 Calls at around 1.31 each.  The Flag pattern is one of the most powerful move patterns.  Its called the Flag pattern because the stock price moves up very rapidly (like a flag pole), followed by a short consolidation that may look like a flag.  A variation on the pattern is called a Pennant - where you have a formation that looks like a Pennant (triangle).  The Pennant can be even a more powerful pattern.  Now the stock has broken out of the pennant formation to the upside and will bear close watching.  If the pattern fails, one is advised to get out immediately.  But a successful breakout can net the investor with some nice profits.  One of the things I like about the Flag/Pennant formation is the the move is approximately known.  The stock will tend to move the same percentage amount as of the previous move.  So if in the first move, if the stock rapidly moved from 20 dollars to 30 dollars then formed a flag / pennant pattern, that is a 50% move.  The next move is also likely to be about a 50% move (from the bottom of the flag).  So if the flag takes the stock to about 26 dollars, the potential move target is around 39 dollars.  This helps me set an exit point that I can put a sell order for ahead of time.  I have made more money using this pattern than any other pattern in the books.  In times of bubbles (and yes, I love bubbles since the most money can be made in the shortest amount of time in those days) flag/pennant patterns are very common.  If you go back and look around the end of 1999 and early 2000, you will see these patterns everywhere.  Using this pattern, I think we are looking for about a 9% move in GS stock.  (Assuming a low of 130 and the top around 147 (average for the flag formation)).  So around a $14 move in the stock starting around 147.  We have already made about a $5 move from there.  I would start thinking about taking profits around 160.  (Although the stock has the potential to move to 172 or so as well).

Also, I am using front month options to play this position.  If I am wrong and the pattern fails, I am risking about 1.31 per stock that I would lose. But I am looking at a potential gain of around 350-400%  if the pattern is successful.  A pretty good risk in my mind.  The options are now at 1.30 bid and 1.46 ask.  So I am getting close to break even.  You must, however, realize the inherent risk in playing front month options.  Time decay really starts affecting the value of the option with a couple of weeks to go.  80% or more of all front month options expire worthless according to industry data. 

Good luck and happy trading.

Market update

It was a busy day for me and I got back home this evening to find that the market closed up yet again.  The DOW ($INDU) is now approaching the resistance point I mentioned earlier (in the 10,600-10700 range).  On a positive note, we now have a higher high and a higher low.  As a bull, I would take this to show promise that the downtrend may be over for now.  On the other hand, looking at long term charts, there is still the possibility that we are approaching the top right point of the right shoulder in a head and shoulder pattern (see older post for charts).  This may be especially true in a monthly chart.  What this means is that there is still money to be made in good stocks but don't commit a lot of your capital if you do play the market a bit.  I am experimenting a little using options to limit my exposure but I am still mostly in cash.  Once the DOW breaks above 10,700 with conviction, I will start taking a closer look at the market.  If the market gets rejected at that point, we may see a significant pull back. 

Some of my favorite stocks are showing leadership at this time.  ISRG (Intuitive Surgical) and CMG (Chipotle) are my top two favorite stocks at this time.  CMG has been showing excellent profit and since they announced the plans for opening of new stores in Europe, I would expect them to do well in the growth arena as well.  Intuitive Surgical continues to be the 800 lb gorilla in their segment.  I liked the earnings call and the fact that their revenue share for hysterectomies is increasing fast.  They are in the razor blade business.  Yes they make money from selling the machines, but the real money is in the procedures and the disposable supplies for the robots.

Stock Update:  Closed out the Sprint Nov 4 calls at 1.10 - pocketing about a 10-15% profit.  However, unless stock moves up a lot soon, I'll give that up in my losses in the Aug 5 calls.  This phenomenon has plagued me for a long time and I am trying to figure out how to improve on this.  I will get into a position and make a decent profit.  Then instead of taking the profits, I will add additional option positions but for a shorter duration.  I tend to do this more for cheap options (and cheap underlying stocks).  Most of the time this ends up biting me, but there are times when I have made a killing.  When I figure this out, I'll post my deductions here - until then if you have figured it out, feel free to leave a comment :-)

Becoming Cautiously Optimistic

We are starting to see some good earning reports out of the usual candidates.  ISRG and CMG have both blown away estimates yet again and rallied strongly in the aftermath.  ETFC has finally become profitable. We may see a very strong rally in ETFC in the next few days.  I may jump into that position again.  I say I am cautiously optimistic because the DOW has not yet crossed the 10700 mark.  We should flirt with that level next week and see if the bulls have the stamina to hang on and push thru that level. 

Short term options (really short term)

This is a very interesting development for option traders.  The CBOE has added weekly option contracts on individual stocks (known as Weekly's). Because of their short term, Weekly's may be cheaper to use and may provide investors with increased short-horizon opportunities for trading.  This could help investors take advantage of market events, such as earnings, government reports and Fed announcements.  For example,  Weekly straddles may be cheaper to play than monthly's.  New weekly contracts are released at the market open every Thursday and expire the following Friday at the close of the market.  Currently only a limited number of stocks have weekly options, but that list should continue to grow each week.  For a current list of stocks with weekly contracts available for trading visit http://www.cboe.com/publish/weelkysmf/weeklysmf.xls.

Not quite sure where to get latest pricing info on these since yahoo finance is not showing these options on their options page.  Check with your broker about the availability of Weekly's.

Of course, do not assume that the Weekly's will be cheaper than the Monthly's (they should be), or significantly cheaper enough to warrant using over Monthly's.  Until they start getting more wide spread usage, tread with care, please.

NetFlix Adventures - 07-23-2010

With NetFlix earnings about to be announced on 07/21/2010 after hours, an analysis of the chart showed that the stock was way extended.  However, there was quite a bit of bearish sentiment on the stock showing a high short interest.  I wanted to buy puts on the stock, but didn't like the prospect of a short covering rally that could take place if NetFlix beat their earnings.  So I decided to try out a Long Strangle.  A Long Strangle is a strategy where a long position in both a call and a put are opened but at different strike prices.  The maximum risk is the cost of the call and the put.  The maximum profit is unlimited on the call side and from breakeven ot $0 on the put side.  The stock was trading around 120.  I bought an August 115 put for around 5.70 and an Aug 125 call for 6.30 resulting in a net cost of $12.00 for the trade.  With the stock up almost 200% in the last year, I was expecting either a strong short covering rally or a fairly big drop if the company missed its earnings.  Please note that the premiums on the options are quite large so the market was expecting a similar move and taking the uncertainty into account. 

After NetFlix announced their earnings, they narrowly missed the wall street estimates (despite posting a 27% increase) and the stock moved down.  By the middle of Thursday, it appeared as if I would end up losing money on the trade since the call value had plummeted but the put had not yet generated enough revenue to offset the loss from the call side.  But the stock continued down and I was around break even by the time the market closed.  I was able to close out my put position for around 13.45 this morning resulting in a profit of 1.45 for the trade (not much really).  But I still have my call that has until Aug 20th to expiration and is worth about 0.75 right now.  I may, however, hold onto it, to see if we get a rally in NetFlix and I might be able to get a little bit more money out of it.  All in all, about a 12% return over two days (not counting my trade cost of $4 roundtrip) but it did cause some anxiety :-)   But I wanted to get comfortable with this strategy so I chose to dip my toes in the water at this time.

$INDU update - 07-18-2010

The DOW has managed to climb back above 10,000, but the last two days have seen the bears take hold of the market.  The charts are looking quite bearish as the moment.  The market must break the pattern of lower highs and lower lows if the trend is to reverse.  The bulls are looking for any positive news that can help reverse the trend, yet it seems as if every rally is another opportunity to sell.  I continue to stay in cash for the time being and watch the market for signs of reversal or an opportunity to go short if critical support levels are breached.

$INDU update - 07-12-2010

Let's take a look at what has happened in the last few days.
The DOW has rallied off the bottom strongly after reaching a severely oversold condition.
The daily chart of the DOW is fast approaching an over bought condition.  We may still have a few rally days left in the market, but its time to be careful. 
The weekly chart of the DOW shows that the DOW has still not broken thru the downtrend line. We are currently sitting at this line.  We should know soon whether the market can break thru this downtrend line or be rejected from it.  Also, last weeks volume was lower than previous week (granted it was a short week due to the holiday).  A rally on lower volume generally does not signal a trend reversal.  However, the fact that the market did not sell off after a good week is an encouraging sign for market bulls.  Maybe the market is taking a breather for now before testing resistence at 10600 level.

The monthly chart is still indecisive.  We will have to wait and see how things play out.

I will continue to hold me cash positions for now and see which way the market will head.

$INDU update - 07-07-2010

Strong rally today.  We have crossed back over the neckline.   If this holds in the weekly pattern, we could have a failure of the head and shoulder pattern.  A failed head and shoulder pattern is very bullish, meaning most of the sellers have already exited the market.  So we could now have a strong rally.  I would closely watch the 10,000 level for the DOW to see if we can continue to hold above it (the DOW broke to the upside in the last half hour). If we can hold this level you can easily see a rally to the 10,600 vicinity.   At least a good short term money making opportunity.

$INDU update - 07-05-2010

On Friday, market looked like it was going to hold and make some kind of rally (which I found quite surprising since I thought people would not want to hold long positions over a long weekend).  But in the end the sellers took over and the market closed down.  We now have a definitive break of the neckline of the head and shoulders pattern.  This is very bearish for the market.  I would expect the market to not drop a lot immediately.  It should drop a little (maybe hit the target I mentioned in an earlier post around 9500).  I would then expect a rally back to the neckline around 9850 give or take a 150 points.  But 10,000 is the real test.  If the market cannot break back above 10,000 in the next 3-4 weeks, I would expect a large drop in the market to follow.

Even if the DOW makes it to around 10,650, its still now out of the woods, since that would show the formation of a monthly Head and Shoulders formation.

Again, all we can do is watch and continue to stay out of the market for now.  The big decision will come if the rally takes us back to the neckline.  I may be tempted to play the market short at that time.  But there is old wisdom "never fight the Fed" and we know that the Fed is doing everything it can to help the economy along.   We will pay for the rescue in the long term but betting short term against the Fed can be scary.  Unless I am convinced that a big drop is coming, I am likely to just stay out of the market and maintain my cash posture for now.

With the European and Asian markets posting losses on Monday,  and the precious metals index ($XAU) showing weakness and a potential top, there is much to be worried about.  A weakness in precious metals could signal investor expectations of deflation which could push the economy back into a double dip recession.