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We’re Not Giving Any Thanks To This Market… But This Indicator Can Forecast Its Next Move

Monday, November 24, 2008
by Jim Stanton, Technical & Quantitative Analyst, Smart Profits Report

With Thanksgiving just a few days away, investors are still just as scared as turkeys when they see the guy with the axe coming.

If this month closes the same way it’s performed over the past few months, we’ll be scratching around looking for crumbs of positive data. Yes, the markets have rallied a few times, but it’s proven to be nothing more than a short-term tease.

Having been on vacation for a couple of weeks, my last edition of “Sector Watch” on November 3 featured an hourly chart of the S&P 500. It showed that the index was probably in a bearish consolidation pattern that would eventually resolve itself to the downside.

I noted that the S&P’s rally should run out of steam on either side of the next resistance levels - 986 points and 1,044. Sure enough, having rallied to 1,007 the very next day, that proved to be the high for the month - and the index has stumbled downward ever since.

So where are we now?

Want To Go Bottom-Fishing? Good Luck!

Over the past few weeks, we’ve seen broad-based, relentless selling, with most sectors trading at or near new lows for the year.

Late last week, the S&P 500 reached my minimum downside target around 765, before the indexes reversed course on Friday and rallied sharply into the close.

In fact, all the major stock indexes reached my minimum downside targets as of Friday. While that sounds bad, it does mean that the correction may be ending.

That said, this is a very dangerous market. Trying to pick a market bottom is a challenge at the best of times, but in this climate, trying to do so is a real risk if you don’t know what you’re doing.

So while I’m seeing some positive signs, the smart play is to wait for more significant buy signals.

Right now, it’s too early to tell when, and at what level, these buy signals could be triggered, given that the indexes only made new lows last Friday. But a close above 835 on the S&P 500 would set up a half-day buy signal.

That goes for individual sectors, too…

Looking For “Black Friday” Bargains

Most of the sector indexes followed the broader market’s lead in making new lows last week. And because none of them have yet triggered any buy signals, it’s a challenge trying to nail anything down with much certainty.

Rather than sit on the fence, though, there were a handful of sector indexes that didn’t make new lows last week and are at least showing some temporary relative strength. If the market gets going to the upside, they might be the best place to start.

Specifically, we’re talking about…

Amex Airline Index (AMEX: $XAL)

Amex Oil Index (AMEX: $XOI)

Amex Pharmaceutical Index (AMEX: $DRG)

Gold and Silver Index (Philadelphia: $XAU)

Of these four indexes, the best-looking chart is the Philadelphia Gold and Silver Index ($XAU)…

Here’s When You’ll Know That Gold And Silver Are Heading Higher

As you can see, the index rallied sharply last Friday and the downtrend line, drawn off the July highs, is around the 101 level.

And because the 50-day moving average (the red line) is sitting right on top of the downtrend line, that level has more significance. 

So what does this mean?

Simply put, a couple of closes above the 101 area should lead to higher prices.

Make A List… Check It Twice… And Watch The Spread

If you want to get a good gauge of the stock market’s direction, rather than trying to pinpoint tops and bottoms, I find it’s more fruitful to look at the following spread chart.

If you’ve read my previous columns, you may remember me referring to it before. It basically plots the difference between the Nasdaq 100 (^NDX) and the S&P 500 (^SPX) and is often a leading indicator of market action. Here’s the latest action… 

As you can see, the indexes rallied from mid July to mid August (the spread chart coincides with the August highs) before embarking on the vicious new downtrend that we’ve endured recently.

Generally, when the market is bullish, the Nasdaq 100 will outperform the S&P 500 and the spread will move higher. In bearish markets, like the one we’ve experienced lately, the spread moves lower.

Here’s what the spread tells us at the moment…

I’ve drawn a regression channel from the August highs. As shown, the top of the channel coincides with the 20-day moving average around the 330 area. If the spread (the Nasdaq 100 minus the S&P 500) can close above this level a couple of times, the indexes should move higher.

That’s it for this edition. All that remains is to wish you and your family a very Happy Thanksgiving.

Jim

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There’s Money In This Sector… Literally

Monday, November 3, 2008
by Jim Stanton, Technical & Quantitative Analyst, Smart Profits Report

Today was originally set to be my colleague Lee Lowell’s turn in the Monday rotation, but since I’m going to be on the road for the next couple of weeks, I’ve switched with him this week. Lee will report to you on the state of the commodities market in the next two Monday columns.

Before we dive into this week’s specific sector, let’s start with a general overview of the stock market and try to pinpoint its next move, using my 1-2-3 Trader analytical system.

Take a look at this hourly chart of the S&P 500, through October 31…

 

Watch For These Two Resistance Levels On The S&P 500

As you can see, the S&P 500 made its lows on October 10, but rallied almost 25% over the next three days as world governments and central banks made a concerted, coordinated effort to deal with the global liquidity crisis.

As often happens, news-related rallies can provide an initial jolt, but are ultimately short-lived. That’s what happened in this case, with the October 10 lows twice being tested since then. In fact, the December S&P futures actually made new lows on October 27 before this latest rally began.

The S&P 500 action, coupled with this type of chart pattern usually means that the index fell too far, too fast, and needs to consolidate for a while. And since both the S&P and Nasdaq 100 futures have traded below the October 10 lows recently, the odds are that it is in a bearish consolidation pattern. This should eventually resolve itself to the downside.

If the above assumption is correct, the rally should run out of steam on either side of the resistance levels - 986 or 1,044.

986: This level was tested last Friday and while the index could trade lower from here, the way the shorter-term charts are set up, I wouldn’t be surprised to see the 1,044 level tested.

1,044: If the S&P 500 can post a couple of closes above 1,044 on big volume and good advance/decline readings, it could change my intermediate-term outlook.

Now for this week’s sector…

From Aces High To A Massive Fold 

From late 2005 until about a year ago, gaming and casino stocks racked up huge gains - especially those with a strong presence in Macau. These include Las Vegas Sands (NYSE: LVS), Wynn Resorts (Nasdaq: WYNN), and the MGM Mirage (NYSE: MGM).

Since late 2007, however, these stocks have endured a huge drop, losing 70% to 90% of their value. Casino-related stocks such as International Game Technologies (NYSE: IGT) and Shuffle Master (Nasdaq: SHFL) have also lost a good chunk of their value.

For China, allowing some U.S. casinos to enter the Macau market is a big deal. This paves the way for further penetration into the Asian markets, which is why the casinos mentioned above did so well from 2005 to 2007.

I don’t think it’s a coincidence that these three casino stocks made their highs in October 2007 - the same month that the Chinese stock market (SSE Composite) topped out. Since then, the SSE Composite has lost close to 70% of its value.

Chinese Visa Restrictions Stifle The Action Around The Craps Table

So why has this sector endured such a brutal selloff?

There are a number of other reasons, including recessionary pressures, a lack of funding for some of the U.S.-based Macau casinos, plus China’s efforts to limit the number of visas that residents of the southern Chinese province of Guangdong need to enter Macau.

As of October 1, residents now are allowed one trip every three months instead of two months - bad news since Guangdong customers are one of Macau’s biggest revenue sources. This has investors wondering if China has any additional changes in mind, with the uncertainty weighing on these casino stocks.

Until last week, that is…

The Upside And Downside Scenarios For These Three Sector Stalwarts

Last Tuesday, LVS, WYNN, and MGM all made their recent lows. But that was the trigger point for a huge rally, with the stocks then posting gains of 100% to 200% over a four-day period.

Let’s take a quick look at upside and downside…

Upside: Based on the intraday charts, these three stocks probably have higher to go, at least over the near-term.

Downside: The intermediate-term picture is a little hazier. None of the three have triggered daily buy signals yet. Moreover, if the stock indexes are in a bearish consolidation pattern and go on to make new lows, they could give back some, or all, of their recent gains.

However, if the S&P 500 makes new lows, and moves down to the 765 area, and these three stocks do not make new lows with the index, it should represent a good, intermediate-term buying opportunity.

How To Play The Casino Like James Bond

If the gaming and casino stocks have set their lows, LVS, WYNN, and MGM should benefit more than the others.

However, if you want to diversify and spread your risk in this sector, there are a couple of other ways to do it.

Take a look at the Ladenburg Thalmann Gaming and Casino Fund (GACFX). Unlike the Market Vectors Gaming ETF (AMEX: BJK), which is less than a year old, I prefer this fund because there is more data to analyze.

Here’s a weekly chart of GACFX, with a regression channel drawn from the October 2007 high.

 

The top of the regression channel this week is around $5.20, but for each week that passes by, the regression channel drops about $0.15. A couple of weekly closes above the regression channel should be bullish over the longer-term.

That’s all for this time. As I said, my commodities colleague will be with you for the next two weeks while I’m away.

Jim Stanton

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As Oil Prices Plunge, Airlines Could Rise

by Jim Stanton, Technical & Quantitative Analyst, Smart Profits Report

“Nowhere to run to, baby… nowhere to hide”

Lyrics from a 1965 hit song by Martha and the Vandellas - and lyrics that sum up today’s financial environment.

The markets are in a deleveraging, liquidation phase, with very few places to put your capital to work and feel comfortable about doing so.

Forced mutual fund selling, panic, and margin calls are all big reasons why most equity sectors are at, or near, their lows for the year. Leveraged hedge funds are selling anything, including commodities, to raise cash.

A Word On The Spread

In the last edition of “Sector Watch” on October 13, I wrote about the importance of the spread between the Nasdaq 100 and the S&P 500 and that if the markets were going to rally, the spread needed two closes above the regression line, which was at the 401 level.

On October 13, the spread did close above 401. On the following day, even though it then traded as high as 460 at the open, it closed the session at 366 and has traded lower since then, as the Nasdaq 100 went on to make new lows.

The reason I bring this up is to show you the importance of how to treat regression channels, trendlines, moving averages, and how it can help in your own trading. When using these technical tools as a confirming indicator or to even generate buy signals, it’s been my experience that you need confirmation in order to “validate” the move. That’s why I said we needed two closes above the regression line, not one, and by using this rule; it kept us out of trouble.

Let’s dig into this week’s specific sector…

Has The Grounded Airline Industry Finally Found A Bottom?

In this market, you may think there are no decent places to invest. While it’s true that with volatility rampant and risk is greatly increased at the moment, there are some sectors that are stronger than others.

For example, Airlines, Utilities, and Drugs haven’t made new lows recently and could instead be forming a bottom.

Of these three, the Airline Index (^XAL) has the best-looking chart.

Take a look at its weekly chart below. You’ll notice that it made its lows back in July but had enough relative strength to stay above that low in October when most of the other indexes were making new lows for the year.

Two Key Numbers

The long-term, weekly downtrend line and the 50-week moving average both currently sit around the $26.50 area, while the $28.22 figure represents the high back in September.

Although not shown on this chart, the 200-day moving average comes in at $24.05 - a level that was tested last Friday morning before the sellers pushed the index back down to $20.44 at the close.

If you’re a more aggressive investor, you could try the long side if the index manages two daily closes above the 200-day moving average ($24.05).

However, the safer play would be to wait for the index to trade above the September high at $28.22 (although be sure that it’s not just a gap higher at the open). Taking out a trendline, an important moving average, and an old high gives you a much better chance of being successful.

Keep Your Eyes On The Sticky Stuff

With oil prices having sunk from highs around $147 in July to the mid $60s today, that definitely bodes well for the airline industry.

It’s no coincidence that when crude oil peaked at $147 in July, it came just two days before ^XAL put in its low for the year.

One of the main reasons that the industry has rallied since then is because crude has fallen over 50% since that high. High fuel costs quickly eat into any transportation-based industry and the sector is currently breathing a sigh of relief.

At the same time, airlines have become extremely “creative” in trimming costs over the past year or two. From slapping baggage charges on passengers, to charging for pillows and seat assignments, and shutting down unprofitable routes, many moves are unpopular, but unfortunately quite necessary.

And now that crude oil is trading below $65, airlines now have the opportunity to at least partially hedge their fuel costs going forward - a luxury that most of them couldn’t capitalize on before.

The mass stock market liquidation may not be over, but keep an eye on the ^XAL. As long as it stays above its July lows when the selling is complete, it could be ready to run higher.

However, keep in mind that if you want to invest in this index or any individual airline stocks, the price of crude oil can have a big influence on how the airlines stocks trade. And right now, crude oil is oversold, so be cautious.

Catch you back here next time.

Jim

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Bear Markets 101: Where This Grizzly Market Is Headed Next

by Jim Stanton, Technical & Quantitative Analyst, Smart Profits Report

Last Friday’s rollercoaster action, with the Dow Industrials swinging wildly from negative to positive, and back down again to end the day down 128 points, capped off one of the worst weeks in U.S. stock market history.

That gave the blue chips an 8-day loss of just under 2,400 - or 22.1%. To put it in perspective, the S&P 500 - the broader indicator that market pros prefer to use as a gauge - posted its worst weekly performance since 1933.

Ouch!

So where the heck do we go from here?

A Brief Bear History

Both the S&P 500 and the Dow have dropped over 40% since making new all-time highs last October. Below, you can see a recap of S&P bear markets since 1970. Because it’s fallen 46% from its peak this time around, it easily takes third place for worst recent history performance.

  

Out of the seven, the longest bear market was the March 2000 bear market, which lasted a total of 30 months. In contrast, the shortest only made it 3 months.

But the odds are against any shorter trends, since only three of the above-listed bear markets lasted 3 to 3½ months. The other four made it to the 18-month point or longer.

One of the more interesting points to note is that over half of them ended in the month of October. Is this significant? Only time will tell this time around.

Up Close And Personal With Today’s Bear

In celebrating its one-year anniversary recently, this bear market has long outlasted the three shorter ones. And in that time span, there hasn’t been a single sector spared.

A rollercoaster ride worthy of any major amusement park, for sure. But kid-friendly, this one ain’t. There have been a couple of days over the past two weeks when it appeared the markets had made a climatic low, only to see the sellers regain control later on in the afternoon.

Last Friday, was different though…

• From high to low, the Dow made a 1,000-point swing.
• The equity put/call ratio closed over 100% for the second day in a row.
• The Volatility Index (^VIX) - commonly referred to as the fear index - reached a record high level of 76.94.
• In addition, the Dow Transports, Nasdaq Composite, and all the smaller-cap indexes closed higher for the day, with the Russell 2000 closing more than 4.5% higher.

This type of action is usually associated with at least a short-term low and since we’re in the month of October, the odds of this occurring are raised a bit.

Volatility has raced to such highs recently that it will take a substantial rally in order to trigger daily buy signals. And there are a couple of indexes that could tip us off that the indexes bottomed out last week.

The Charts Will Show Us Where The Market Is Headed Next

One of the numbers I always keep a close eye on is the point spread between the Nasdaq 100 and S&P 500. That’s because during bull markets, the Nasdaq 100 usually outperforms the S&P 500 (on a point basis) - something that began happening last week. Below is a daily spread chart of the Nasdaq 100 minus the S&P 500, which includes last Friday.

  

The high point on the chart was the last swing high for both indexes, which occurred in the middle of August. As you can see, the spread dropped as these indexes sold off, losing 365 points in the process.

Despite all the indexes hitting their recent lows last Friday, the spread began improving after Wednesday’s open and closed higher for the last three days of the week.

I’ve drawn a regression channel from the August highs, with the upper band hovering around the 400 level. The high on Friday, October 3, was 400.89, so a couple of closes above 401 would be a positive sign for the indexes.

If you don’t have a chart program that can generate spread charts, you can do the calculation after the markets close. Simply subtract the cash value of the S&P 500 from the cash value of Nasdaq 100.

If the markets turn higher and you want to trade this spread, the ratio is 2.85:1 if using the ETFs that represent the S&P 500 and Nasdaq 100 respectively - the SPDR Trust (AMEX: SPY) and PowerShares QQQ Trust (Nasdaq: QQQQ).

That means for every SPY share you short; you’d have to buy 2.85 shares of QQQQ. For e-mini traders, you’d buy five Nasdaq 100 contracts and simultaneously sell short two S&P contracts.

That’s all for this edition.

Jim

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“Sector Watch”: Forget Washington’s Hot Air… Here’s How To Profit From Wind

by Jim Stanton, Technical & Quantitative Analyst, Smart Profits Report

 At the moment, one hour can seem like a long time when it comes to financial news and stock market activity.

So two weeks is almost an eternity in comparison!

Since I last wrote to you on September 15, I hardly have to tell you about the current state of the U.S. financial system and punch-drunk behavior of the stock market as a result.

My column two weeks ago came just one day after Lehman Brothers declared bankruptcy, sending the financial markets into a vicious tailspin.

It would have been remiss for a column called “Sector Watch” to not take a look at the most critical sector at the time - the financials. So I highlighted the Financial Select Sector SPDR (AMEX: XLF).

These Two Financials Are Outperforming Their Crushed Competitors

According to the system I’ve developed for my 1-2-3 Trader service, the stock had to go up to at least $24.40 - despite the sector’s woes. With that in mind, I stated that investors would have a good, low-risk buying opportunity under $20.

As the problems mounted, including the troubles at the world’s largest insurance company, American International Group (NYSE: AIG), XLF did indeed trade below $18 on Thursday, September 18.

Then, thanks to talk of a federal bailout and Bank of America’s (NYSE: BAC) quick buyout of Merrill Lynch (NYSE: MER), the financial sector staged a sharp reversal later that day. On Friday, September 19, XLF reached a high of $24.50 before selling off again.

At this point, there’s no way to tell if another big bank or investment house will go the way of Lehman Brothers. And in the latest twist, Congress today rejected the $700 billion bailout plan - which hardly helps restore confidence.

So as I mentioned in my last article, if you’re brave enough to play the financial sector, stick with the companies that have performed well. The two I mentioned last time were BB&T Corp (NYSE: BBT) and US Bancorp (NYSE: USB), both of which have made new highs for the year over the last two weeks.

Let’s switch focus to one of the market’s other big sectors - energy.

What A Difference A Year Makes… Tough Times For Two Of Alternative Energy’s Biggest Players

With the steady climb of oil prices over the past few years, it’s become apparent that higher prices are here to stay.

As a result, the market has spawned dozens of new alternative energy stocks - and subsequently, ETFs devoted to the sector.

However, with alternative energy technology developing rapidly and sub-sectors like wind, solar, geothermal, bio-fuels, and bio-mass all springing into the headlines, it can be tough to know which stocks or ETFs an investor should play.

Fortunately, ETFs give you broad exposure and diversity to certain markets, with less risk than owning individual stocks.

For example, the two most widely followed alternative energy ETFs are the PowerShares WilderHill Clean Energy ETF (AMEX: PBW), which is mostly made up of American companies, and the Market Vectors Global Alternative Energy ETF Trust (NYSE:GEX), which gives you international exposure to some of the largest companies dealing in wind power.

In 2007, these ETFs turned in outstanding performances, chalking up gains of 62% and 50% respectively. And GEX may have done even better, due to the fact that it did not begin trading until May 2007.

In 2008, however, the funds haven’t been able to sustain that performance. As of September 26, PBW is down about 40% for the year, while GEX has lost 25%.

“Springing” Back To PBW

Back in the spring (March 24, to be exact), I highlighted the performance of PBW in my “Sector Watch” piece. At the time, the stock was trading around $21 and had recently tested its January lows. With the chart pattern still bearish, I said it represented a good short-selling opportunity.

Before it rebounded last week, PBW had traded below $15. But as long as oil prices remain high, ETFs like PBW should come back into favor. Moreover, after the beating they’ve taken this year, they look like good value.

That said, I don’t like trying to pick bottoms, so let’s take a look at the daily chart of PBW for more clues…

As you can see, the downtrend line drawn from the highs last December currently sits at $18.95. As time goes by, this number will go lower, but a couple of closing prices above this downtrend line will signal a change in trend - and that the stock is probably worth buying.

Profits From Thin Air

Between PBW and GEX, though, I actually prefer GEX, due to its higher exposure to the wind power segment. This fast-growing area is gaining some serious momentum and greater investment, thanks to the publicity that T. Boone Pickens is bringing. Pickens is a very smart businessman, who is investing billions towards the largest “wind farm” in the U.S. And you can see why he’s on board…

Wind power is the second largest source of new power generation in the U.S., surpassed only by natural gas.

• In 2007, wind provided enough power to satisfy the residential electricity needs of 150 million people.
• Capacity increased by a record-breaking 20,000 megawatts, which puts the world total at 94,100 megawatts.
• According to the U.S. Department of Energy, since 1980, the cost of producing wind power has declined by as much as 90%.
• Electricity from new wind power projects will be cheaper than electricity from new conventional power plants by 2010.

If you’re a fan of wind power, there is a relatively new ETF that deals strictly with the field. It’s called First Trust ISE Global Wind Energy (NYSE: FAN) and it began trading in June 2008.

Having hit a high of $31.50 in June, FAN has sold off, along with the other alternative energy ETFs. Earlier this month, it traded as low as $20, so let’s take a look at the chart to see what the next move might be…

With only a few months of data to go on, projecting the stock’s next move is a little trickier, but we have enough information to draw a regression channel from the June highs. The upper band of the channel is currently around $24.15 and a couple of closes above that level should lead to higher prices for the stock. We’ll keep an eye on this one, as wind power continues to gain traction.

That’s all for this edition. I invite you to join me here again in two weeks.

Jim

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If You Invest In Financial Stocks… Here’s What You Need To Do

Sector Watch: Lehman Lays An Egg… And The World Chokes On It: How To Invest In Financials From Here

by Jim Stanton, Technical & Quantitative Analyst, Smart Profits Report

Lehman Brothers (NYSE: LEH) has a lot to answer for…

No sooner had I wrapped up this edition of “Sector Watch” than the company declared bankruptcy, thus forcing me into a swift re-write! So much for my plan to go fishing yesterday…

Anyway, with Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) getting bailed out last week, Lehman’s bankruptcy comes at the same time as Washington Mutual (NYSE: WM) and insurance giant American International (NYSE: AIG) teeter on the edge of bankruptcy, too.

So now is the time to take a look at the latest carnage unfolding within the financial sector…

If You’re Investing In Financial Stocks… Here’s What You Need To Do

Despite the recent woes in the financial sector, it actually wasn’t faring too badly. Since the markets bottomed out on July 15, some banks have performed very well. Like BB&T Corp (NYSE: BBT), for example - up a whopping 82% - and US Bancorp (NYSE: USB), which has risen 64%.

Aside from the obvious major problems in both the bank and brokerage sectors, the brokerage stocks, which use more leverage in their businesses, seem to be getting the worst of it. For example, while USB was making a new two-month high last week, Merrill Lynch (NYSE: MER) traded at a 12-year low.

The moral of this story is this: If you’re going to trade the financial sector from the long side, you’d better do your homework and stick with these well-capitalized banks.

On the other hand, you can diversify and lower your risk from the sector through one of its most widely traded ETFs - the Financial Select Sector SPDR (AMEX: XLF)

As you can see below, the stock has remained stuck in a consolidation pattern since late July.

The Offsetting 85

However, this consolidation pattern is a bullish one - and for a good reason.

Because XLF is comprised of more than 85 stocks - mostly including banks, brokers, and insurance companies - when some of them are faring well and some doing poorly, the resulting action is sideways trade.

However, XLF appeared to trigger a daily buy signal off the July 15 lows and unless an alternative upside target is generated, the stock should eventually trade up to at least my minimum target around $24.40.

And that gives investors a good, low-risk opportunity to buy.

That’s because in the wake of the Lehman fallout, the stock will probably trade back down to the bottom of the consolidation pattern in the $19-$20 area. Beware, however…

A Financial World Still Crumbling

If you’re looking to invest in financials in hopes of grabbing some bargains, remember that the sector is still in crisis. Moreover, nobody really knows for sure if other institutions will stumble down the same path to bankruptcy as Bear Stearns and Lehman Brothers.

The best course of action is to wait for the dust to settle and see if XLF can hold the $19 area.

And on a broader scale, the S&P 500’s low for the year is 1,200.44. If the index closes below that level, it should have further to go - in which case, I’d hold off on buying anything until the dust settles.

Commodity Rewind… And Flash Forward

In the last couple of editions of “Sector Watch,” we’ve looked at some of the commodity sectors, including energy and gold, along with their related ETFs.

According to the analysis generated by the trading system I developed for my 1-2-3 Trader service, we noted that they all had bearish daily chart patterns.

And over the past couple of weeks, the US Oil Fund (AMEX: USO), SPDR Gold Trust (AMEX: GLD), and the US Natural Gas Fund (AMEX: UNG) have all made new correction lows.

In fact, USO and GLD have similar chart patterns and they reached my minimum downside objectives over the past week. With UNG, the chart is more complex and it’s hard to tell at this point if the “C” wave (or “3rd wave”) is complete.

Regardless, most of the commodity sectors are now reaching oversold territory and if nothing else, we can probably expect at least a decent rebound to work off the oversold conditions.

USO and GLD are now all set up for daily buy signals, so the risk of being short is increasing.

That also goes for the Powershares Commodity ETF (AMEX: DBC). Let’s take a fresh look at the chart…

We originally highlighted this chart in the August 25 edition of “Sector Watch.” At that time, the stock was trading above $38, and the “C” wave decline was just getting underway. Since then, the stock has made new correction lows and reached my minimum downside objective of $34.60.

So as I said, the same theory as USO and GLD applies here: The chart is set up to trigger a buy signal, so be wary of going short at this point.

We will revisit the commodity ETFs once we see what unfolds from here.

Take care till next time.

Jim

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Sector Watch: Let The “Waves” Guide You Towards Profits On Oil, Natural Gas, & Gold

Monday, August 25, 2008
by Jim Stanton, Technical & Quantitative Analyst, Smart Profits Report

Not to steal the show from my colleague and commodities expert Lee Lowell, but I want to take a moment to chat about oil, natural gas, and gold.

Of course, I do things slightly differently, looking at the ETFs that represent these markets, rather than the more direct futures market.

In my last column, I pointed out that the U.S. Oil (AMEX: USO) ETF and natural gas ETF, U.S. Natural Gas (AMEX: UNG), were in the process of tracing out at least an A-B-C correction to the downside.

Click this link to check out the chart from two weeks ago. Since then, USO has rallied enough to qualify for the “B” wave rally. From here, there are basically two scenarios…

• 1. If the “C” decline has already begun, the stock should trade down to at least the $86.50 area.
• 2. If the “B” wave rally is not yet complete, and USO trades above last week’s highs, the next resistance level is around $100.95.

Either way, USO should make new correction lows before a sustainable rally could unfold.

Gas Still In The “A” Wave

The natural gas market has performed more weakly than crude oil, and made new lows again last Friday. This means that UNG is still in the “A” wave decline and alert investors could have an opportunity to short the stock on the first decent rally, which would be the “B” wave.

Aside from that, most commodities have endured heavy selling pressure since topping out in early July. We’ve seen oil trade below $112 a barrel and gold dip below $800 an ounce before both rebounded last week.

Part of the rebound came as a result of a pullback for the U.S. dollar. So since commodities are strongly correlated to the dollar - and that appeared to be the focus of many traders last week - I’m going to take a look at a couple of the most active and interesting-looking charts this week…

This PowerShares ETF Is Powering Down

The chart below shows the daily performance of the PowerShares DB Commodity Index Tracking Fund (AMEX: DBC). As you can see, it looks very similar to the USO chart.

In mid July, DBC triggered a sell signal - and based on the chart pattern, it appears to be in the “B” wave of at least and A-B-C decline.

If DBC and all of the ETFs mentioned above have put in major, long-term tops, these three wave (A-B-C) declines could actually turn out to be longer-term, five-wave declines. However, it’s too early to determine if that’s the case yet, so we’ll stick with what we know for now.

So if the “B” wave on DBC is complete, the stock should trade down to the $35 area before a sustainable rally could get underway.

When Three Waves Becomes Five Waves

This next chart caught my eye because it traded down to its long-term trendline last week and has so far held above it.

Because the commodity futures create more accurate charts, while the ETFs just follow their lead, I’m going to break with tradition a little bit and use a weekly chart of the December Gold futures (GCZ8) for analysis here, rather than the SPDR Gold Shares (NYSE: GLD) chart.

The trendline on this chart goes all the way back to July 2005 and you can see that it was tested when the futures price traded down to $778 on August 15. Since that low, gold has rallied by about $55, but we still haven’t seen any significant buy signals get triggered so far - something that would tell us that the correction is complete.

However, this development spilled into GLD, as the stock posted an equivalent low of $76.61 on August 15. This was also around the same time that the dollar peaked.

The sharp dollar rally was a mirror image of the drop in GLD and usually after this type of action, the odds are that these markets could consolidate before making their next major move.

The Next Moves

The price action over the next week or so should be a good indicator of where GLD is headed next. If GLD begins to consolidate in the $80-86 area for a while, there’s a good chance that once the consolidation is complete, the next move will be down - especially since DBC still looks bearish.

If GLD and the December Gold futures make new correction lows, the selling could intensify, as we’re not the only folks watching the long-term trendline. However, if GLD begins to rally strongly on heavier volume, and closes above $88.50, the correction may be over.

According to the trading model used in my 1-2-3 Trader service, we could see buy signals triggered on GLD prior to reaching the $88.50 area, so I’ll keep you posted on the situation right here.

Until next time…

Jim Stanton

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Sector Watch: It’s As Easy As A-B-C… Or 1-2-3: How To Crack The Market’s Code

Monday, August 11, 2008
by Jim Stanton, Technical & Quantitative Analyst, Smart Profits Report

In today’s “Sector Watch,” I’m going to play off not only my last edition here on July 28, but also my Smart Profits Report column last Thursday.

I want to achieve two things here. First, I want to use it to follow up on my previous chart analysis. And second, I also want to give you a bit more insight into the “code” I cracked - and now use all the time in the chart pattern recognition component of my trading system, so you can see how it works.

I know this may seem confusing, but it’s really quite simple.

Just ask the subscribers to my service - 1-2-3 Trader - who recently racked up quick gains on Boeing (NYSE: BA), Coca-Cola (NYSE: KO) and Harley Davidson (NYSE: HOG).

Here’s how they did it…

Cracking The Energy Sector Code

In my last “Sector Watch” column, I pointed out that Crude Oil futures had generated a daily sell signal and, in keeping with the sector ETF analysis that I do here, the way to play the oil market was by using the U.S. Oil Fund (AMEX: USO) - the ETF that tracks the performance of West Texas Intermediate (WTI) light, sweet crude oil by investing in futures contracts for WTI, as well as other types of crude oil, heating oil, gasoline, natural gas and other petroleum based-fuels.

So what did the “code” tell us?

Quite simply, the way the daily chart pattern looked, USO was tracing out at least an A-B-C (or 1-2-3) Elliott Wave Theory correction.

This means that the initial drop is the “A” (or “1″) wave down, followed by a “B” (or “2″) wave rally, then finally, a “C” (or “3″) wave decline to new correction lows.

This forms just one of the three parts of the system that I use to accurately pinpoint index and stock movements, so I can guide my readers toward profits.

But it’s also really as easy as “1-2-3.” Which is why I decided it had to make up the name of my trading service - the 1-2-3 Trader.

As for USO, the stock was trading above $99 when I last wrote to you two weeks ago. Today, however, it’s fallen to around $91.50.

If you want to play USO, the good news is that it’s still in the “A” (1) wave down, which means that we’re still waiting for the “B” (2) wave rally to begin - the point where we can initiate a put position.

Now onto this week’s highlighted stock…

An Opportunity To Profit From Oil’s Partner In Crime

In last Thursday’s Smart Profits Report, I showed you an example of how the pattern recognition component of my system generated a profitable trade on Harley Davidson (NYSE: HOG).

Specifically, we bagged a 112% gain in less than a month.

The very same “1-2-3″ system also churned out three other winners…

• An 80.4% gain in just three days on Boeing
• An 89.1% gain in a week on Coca-Cola
• A 53.4% gain in a day on Federal Express

As good as those profits were, they’re in the past now. It’s time to show you how the pattern recognition component of my system can predict what’s going to happen in the future.

Take a look at the daily chart of the U.S. Natural Gas Fund (AMEX: UNG) - the ETF that reflects the performance of natural gas prices. Whenever possible, I like to look at other stocks in the same sector to confirm my analysis and UNG has a very similar chart pattern to USO.

Yes, UNG has undergone a much larger correction than USO, but the chart patterns are almost identical.

The 1-2-3 Way To Profit From Natural Gas

Since reaching its high of $63.89 on July1, UNG triggered a daily sell signal and has fallen by more than 35%.
 

Once a sell (or buy) signal is triggered, my trading system calls for at least a three-wave move.
 

As you can see, the current chart pattern suggests that UNG is still in the “A” (or “1″) wave of the selloff, and when the initial selling is complete, a “B” (or “2″) wave rally should get underway. 

Right now, there is no way to tell for sure if the “A” wave is complete, or how high the “B” or “2″ wave will go when it gets underway. But we can say one thing:

 

Assuming that no damaging hurricanes enter the Gulf of Mexico, when the inevitable, counter-trend rally begins, I would buy put options on a retracement of 30% to 50%.
 

And an important word of warning: When trading the short side of the energy markets during hurricane season, it is very important that you only use put options.
 

While you may be tempted to short the stock in question, the risk is just too high. Put options limit your risk, which is necessary this time of year.
 

Keep An Eye Out For This Special Report
 

That’s just a brief illustration of how I use my system to generate profits - even in a market that is sending many other investors scattering in fear. So as I said in last Thursday’s column, don’t listen to the naysayers on television, who say you can’t predict, or time, the market. You can - and the proof is in the 591% cumulative profits that this simple “1-2-3″ pattern recognition system has generated this year. It tells you exactly when to buy for minimal cost and exactly when to sell for maximum profit.
 

If you’d like to find out more, look for a special report from the Smart Profits Report team in your e-mail tomorrow, which will focus on the “1-2-3″ code - what it is and how it works - in much more detail. It’s exactly the same one that I use every day for my subscribers, who’ve enjoyed some handsome profits recently - even in a market that the so-called experts say you can’t beat.

 

Jim Stanton

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Sector Watch: It’s Time To Keep Your Eye On More Than Just Hurricanes…Though That’s A Good Idea Too

Sector Watch: It’s Time To Keep Your Eye On More Than Just Hurricanes…Though That’s A Good Idea Too

Monday, July 28, 2008
by Jim Stanton, Technical & Quantitative Analyst, Smart Profits Report

The last time we checked in, I had written about a potential Dow Theory buy signal. Lo and behold, the very next day the indexes reversed and started moving higher.

Primarily due to frantic short covering in the financial sector, it was still helped along by declining oil prices and a little government intervention in the short sale department.

The Dow Industrials came very close to triggering a daily buy signal, which would give us a Dow Theory buy signal. But in order to accomplish that, the Dow Industrials need to trade above last week’s high.

Many of the financial stocks, which were deeply oversold, rallied 50% or more off their lows before pulling back late last week. And that means that much of the short covering is over; financial stocks will now have to perform on their own merits without the help of a large, overhanging short position.

Mixed Results For Nasdaq

The Nasdaq indexes have been the laggards over the past two weeks due to negative reactions from earnings reports in stocks such as Google, Microsoft, and Apple. And yet, the Nasdaq 100 has performed relatively better than the Dow and S&P 500 over the last few sessions.

Below is a Daily spread chart of the Nasdaq 100 over the S&P 500. This chart plots the differential between the two indexes, and is something I keep a close eye on. When the Nasdaq 100 outperforms the S&P 500, the spread price moves higher and vise versa.

Generally speaking, all of the stock indexes usually do well when the spread is moving higher and as you can see, the spread bottomed out last Tuesday and is now close to breaking above the downtrend line.

The spread differential closed last Friday at 588.79 and the downtrend line is currently around 592. Two closes above the 592 level should be a plus for all of the indexes.

Oil Industry Is Still Driving Markets Crazy

As I mentioned before, the financial sector and oil prices have been driving the markets lately. A although the government may have a few more tricks up their sleeve, since much of the short covering is probably over in the financial sector, I thought we’d take a look at the oil sector this week to see where it’s headed.

The only stock I follow that is a mirror image of the crude oil contract is the United States Oil Fund (AMEX: USO). It trades at about a 20% to 25% discount to the price of crude oil, due to the fund’s structure, but has about a 99% correlation to crude prices.

The stock made a new high above $119 on July 11, and held its gains for a day before falling over $5 on July 15, which was the same day that the Dow and S&P made its lows for the year.

USO has continued to fall since then and in the process, has closed below its 50 day moving average and the uptrend line drawn from the February lows.

The stock triggered a daily sell signal and - barring a new buy signal (and there’s only a 20% chance of that) - should undergo at least an A-B-C correction to the downside. That means that when this first “A” wave of selling is complete, we should see a “B” wave rally followed by a “C” wave decline to new lows.

On a short-term basis, USO is getting oversold and last Friday it tested the previous low point, which was made in early June at $98.62. If it can hold in this area, the “B” wave rally should begin shortly. When it does begin, the question is: How high will the rally go?

Predicting The Oil Market

Of course that’s a good question, and here’s the answer…or at least a range of possibilities.

If USO rallies from this area, a number of outcomes could play out. Considering Fibonacci’s Theory, note that the 38% Fibonacci retracement is around $106.50 which means that the 50% retracement would take it up to around $108.95. It could also rally back up to the bottom of the uptrend line, which moves higher every day or, it could test the 50-day moving average, which is currently around $108.

If the stock moves lower from here, these numbers will change a bit when the “B” wave rally begins but assuming that we’ll see higher prices sometime this week, I would be looking to buy some put options somewhere between the 38% and 50% Fibonacci retracement levels. If it only trades up to the $106.50 level when the “C” decline begins, the stock should drop down to at least the $96 area.

Act Now On The Oil Industry But Stay Tuned To Sector Watch

But just remember what time of the year we’re in the middle of. You’ll notice I said I would be looking to buy puts, not shorting the stock, or selling naked calls, and there’s a good reason for that.

Folks, we’re in hurricane season and if one gets into the Gulf of Mexico, all bets are off. While technical analysis is very reliable, it works off of averages, past records and trends. It quite simply can’t take into account any true surprises, which the weather is all about.

Playing the short side of oil during hurricane season can be very high risk so I would take a smaller-than-average position, with limited risk. Cheap puts are the best way to go right now.

That’s all for this time.

Jim Stanton

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Sector Watch: Mr. Market Meets Mr. Bear… What This Reliable Indicator Reveals About The Next Move

Monday, July 14, 2008
by Jim Stanton, Technical & Quantitative Analyst, Smart Profits Report

I hope you like bears… because Wall Street has just officially snagged a big one.

Last week’s volatile stock market action sent the S&P 500 into what economists officially call bear market territory, having fallen 20% from its 2007 high. It joins the Dow Industrials, Nasdaq Composite, NYSE Composite, and S&P 100 in “bear ground” and in making new lows for the year.

With the market still under heavy pressure from record oil prices, the financial sector fallout, and now the failure of massive mortgage brokers Fannie Mae and Freddie Mac, it feels like the bears are in complete control.

It was the fourth straight weekly decline for the Dow and the sixth consecutive weekly decline for the S&P 500 and the Nasdaq.

However, while the Dow and S&P 500 had weekly declines of around 1.75%, the Nasdaq was only down 0.3% and the smaller-cap indexes (Russell 2000, S&P Mid-Cap, and S&P Small-Cap) actually closed higher for the week.

The biggest surprise last week was the Dow Transports, which gained close to 100 points.

So far, the Dow Transports, Nasdaq and smaller-cap indexes have managed to stay above their lows from earlier this year.

But hey, there is a glimmer of hope…

A Silver Lining… Albeit A Thin One

Let me preface this by reminding you that markets can stay oversold longer than expected.

However, as long as there are no new surprises in the financial sector and the oil market calms down from its frantic up and down action of last week, we should see a rally begin sooner rather than later.

That’s because on an intermediate-term basis, the indexes are pushing into oversold territory. Based on the action in the Dow Transports, Nasdaq, and smaller-cap indexes last week, they look ready for at least a technical rally in order to work off the oversold conditions.

That’s the intermediate-term. Longer-term, however, the jury is still out. As I noted at the top, all three major stock indexes have descended into bear market territory.

As of this morning, the Dow Industrial Average is down 21.6% from its record closing high of 14,164.53 in October.

The S&P 500 is down 20.8% and the Nasdaq is off 21.7%.

A Long-Term Lag

Quite frankly, I don’t put much stock in the 20% bear market theory - I prefer to read the charts, rather than adhere to any official bear market tags.

And both the daily and weekly charts show me that the correction may have further to go over the longer-term. The Dow and S&P 100 did reach their minimum downside targets last week, but the S&P 500 and the NYSE Composite should have gone lower to set up an ideal reversal point.

The most bullish scenario would be a high volume, panic selloff with a very high $VIX (volatility index) and put/call readings. This would clear out all the sellers and set the market up for a sustainable rally.

This is still a possibility over the next week or two, but if the markets rally prior to that happening, and the volume and advance decline readings are unimpressive, we can probably expect more selling once the rally runs out of steam.

Let’s take a look at two of the most crucial indexes…

Dow Theory Revisited

Aside from a few exceptions (mostly commodity-related), most of the ETFs and sector charts look very similar, so let’s take another look at what “Dow Theory” is telling us over the longer-term.

If you’re not familiar with the Dow Theory, it simply states that the Dow Industrials and Dow Transports must move in unison in order for a trend to continue. If one makes a new high or new low, which is not confirmed by the other, it sets them up for a reversal.

And who said technical analysis was complicated?!

If you want to read about the concept in more detail, just take a look at a couple of my previous columns - one in this “Sector Watch” on May 19 and another one here.

The Theory In Action… How The Sell Signals Worked

Take a look at those red asterisks on the charts. Just like at a traffic light, they indicate a stopping point for the indexes - that is, a non-confirmation by one of them. In turn, this led to Dow Theory sell signals.

In addition, the Transports made a token new high on May 19, but reversed immediately, setting up another Dow Theory sell signal.

On the other hand, the lows (marked in blue) occurred at the same time, meaning that it was a confirmation that the downtrend was still intact.

As you can see, both of these sell signals worked, as the Dow Industrials failed to make new highs and the index is sitting at new lows for the year.

However, in order for the Dow Transports to confirm these new lows, it would have to drop another 700 points! Not impossible, but a very tall order.

So if that doesn’t confirm a low, does it mean a buy signal? Not quite…

Setting Up The Buy Signal

While that 700-point margin does not constitute a Dow Theory buy signal, it does tell us that the indexes are set up to trigger one. With that 700-point cushion, the Dow Transports could still fall quite a bit and still be set up for a Dow Theory buy signal.

In order to trigger a Dow Theory buy signal, the Dow Industrials would have to trigger a daily buy signal and although it’s set up for one since it reached its minimum downside target, it’s too early to tell where that would occur.

If these indexes rally from here, a Dow Theory buy signal is possible but at this point, the odds are against it. As I mentioned above, a sharp panic selloff would set up a much better situation for the indexes to make a meaningful low - especially if the Nasdaq, smaller-cap and, of course, the Dow Transports don’t make new lows for the year.

That’s all for this time.

Jim Stanton

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