Weekly Trader Alert #80
11/27/2006 8:41:48 AM

Overview

This week we are going to examine what appears to be a change in the underlying psyche in the market. With company earnings reporting season drawing to an end, there is more and more concern over economic news. To that end, the uptrend seems to have stalled.

The past week has seen $50B in M&A deals announced, a one week increase in unemployment, a small decline in consumer sentiment, and nervousness on the part of investors. It may even be enough to cause a change in underlying sentiment. It also saw a collapse of the dollar.

The argument still continues between soft landing and hard landing camps, due to the collapse of the housing market. The quandary now appears to be whether the Fed will lower rates if the housing market drags the rest of the economy into a recession, or whether they will raise rates in order to make the dollar more competitive or to combat inflation.

Natural gas is little changed from last week closing a bit above eight dollars. Oil is back above sixty dollars.

To understand more about our view on the markets, we will have to look at the charts.

Market Climate

The broad market continued to move up next week, We had suggested that at the beginning of the week, the markets could either move up to break through resistance or down to break through the 20-day moving average. The market continued to move higher week over week, with the 20-day moving average obediently moving up to support price as it climbed.

A chart of the composite of over 8,000 stocks traded on the U.S. Stock markets continues to be included.

The U.S. stock market composite chart:

Price has narrowed into an ascending wedge, that has been growing steeper during this uptrend. Price has fallen back from the upper Bollinger Band and the daily trading range has narrowed as volume continued to subside. With RSI and MACD at extremes, a pullback in the broader market is likely. While neither RSI nor MACD have yet reversed themselves, they are an historic levels, so a reversal is now a probability.

Now, let's take a look at the charts for the major indexes.

A look at the chart for the Dow Industrials is represented by the Diamonds ETF (Amex:DIA).

Abbreviations and color key appears below:

Note the following order is Red, Yellow, Green, just like a stop light, so it might be a helpful mnemonic:
Thick Red line represents the 200-day simple Moving Average, (200DMA)
The yellow line represents the 50-day simple Moving Average, (50DMA)
The green line represents the 20-day simple Moving Average, (20DMA)
The light blue line represents the 3-day Moving Average, moved forward three days in time, (3x3MA)
The thick blue line indicates the exponential 13-day Moving Average (13DMA)
Bollinger Bands are abbreviated as BB. There is an upper and a lower Bollinger Band that varies in distance from a central moving average (shown as light red/pink) based on the volatility of stock price movements.
RSI stands for Relative Strength Index. It is an oscillator, which can be used to determine how overbought or oversold a stock may be.

The DIAmonds have initiated a downward move that looks like it may continue for awhile. There is support likely to be seen first in the mid-$121 range. If that fails, the bottom of the uptrend channel support line is also in the $121 range, so effective support may be garnered. If this level is broken, then the four month uptrend will be broken and a new downtrend will be underway.

The choppiness indicator turned up just shy of the 40 level, which generally indicates a trend is exhausted. This may be it for this latest uptrend, but we will have to see if there is a sideways consolidation or the beginning of a new downtrend in the offing.

Note that the weekly chart shows a Harami pattern, which should be confirmed to indicate a market top. This particular pattern, is of a higher probability than the regular Harami.

The S&P 500 ETF, known as the Spyders (AMEX:SPY) is shown in the chart below:

Last week we suggested the uptrend would stall around the $141 level, which is what occurred. Not, they look similar to the DIAmonds, in that they look ready to begin a new move downward. Light volume makes any move suspect at this time.

Similar to the DIAmonds, the choppiness indicator signaled this latest move was a trending move and it hasn't yet reached the point of exhaustion.

Note that the weekly chart shows a Harami pattern, which should be confirmed to indicate a market top. This particular pattern, is of a higher probability than the regular Harami.

This week's NASDAQ 100 ETF (QQQQ) Chart is below:

The QQQQs have been leading the market upward, and haven't yet broken that uptrend leadership. However, they did slow down and are vulnerable to a sell-off at this point. The choppiness indicator shows the current uptrend is exhausted.

We will look for support around the $43 level as the QQQQs likely sell-off a bit here.

Fundamental Trends

There are no surprises in the leaders with department stores dropping to sixth place and basic steel rising to first place. The other leaders merely jockeyed for position.

The leaders now include both steel industries. The top screen now include only two retailers compared to last week's five retailers. We don't believe it is a coincidence with Black Friday (the official start to the holiday selling season) having been the last day of last week. This is something of a buy the rumor (of big holiday revenues), sell the news.

There are two apparel industries supplying the apparel retailers (18th place) with product. There are three petroleum industries in the top screen (last week there were two).

There are three building industries in the top screen (concrete, heavy construction, and residential/commercial builders. Yes, those are the same companies that overbuilt the housing market and aren't likely to see a turnaround until some time next year at the earliest. Investors seem to be jockeying for position to get in before a turnaround in this industry, which could take place as early as next year.

The auto and truck industry continues in the top screen. Finally, the most interesting is the staffing industry. Staffing implies a need to fill jobs. This implies expansion of the labor market or at least more competition to attract labor.

We continue to look for a bargain in the oil space.

The Industry leaders (ranked 1st-5th out of 190) are:

The laggards have the same participants over the last week or two, with the addition of drug stores to the mix (moved from sixth to last to second to last place). Drug stores have been under pressure from a generic drug program that Walmart has announced.

The Industry laggards (ranked 186th-190th out of 190) are:

Trade Recommendations

We didn't make a new long recommendation intraweek, as the market weakened.

This week we will likely recommend a short trade and may put that recommendation out on Monday after the open. Please monitor your inbox, but it is likely to be an index ETF to allow us to move in and out of this trade easily as a swing trade.

We are also looking for an entry to a long trade on CNE, which is a Canadian Royalty Trust that sold off sharply but has made a good rebound. We would like to get an entry into this stock at a lower price, in sympathy with market weakness that we expect to develop in the coming week.

Current Portfolio

For those who delayed entry into SWKS until it hit out recommended level of $6.75 to $6.80, you were rewarded for your patience. The model entered the trade at $6.99 and Friday's closing price was $7.04, so we are modestly positive in this trade. Raise the stop on this stock to $6.92.

FDG has rebounded from a bottom, but is still trending below its 20-day moving average. When it breaks above this, we should see the start of a new uptrend.

Generally, our model uses set stop prices to control risk. Index ETFs, including DIA, SPY, QQQQ, and IWM are managed somewhat differently, in that trades will be reversed to time the market, as opposed to using a set stop limit.

Unlike the majority of position trades in the fundamental trader, our ETF trades may see us exit positions prior to specific profit goals being achieved, as we are more concerned with positioning for the correct direction of the market more than with achieving a specific profit level. The reason for this is the profits come over time with a fair number of exchanges for long and short trades.

* Initial stop prices are set to cause us to exit our positions if they close below these levels. You will note they are generally kept pretty tightly the opposite side of the trades we initiate. Historic volatility would imply that intraday price action may trade outside of these values, so that condition is insufficient to cause an exit from an existing position. On significant movement beyond our stop prices, we may issue an intraday message to exit the position or to maintain the position. You may chose to implement an absolute stop below these suggested stop values, but that stop should be wide enough to take care of the daily volatility for the stock in question. You can examine the candlesticks for an idea of intraday price fluctuations.

Entry prices are adjusted to account for dividends paid. The stock price was adjusted by your broker, to reflect the dividend taken out. The non-adjusted entry price reflects the actual entry price, without the adjustment for dividend values.

LVPB Concept: The concept is a Light Volume Pull Back, where a stock's price will pull back to a support level on light volume. Obviously, heavy selling is a sign of weakness, and we would not want to buy on a heavy volume pullback. However, we will occasionally place stocks on the LVPB (Light Volume Pullback List) to indicate a "re-entry" buying opportunity, when we have already entered a position. This should be used to add to existing positions, or to enter a position if you missed the initial entry.

LVPB Portfolio Stocks:

Conclusions

With the dollar sell-off, and talk on Wall Street turning to less interest in buying as much U.S. debt, to support the swelling US deficit, investors may begin to re-allocate their investment dollars. The topic of liquidity continues to make the rounds, in this context, as well as private equity dollars, and fund managers and companies still flush with cash.

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Regards and Good Trading,