General Market Index (GMI) table

Market Showing Serious Signs of Weakness; Surprising TC2007 Submarine Scan Results

@ 7:00 am
GMI5/6
GMI-R7/10
T210864%

I have noticed that during market up-trends, stocks tend to rise in anticipation of the release of good earnings.   Once the results come out and after the immediate reaction, many stocks tend to regroup and often decline, until they begin to rise as the next quarter’s earnings season approaches.   We are now in the period when many stocks have reported and we may be in the refractory period when stocks consolidate or decline.   Regardless of the true story underlying recent market action, it is clear to me that my indicators are weakening and that the coming week could cause a serious deterioration in the GMI and GMI-R.   If a short term down-trend begins, we never know how long it will last.   We have to wait for definitive signs of a new up-trend.

So, here are the facts as I see them now.   First, many of the stocks that led this advance are breaking down or failed to hold new highs reached recently (GOOG, ISRG, GMCR,to name a few I have traded). Even AAPL, the leader of the tech sector, could not hold new high ground last week.   (AAPL remains in an up-trend.)   Then, the Worden T2108 Indicator began to break down, now at 64%, and is in a down-trend.   This pendulum of the market is an excellent indicator of market extremes.   Having held around 80% since early March, it finally has begun to decline.   Many market declines bottom out when T2108 is around 20%. (T2108 measures the percentage of NYSE stocks that closed above their average price over the past 40 days. If a stock is trading below its average price over the past 40 days, one might think of it as a sign of weakness.) I also monitor the percentage of Nasdaq 100 stocks whose daily MACD (12/26/9) is above its signal line.   That percentage is now at 24%, lowest since last February and is another sign of short term weakness. The GMI is at 5 and the GMI-R is at 7.   (The QQQQ short term up-trend completed its 50th day on Friday.)   A further market decline next week could reduce these values quickly, but I try not to jump the gun.

I told you that to hedge my long positions I had purchased call options on gold (GLD) and on the 3X   Tech Stock Short ETF (TYP) that rises as tech stocks fall.   Both of these positions advanced last week, minimizing declines I had in a few remaining long positions.

As long as the general market indexes remain in up-trends (and this could change next week), I do not like to short stocks.   But I wanted to alert you to a scan I ran using TC2007 to find “submarines,” stocks that appear to be entering a major down-trend, according to certain technical patterns I watch.   Because I look for fallen leaders to short, this scan was limited to stocks in my TC2007 watchlist that contains present/past IBD100 or New America stocks, published by IBD.   Note that stocks typically begin declines before the fundamental reasons become public.   Therefore, when I short, I rely solely on the technical patterns.   I was so surprised to see some of the stocks that came up in this scan that I thought I would post the list.   If I   owned any of these stocks (which I would not, because they are below critical levels I follow), I would move my sell stops up, hedge them with puts, or sell them outright.   I do not buy “bargains” that have declined far from their tops. This is not a recommendation, just intended to teach you how technical analysis can be used to reduce risk.

Here is the list of 13 stocks: MSTR, SWN,CVLT,GILD,ATHN,PWRD,NTES,GS,ABVT,SYKE,GOOG,SQM,MCFE. Some of these stocks had terrible days last week but did show up in my scans before those days.   To my surprise, GS and GOOG are on the list.   I was especially interested in the fact that two stocks in the same industry showed up with ominous similar chart patters, PWRD and NTES.   This “naked” weekly chart of PWRD,without prices, shows more clearly the pattern of key weekly moving averages.  (NA represents about when the stock was written up in IBD’s New America column.)   When the shorter averages (4 dotted, 10 blue) are below the longer term average (30 red) which itself is beginning to curve down, it suggests to me that the prior up-trend is over and a new down-trend is likely. The end of the up-trend should be evident to even eyes unaccustomed to technical analysis. When shorting, I like it if multiple stocks in the same industry are failing, indicating a potential sector-wide decline.   (Both NTES and PWRD are Chinese online gaming stocks.) Over 2 years ago, I wrote about an impending meltdown in the banking sector when I saw how many financial stocks were giving me similar sell signals.   With regards to this list of   stocks, maybe I am wrong this time….

True Religion (TRLG) break-out?

@ 7:00 am
GMI6/6
GMI-R10/10
T210881%

I have been watching TRLG for a while.   It came to my attention when it hit a 52 week high a few weeks ago.   I went to its monthly chart (click on chart to right) and saw that the stock has two promising characteristics.   First, it was about to break its all-time high.   TRLG reached a high of 31.82 in September, 2008, just before the market began its swoon. This maker of high priced jeans was probably hurt by the coming recession but may do well as affluent consumers spend again.   Second, TRLG is a recent IPO, having come public in 2005. My students should remember   that William O’Neil has said to look for great stocks among those that have come public in the last 8 years or so.   The “NA” on the chart indicates that IBD wrote about TRLG in its New America column last summer–another plus. So, TRLG got my attention as it approached its all-time high.   It has fought back from a low of 7.80 in March, 2009.   When a stock can regain all of its lost ground and push to an all-time high, I become very interested.   And last week TRLG did that, closing at 33.11.   The only thing that was missing was   unusual high volume when it broke out. The other potential problem is that earnings are coming out on May 4th.   Maybe the stock is rising because insiders know earnings will be great, or maybe the company will miss and the stock will dive.   TRLG has a short ratio of 11.7 and it could really rise if the shorts have to cover. I have bought some May call options on TRLG and am betting on a rise.   I really like stocks that can push through to an all-time high. (I posted about AAPL weeks ago.) If I am wrong and TRLG comes back down, the most I can lose is the cost of the calls. If I am right, I GES you may call me a jeanius!

Meanwhile the GMI and GMI-R remain at their maximum readings. Friday was the 45th day of the current short term up-trend in the QQQQ.   QQQQ has not closed below its 10 day average since last February.   This has been an amazing and rare up-trend.   Both the SPY and QQQQ have closed above their 10 week averages for 8 weeks.   The Worden T2108 Indicator remains at a high level, at 81%.   T2108 has been above 77% since March 5th.   This indicator acts like a pendulum of the market.   The market tends to hit tops around 90% and bottoms below 20%, but not always.   Anyway, with the up-trend in place I remain fully invested in my university pension and have been trading individual stocks and options in my IRA.   The scan I talked about in the Worden webinar and the TC2007   scan I posted last week has helped me to find some promising stocks.

How I buy AAPL for 12% down without using margin!

@ 7:00 am
GMI6/6
GMI-R10/10
T210879%

I thought you might like to know a way to buy a stock for little money down using deep in-the-money call options.   I became aware of this option (pun intended!) by reading Lee Lowell’s wonderful book on ways to get rich from options. A call option provides someone the right (but not the obligation) to buy 100 shares of a stock at a particular price (strike price) for a period of time (until option expiration).   Most people gamble with call options and try to buy a cheap call that is far out-of-the-money.   For example, if one goes to yahoo finance and enters AAPL and then selects options, one can get a whole table of possible call and put options for AAPL.

Looking at this table of May options on Sunday evening, I see that I could buy an out-of-the-money call on AAPL with a strike price of   $270 for about $2.47 per share or $247 total for 100 shares (excluding commissions).   This call gives me the right to buy 100 shares of AAPL at $270 per share through May option expiration (3rd Friday of each month).   Since AAPL stock is trading at $247.40, this option is far out-of-the-money.   It would have no real value to anyone until AAPL is above $270 per share (strike price).   The reason people are willing to buy the option for $2.47 per share is that they hope (and are betting) that AAPL will be above $270 by option expiration.   The money they are paying for what is currently a worthless option is   called time premium. In fact, this option buyer would have no profit at expiration unless the stock is selling at $270 + $2.47 (price paid for option) = $272.47   This is gambling.   But remember, if AAPL closes at, say $280 per share by option expiration, the option that was bought for $2.47 per share would now be selling around $10 per share, a quadrupling of the initial investment!   This is because one could execute the option and buy the 100 shares at $270 per share and then turn around and sell them immediately in the market for $280 per share.   One does not need to buy the shares, however, to reap the profit.   Before the option expires, one could just sell the option in the option market for around $10 per share ($1,000 total) in this example.

But an unusual characteristic of options is that as the option is deeper in-the-money, the time premium becomes very small and a small rise in the stock can make the option profitable to a buyer.   For example, the May call option with a strike price of $220 is offered at $29.40 per share, or $2940 for 100 shares.   This means that I could pay $2940 to control $24,700 worth of AAPL through May expiration.   Since AAPL is trading at $247.40, the May $220 call already has real (intrinsic value) value of $27.40 per share ($247.40-220.00).   Since the option would cost me $29.40 per share, the stock only needs to rise $2.00 to $249.40 before I begin to make money as AAPL rises.   Thus, for an investment of $2940 I get to reap the benefit of the gains in a $24,700 stock.   This equals about a 12% down payment, without the need to go on margin and pay interest!

What is the down-side?   Since I pay $2940 for the option, if AAPL closes below the strike price of $220, the option would expire worthless (why would someone buy the right to buy a stock at $220 if at expiration the stock   is   trading below $220?)   So, one can lose the entire investment if the stock falls a lot.   But this strategy loses less money than if one had paid full price for 100 shares   and then seen it fall far below $220!   The most one can lose is what they paid for the option. The big temptation to be avoided here is using the leverage to buy options on more shares than one could have bought outright. That is the way to make a huge bet and lose a lot of money.   I use this option strategy to buy the right to purchase about the same number of shares I would   have been able to purchase.

If you like this strategy, I suggest you read Lowell’s chapter on this topic.   Also, read up on how to open an options account and trade options. By the way, I would not even consider buying AAPL call options until after the earnings come out this week.   Look what happened to other high fliers last week, after they reported great earnings.

Now, the GMI and GMI-R are still at their maximum values.   However, the action in ISRG and GOOG led me to sell out some positions on Friday.   I think it is a warning sign when the leaders crack like that.   Remember, as trend followers, we only tend to exit the market after the trend has changed.   Thus far, the markets remain in an up-trend.   However, I am moving my stops up and am ready to get defensive. Friday was the 4oth day of the current QQQQ short term up-trend.   The last time the QQQQ closed below its 10 day average was February 23rd! That moving average is now at 49.17, only .36 below the current value of QQQQ.   It would not take much of a decline in QQQQ   to break below this important moving average. Note that the Worden T2108 Indicator is now below 80% and may be getting ready to decline.   Be careful out there.   Things probably can’t get much better.