Newsletter 10-10-08

Previous Issue:
I stated:
I believe that "CASH" is the place to be until our Congress and Senate stop the political posturing.

For the most part I see no reason to change that position.

This Issue:

Last week, I mentioned I was 90% cash. I am now 100% cash. However, after Thursday, I will start looking for long positions. I plan to be very selective. I’ll be building a WatchList of stocks starting to show bullish signs. As expected, Thursday the market gapped up. That was to get all us suckers back in. In my case it did not work as I stayed in cash. The DOW managed to give it all back by 10:30am and made a new low 9,046 in the process. By the end of the day we had a "Low of the day" close at 8,579. That was telling us it is not yet at a bottom. Today, Friday, the market officially opened with the DOW at 8,565 but within 7 minutes we were at 7,891 or 674 points lower. Then 32 minutes later we had a high of 8,662. The market close at 8,451 down 128 points. Certainly not a market for trading but if you want to gamble then jump in.

However, now is the time to start looking for bullish patterns, such as,

Engulfing
Morning Star
Hammer
Three White Soldiers
Kicking

I would add the Bullish Piercing Line to the list. I expect we will see lots of Morning Star patterns as they occur in numbers at all major bottoms. I’m not buying, I’m just looking for potential candidates. Again, We are not through with this downtrend.

At the beginning of all the Bailout talks, I did something I do not normally do. That was watch Jim Cramer at 6:00 pm on CNBC. I can’t take all his ranting so I find it hard to watch him. Whether you like him or not, he is a very, very sharp person. He said he had a target of 8900. He did not explain how he derived at that figure. So I thought I’d take a shot at explaining how he got there. First we need to look at the really long picture, all the way back to the start of the Internet Bubble burst in January 2000 when the DOW hit a high of 11,750 and in 22 months in October 2002 fell to 7,197. From there the DOW had a 5 year bullish run 14,198 a 150% retrace to the 22 month decline. We have now had the fastest decline ever, in only 12 months to date, in the DOW.

The following 2 charts show the extent of the fall as of 2:30 pm on Thursday. This is what I had prepared to publish but the 500 point drop in the final hour on Thursday meant I had to rework this newsletter. I decided to leave these 2 charts in. After all, I spent a lot of time preparing them. I'm also adding Today's chart below.

In first monthly chart we look at the Fibonacci extensions to determine the C-D movement percentage. We have already given back over 100% of the Jan00 to Oct02 move.

Retrace of the Jan00 high to the Oct02 low

The second chart shows the Fibonacci Retracement of the B-C wave. We are now at 74%. Just 1% from the 75% mark of 8947 for the DOW. It is not rocket science it's just simple Fibonacci projections.

Retracement of A-B

If we break through the 75% mark there is an excellent chance we will take out the Oct02 low of 7197. I don't that is going to happen but then I thought the Financials would recover once the bailout was passed. Shows what I know. That's why I keep my stops tight and buy protective puts when I am not that confident in the trade direction as you will see below in my explanation of the XLF trade I made on 9-26-08.
All above comments were reflecting the market as of Thursday 2:30 pm.

The below comment reflect Friday, October 10, 2008 which will most likely go down as one of the strangest day ever for the DOW as it had a trading range of 1,019 points. Swings of 300 points happened about every hour 9 times total. What awild ride it was. Personally, I don't think that is a place for anyone to be. Yes, there is a ton of money to be made if you are a gambler.
Many are saying this was the bottom. Maybe, maybe not. I'm sure if it is then they will be telling us over and over how they called the bottom to the penny. We closed down 128 points and that normally would be considered a bearish move. However, technically, today's candle qualifies as a DOJI thus making it an indecision day or slightly bullish. Above I mention that Morning Stars are common at major bottoms. Look for Monday's price action to form the third candle for the Morning Star. if so, then we have a good chance it is a bottom. If that happens I'll be checking for candidates for the expected bullish move. We can't jump the gun and get in to quickly. Let the market shows us it has reversed.

The next chart shows both the Fibonacci Extensions and Retracements as of the close on Friday, 10-10-08 where the DOW closed today RIGHT ON THE 127% Fibonacci extension. Can that be an accident?

Dow's biggest one day trading range ever

Dow's biggest one day trading range ever

I mentioned in the previous newsletter that I purchased XLF, the ETF for the financial sector. As I expect it to see some positive movement in the coming weeks. Well, we all know that has not occurred. So you are probably thinking I made a bad trade. Well, yes and no, the XLF purchase was bad. Here is the details of the trade. Hopefully, it will be a worthwhile lesson for many of you. Always, protect your downside.

I bought 500 shares of XLF at 20.55on 9/26/08 and also purchased 5 contacts on the NOV08 20 PUT for 1.55.
I sold XLF position at 19.65 on 10/02/08 as it failed my 3 day rule. Plus, it was obvious that we were not going to see the surge in the Financials.
I kept the NOV08 20 PUT until 10/08/08 where I sold it for 5.00.
I lost 90 cents per share on the XLF purchase
I made 3.45 on the NOV08 PUT.
I made 2.55 per shares or 11% in 8 days

So the total trade was good and provides a good lesson in why it is sometimes best to hedge your position. Since I had the Protective PUT in place I did not need a Stop-Loss order. Had I put a Stop-Loss in place at 19.10 (equivalent to the 1.55 for the cost of the PUT) I would have gotten stopped out the following Monday when XLF hit a low of 18.39. Since I was willing to risk the 1.55, why not buy the PUT and minimize my downsize exposure. However, had I been right and the Financials did move to the upside then I would have had wait until it reached 22.20 to break even. To me that was okay as well, since I expect the upside target to be in the 27 area. Still think that is the target when the financials start to move. So I am watching XLF.

As of close Thursday, the NOV08 20 PUT was worth 6.60 and on Friday had a high of 7.50. That's okay, I'm good with the 11% profit in 8 days. Next week I'll analyze the trade in more detail to see what I did right and what I did wrong. Another one of my trading rules - wait 5 days before analyzing closed trades

Using protective PUTs is covered in my seminar along with other means of protecting your positions.