Investing Adventures

“The bear market’s over!”
“We’ve just seen the bottom.”
“The VIX has retreated; therefore, we’ve hit the bottom.”

This is what I’ve seen or heard since Thursday. So have we seen the bottom, waved, and moved on on merry way?

Last week was definitely an interesting week. Bear Stearns (BSC) was purchased for $2 per share (yes, $2 and not $20 as most figured $2 was a typo). The Fed cut the discount rate not once, but twice last week. Sunday evening, the Fed cut the discount window by a quarter point. What was more important was the opening of the discount window not only to banks as usual but to investment banks as well such as Lehman (LEH) and Goldman (GS). Could this move have saved BSC? I don’t think we’ll have the chance to see that but one never knows seeing as how the sale may take longer than expected due to litigation, BSC employees and BSC stockholders.

Liquidity issues? Doesn’t seem to be an issue anymore. Credit crisis issue solved?

Not to be outdone, the Fed on Tuesday cut the discount rate by another half point to 2.5% as well as the funds rate by three-quarter points to 2.25%. After putting in a strong hammer candle on Monday, the combination of the technicals from the hammer plus the rate cut helped boost the markets Tuesday.

Wednesday’s drop could be perceived as profit taking as well as full digestion of the previous day’s rate cut. The bears also have a strong foothold on the 1330 S&P level so some resistance was expected.

Thursday was expiry day with a number of derivatives expiring including March options. Was Thursday a solid rally day or more of a short covering into a holiday weekend? I will point out if you look at Thursday’s candle, it’s very close to a bullish engulfment. Normally, a bullish (or bearish) engulfment will “engulf” the previous day’s candle. In Thursday’s case, the bullish candle closes just slightly lower than Wednesday’s open. If you notice, the top tail of Thursday’s candle does reach Wednesday’s open but backs off slightly indicating continuing strong resistance at S&P 1330.

So what does this mean for Monday? I foresee a battle between the bulls and bears at that 1330 level. If the bulls can push it past Wednesday’s high, in the short term expect the markets to move higher. The next logical level appears to be near the 1390-1400 area. It all hinges on the financials. If they can keep up their current bullish sentiment, expect S&P 1400 to be here much sooner than you think.

As I learn every day I trade, today I learned about market breadth and how it can affect the markets during the day and potentially the following day. Today, the Dow closed approximately 12 points higher with the Nasdaq down a few points and the S&P unchanged. Normally, I’d think of that as a flat day with little to no action. Thanks to my trading platform, thinkorswim, and their chat room with the shadowtrader, I learned how to analyze market breadth and how it can impact tomorrow’s open. Here’s the setup I was taught to analyze market breadth on the fly:

A quick explanation of the setup. In order from top left to bottom right going down each row, you will see advancing volume against declining volume for the NYSE and the NASDAQ, advancing issues against declining issues for the NYSE and NASDAQ, and the TRIN (also known as the Arms Index) for the NYSE and NASDAQ. The green line for each represent positives while the purple represents negatives.

So while today was relatively flat, let’s look at the volume and issues for the NYSE and the NASDAQ. For the NYSE, notice the volume chart (top left) versus the issues chart (middle left). While the advancing issues were above the declining issues by about 1.12 to 1, the declining volume outpaced the advancing volume by about 1.6 to 1. The NASDAQ shows a more consistent story with declining volume and issues versus advancers 1.5 to 1, and 1.75 to 1, respectively. If I had to take a guess, I’d say today was overall a win for the bears.

What’s interesting is the concept of the TRIN, or the Arms Index. Without going into detail, the Arms Index, is a contrarian indicator. A value above 1.2 suggests an oversold market while a reading below 0.8 suggests an overbought market. So what does that mean for today’s action? The NYSE TRIN finished the day at 1.7, or reading an oversold NYSE while the NASDAQ TRIN is reading 0.66, or overbought.

So what does all of this mean? Well the NYSE TRIN is reading oversold with declining volume outpacing advancing. I’d take a guess that we’ll see the NYSE have some sort of bounce, perhaps early in the trading period. The NASDAQ TRIN is reading overbought with declining issues and volume outpacing advancers by a bit. My guess is we’ll see more weakness in the NASDAQ tomorrow morning. Now remember that this is my first attempt at reading market breadth so it’ll be somewhat of a trial and error but so far, without accounting for the jobs data and other economic indicators being released, my guess is we’ll see more weakness continue tomorrow. Great start to the January bounce, eh?

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