Mid-Caps & Transportation Show Upside Targets For Next Rally

An important technical conclusion stemming from the recent volatility spike is that prices must continue to push higher, above previous highs, in order to confirm the continued upside price expectations. 

The recent volatility spike and downside rotation in the US major stock market were big enough to reset many trending systems and prompt new upside price targets. In this research article, I will share our targets on the Mid-Caps and the Transportation ETFs to show you want we expect from the potential rally.

IWM Breakout Above $218.35 Suggest Rally is Just Starting

The IWM, the Ishares Russell 2000 ETF, Daily chart highlights the recent rotation in price and shows a Fibonacci price extension range from the late December 2020 lows to the recent late January 2021 highs. I use these Fibonacci price extensions as a means of measuring potential upside or downside price targets, which seem to be fairly accurate. Watching what happens near the 61.8% level on the chart will guide us in determining if the 100% target level will be reached quickly or after a bit of consolidation....Read More Here.

Have The Small Cap Stocks Bottomed Yet?

Get our Free Trading Videos, Lessons and eBook today!

The IWM ETF represents the Russell 2000 small cap growth index. This ETF peaked at 84.66 this spring and has fallen in the the 74′s before the recent two day bounce. What we are looking at is a possible 5 wave rally from October into March, and now a possible 3 wave correction (Wave 2) of 38-50% of that entire 5 wave rally.  Elliott Wave theory is broken down into 5 wave and 3 wave movements in the markets and individual stocks, where a full 5 wave pattern in a Bull market is obviously bullish and a 3 wave pattern corrective of the prior 5 wave rally.

The small cap index peaked with the reset of the market in March of this year, interestingly about 3 years into the Bull Market. The first low so far was a  typical 38% fibonacci retracement of the rally from October through early March.  The next low pivot would be a 50% pullback.  This would place the IWM target around 72.10 plus minus some pennies.

In the 72′s that would represent a C wave decline that is equivalent to 161% of the A wave decline in the chart below from the 84.66 highs. ABC declines are common in a Bull cycle and are designed to throw investors off the back of the Bull. Normally the C wave is where investors finally throw in the towel near the bottom, as we saw in early October of 2011.  I wrote an article on October 3rd last year, one day before the bottom outlining why a massive rally was about to ensue.  Will we see the same thing now?

Well, this correction could indicate one more possible decline of 4-5% worst case should this projection in the chart below fulfill.

That said, the 38% retracement we have had so far would also qualify as a Wave 2 low last Friday. Therefore, this outline is to give you some indications of what to watch in case we drop further and pierce those lows.  If we can hold this rally and rebound smartly again, then the C wave of the ABC is likely over and we can get an all clear to be more aggressive.

Join us at Market Trends Forecast.com for weekly reports and or a subscription and a 33% discount!

It’s Easy, get started trading options today. Let’s us show you how

Evidence Supports the Bears’ Case for the S&P 500

I am not one to discuss fundamentals or macro views, but this situation in Europe is beginning to morph into a media frenzy. Price action in the marketplace is changing rapidly in short periods of time based on the latest press releases coming from the Eurozone summit.

I cannot help but comment on the seemingly arbitrary actions coming from this high profile meeting. Nothing has happened that market participants were not already privy too. The European Union is going to strengthen their EFSF fund by levering it up roughly 4 : 1. I have yet to hear how exactly they plan on doing this, but this action was no surprise to anyone that has read an article about the sovereign debt crisis in the past month.

There was also discussion about backstopping European banks’ capital position. Since European banks are holding billions (Euros) of risky sovereign debt instruments, it would make sense that their capitalization is a primary concern of Eurozone leaders based on current fiscal conditions. I would argue that the banks should be well capitalized regardless of economic or fiscal conditions in order for a nation to have a strong, vibrant economy that has the potential to grow organically.

The final piece of this week’s political nonsense involves write-downs on Greek debt in the neighborhood of 50% – 60% in order to stabilize Greece’s debt to GDP ratio. Apparently Eurozone leaders want to structure the write down so as to avoid payouts by credit default swaps which act as insurance against default. How does a bond take a 50% – 60% valuation mark down without a creating an event that would trigger the payout of CDS swaps?

If a write down of that magnitude does not trigger the CDS swaps, then I would argue they are useless as a tool to hedge against the default risk carried by sovereign debt instruments. If the CDS swaps do not payout as projected by European politicians, the risk assumed by those purchasing government debt obligations around the world would be altered immediately.

The impact this might have on the future pricing of risk for government debt instruments could be extremely detrimental to their ability to raise funds in the private market. Additionally, the write downs would hurt European banks’ capital positions immediately. If the CDS swaps were to pay out, bank capital ratios would suffer as those who took on counter party risk would be forced to cover their obligations thereby straining capital positions even further potentially.

Price action today suggested that the equity markets approved of the package that European leaders were working on. However, the biggest push higher came when news was released that China was interested in purchasing high quality debt instruments as a means to help prop up poorly capitalized banks and sovereign nations in the Eurozone through an IMF facility.

The market did an immediate about face which saw the Dollar selloff while the S&P 500 rallied higher into the close reversing a great deal of Tuesday’s losses. Inquiring minds wish to know where we go from here? I would be lying if I said I knew for sure which direction Mr. Market favored, however that did not stop me from looking for possible clues.

It has been a while since I checked out the short-term momentum charts that are focused on the number of stocks in U.S. domestic equity markets that are trading above their 20 & 50 period moving averages. The charts below illustrate the current market momentum:

Equities Trading Above the 20 Period Moving Average

It is rather obvious that when we look at the number of stocks trading above their 20 period moving average that momentum is running quite high presently. This chart would indicate that in the short-term time frames equities are currently overbought.

Equities Trading Above the 50 Period Moving Average

A similar conclusion can be drawn when we look at the number of stocks trading above their 50 period moving averages. It is rather obvious at this point in time that in the short to intermediate term time frames, stocks are currently at overbought levels. This is not to say that stocks will not continue to work higher, but a pullback is becoming more and more likely.

Additional evidence that would support the possibility that a pullback is likely would be the  recent bottom being carved out in the price action of the U.S. Dollar Index. The U.S. Dollar has been under selling pressure since the beginning of October, but has recently started to show signs that it could be stabilizing and setting up to rally higher.

The daily chart of the U.S. Dollar Index is shown below:

The U.S. Dollar Index is sitting right at major support and is oversold based on historical price action. If the Dollar begins to push higher in coming days and weeks it is going to push equity prices considerably lower. Other risk assets such as gold, silver, and oil would also be negatively impacted by higher Dollar prices.

Members of my service know that I focus on several sectors to help give me a better idea about the broader equity markets. I regularly look at the financial sector (XLF), the Dow Jones Transportation Index (IYT), emerging markets (EEM), and the Russell 2000 Index (IWM) for clues about future price action in the S&P 500.

During my regular evening scan I noticed that all 4 sector/index ETF’s are trading at or near major overhead resistance. With the exception of the Dow Jones Transportation Index (IYT), the other 3 underlying assets have yet to breakout over their August 31^st highs. The significance of August 31^st is that is the date when the S&P 500 Index put in a major reversal right at the 1,230 price level before turning lower. It took nearly two months to regain the 1,230 level and its significance continues to hold sway.

The daily chart of IWM is shown below illustrating its failure to breakout over the August 31^st highs:

The chart above illustrates clearly that IWM has failed to breakout above the August 31^st highs. I am going to be watching IWM, XLF, & EEM closely in coming days to see if they are able to breakout similarly to the S&P 500. If they start to rollover, it will not be long before the S&P 500 likely follows suit.

Currently the underlying signals are arguing for lower prices in the short to intermediate term. While it is entirely possible that the S&P 500 rallies higher from here, it is without question that current market conditions are overbought in the short to intermediate terms.

Key sectors and indices are not showing follow through to the upside to help solidify the S&P 500′s recent break above the key 1,230 price level. Additionally, the U.S. Dollar Index is currently trading right at key support in addition to being oversold. At this time I am not playing the S&P 500 in either direction, but I will be watching the underlying price action in the U.S. Dollar Index closely. I will be watching for additional clues in the days ahead.

Market and headline risk is high presently.

Subscribers of OTS have pocketed more than 150% return in the past two months. If you’d like to stay ahead of the market using My Low Risk Option Strategies and Trades check out OTS at Options Trading Signals.com and take advantage of our free occasional trade ideas or a 66% coupon to sign up for daily market analysis, videos and Option Trades each week.

Chris Vermeulen & J.W. Jones

SP 500 Being Left Behind By The Russell 2000

Before discussing why I think the S&P 500 may be setting up to rally I have to discuss an options strategy that often times is overlooked. Besides writing covered calls and cash secured naked puts (same risk profile by the way), one of the most basic spread constructions available to option traders is the vertical spread.

A vertical spread can be written when an option trader believes prices are going up (bull call spread) or when prices are going down (bear put spread). In addition to the previous trades which are placed as debit trades, option traders also have the ability to place vertical credit spreads too. While vertical spreads regardless of nature are a very basic option trading strategy, they can produce strong returns with defined risk.

A brief description of a vertical debit spread involves buying a call or put and simultaneously selling a strike further away from the money. Vertical debit spreads always have a directional bias depending on whether calls or puts or used. The sale of the call or put that is further away from the money results in a credit and helps reduce the total cost of the spread thereby reducing the capital risk. A call debit spread, also called a bull call spread is used when a trader expects higher prices. A put debit spread, also called a bear put spread is utilized when the option trader expects lower prices.

A vertical credit spread is established in the opposite construction of a vertical debit spread. The construction involves selling a call or put that is closer to the money and buying a strike that is further away from the money. This strategy profits from time decay as well as price action. The maximum gain is limited to the difference in the credit received for the contract that is sold and the debited premium that is required to purchase the long strike. Vertical credit spreads always result in a trader receiving a credit. A call credit spread, also known as a bear call spread is used when an option trader is expecting lower prices. A put credit spread, also known as a bull put spread is utilized when an option trader expects higher prices.

I typically use vertical debit spreads when I want to place a trade that has defined risk and when I am expecting an underlying’s price action to move in a specific direction. However, vertical credit spreads are often overlooked by many traders and this is most certainly a mistake. My favorite time to utilize a vertical credit spread is when price action across the equity indices is ugly. In fact, a nasty selloff where implied volatility is juiced in most equities presents an outstanding opportunity to construct vertical credit spreads.

With the commodity complex getting hammered recently as the U.S. Dollar increased in value, a lot of the agriculture based companies have suffered. The ETF MOO as an example has lost close to 10% from recent highs. I was stalking $MOO looking for a bottom in the price action and on May 23 I looked on as MOO was close to testing its 200 period moving average shown below:

I had also been stalking Deere & Company (DE) for a while looking for a bottom. As it turns out, $DE is the single largest individual holding held in the MOO ETF. When I saw MOO bounce near its 200 period moving average while at the same time I looked on as $DE closed in on its 200 period moving average I felt that we were near a short to intermediate term bottom in the agriculture space. I immediately looked at the $DE option chain as well as the historical implied volatility chart. The trade offered solid risk definition as the 200 period moving average was my support level and credit spreads offer an option trader precise capital risk attributes.

Since Deere & Company had been under significant selling pressure implied volatility was elevated which would also put the wind at my back. When writing credit spreads, implied volatility is critical and must be monitored. I knew I was selling juiced option premium as the implied volatility was historically elevated. The closest at the money strike on the put side was the June DE 80 Put contract. I proceeded to sell the June DE 80 Put contracts and bought the June DE 77.50 Put contracts in a 1:1 ratio to setup the spread.

The maximum risk per put credit spread was $197. The maximum gain was $53 per spread. At expiration the maximum yield would be earned if $DE closed at $80/share or more. The maximum yield of the trade would be 27% (53 / 197) based on maximum risk. The profitability curve of the DE Put Credit Spread is shown below:

I had absolutely no intention of holding this trade to expiration. In fact, my trading plan was to close the trade as soon as a 15% return based on max risk was reached. I employed a hard stop based on the underlying Deere & Company stock price of $80.90 /share. Essentially the trade had a 1:1 risk versus reward ratio (also referred to by traders as a 1R trade). I entered the trade and at this point still have the trade open, but with the higher prices I am seeing this morning (Friday) in $DE, I will be closing my trade with a gain near 15% of my maximum risk and 100% of my hard stop based risk.

Often times option traders overlook basic trading strategies like a vertical credit spread. In a stock market correction or in a situation where a particular underlying has been under selling pressure for quite some time and implied volatility is juiced and a major support/resistance level is nearby, vertical credit spreads offer solid risk / reward. Often times option traders fail to use basic strategies like vertical spreads which provide them the opportunity to trade around bounces, topping patterns, and bottoming patterns without the total capital risk associated with buying/shorting stock.

Russell 2000 Index (IWM)

Members of the service I run are used to seeing analysis about the Russell 2000 Index on a daily basis. Every day I monitor the price action in the Russell 2000 Index (IWM), the Dow Jones Transportation Index (IYT), and the financial complex (XLF). Quite often one, if not all of these ETF’s start throwing off clues about Mr. Market’s favored market direction.

During strong moves in the market, all 3 ETF’s will generally be moving in the same direction regardless of whether prices are going up or down. If the move is strong and has momentum they all move the same way, but generally speaking one of the ETF’s displays relative strength against the S&P 500 and the other ETF’s.

Recently the Russell 2000 Index started showing signs of life and then the transports and financials followed the small caps higher. While both the Transports (IYT) and financials (XLF) traded higher the past two days, neither have had the relative strength that the Russell 2000 ETF (IWM) has shown. When the small caps speak, I listen and they have been screaming the past two days that higher prices may be likely next week and into the first week of June. However, as the daily chart of IWM below illustrates, they have some major work to do the rest of Friday and next week.

If the price action in IWM can push above the upper bound of the recent downtrend and show continuation higher, we will likely watch as the S&P 500 pushes up to the key 1340 price level for a retest. If the S&P 500 is able to penetrate the resistance area I believe we will likely see the 1,400 – 1,450 S&P price level come into play. The daily chart of the S&P 500 Index (SPX) is shown below:

I am leaning bullish on the S&P 500 and risk assets in general (commodities) going into the final week of May and the early part of June. I am expecting a news event to move the markets in a big way within the first few weeks of June. My guess is that an announcement coming out of Europe will be the headline that finally pushes the market into overdrive. For right now, the price action is coiled and we are about to witness a big move.

While I am leaning bullish, I am certainly not willing to risk capital in an attempt to game price action. I will sit back and wait for price action to confirm and pick my spots. Anticipatory trades do not fit my risk tolerance or trading style and I consider them sophisticated gambling. I’m going to let others do the heavy lifting and wait for confirmation about the trend’s direction. At this point in time, the small caps are signaling that higher prices are likely for equities but the real question is whether Mr. Market is just toying with us and this is nothing more than a head fake. Risk is excruciatingly high.

If you would like to be informed several times per week on SP 500, Volatility Index, Gold, and Silver intermediate direction and option trade alerts… take a look at Options Trading Signals today for a 24 hour 66% off coupon, and/or sign up for our occasional free updates.

Share

5th Wave of Market Advance is Tiring Out

From guest blogger Dave Banister....

The Market Advance in the Final Stages?

It’s time for a review of the broader market indices and possible implications for traders and investors: This analysis may prove controversial, but I tend to make big picture calls at critical junctures. This analysis is getting more bearish I realize, as I’ve been bullish since Feb 25th on the markets. I simply look at all the evidence, and instead of burying my head in the sand, I take it all in and plan accordingly. Being a perma-bull or perma-bear is a quick way to under-perform the markets. I try to be nimble and trade/invest accordingly. The next few weeks are likely to be volatile, possibly to the downside a bit. The market may not have peaked quite yet, but it’s feeling like the 8th inning in the game. Below are my thoughts:

1. It appears we have the qualifications to have a potential top in since the March 2009 lows. This is due to the rebound of the Dow to above my 10400 targets I put out in late February of 2009. We have had a 61% Fibonacci retracement of the 2007 highs to the 2009 lows. In addition, we have had about a 61% time period duration with an 11 month rally which followed a 17 odd month decline. From the world in which I work, this means that the markets have fulfilled intermediate objectives for a top.

2. The caveat in this analysis, is that markets could still work their way higher. Just because we have met certain typical patterns in Time and Price movement, elliott wave patterns and the like, doesn’t mean we have peaked for sure. The markets could continue in a higher % retracement of the 17 month decline and the indices work their way higher. What I am pointing out today is that the requirements for a top have been met, and we need to be on guard. Also, we have other non elliott wave measures I use that are giving me some topping signals (Below).

At the bottom of this post is my 5 wave Elliott pattern on the Russell 2000 index. I will again note that this pattern could be re-interpreted if I wanted into a 3 wave (A-B-C) corrective pattern. It is all in the eyes of the Elliott Wave beholder I guess. Sometimes you need to take a little poetic license in the analysis. Elliott wave theory is not foolproof by any means, so I try to overlay other factors. Read my Feb 25th 2009 article on 321Gold.com if you want to see my point there. We have bullish sentiment running at extreme highs. We have the VIX or “Volatility” index running at extreme lows. The last time we had this many bulls in surveys vs bears was July and October 2007. I think we all know what happened then.

Therefore, whether this was an impulsive 5 wave pattern from March, or an A B C correction upwards… doesn’t matter much near term because in either event, the evidence is mounting for an interim top in the next 1-2 months or less. Tops don’t usually happen in one day or one week, they are a process… and we are mounting the top of this mountain I think. The bull to bear ratio is a warning flag.

Other Factors: Consumer Expectations index has rallied from a low of 22 in February 2009 (My bullish article period) to a reading of 70 now. This would make sense as these bottomed with a low market, and rise with a rising market. This means expectations have soared off the lows, along with the markets. However, how people feel about their “present situation” is rather unnerving. It has hit all time lows even with the market rebounding. This is a potential problem for sure. This is also reflected somewhat in the % of bulls in the market vs the bears… again, a warning flag.





Bottom line: Markets are at a critical juncture of higher than normal risk levels here. This does not mean we can’t trade and make profits on the long side however. What it does mean is what I’ve been hinting at lately. We are in the 5th wave up in this structure since March lows. 5th waves can be very difficult to forecast as they can be extension waves or “truncate” and reverse sharply. Friday last week was ugly, but it was also options expiration week, making analysis more difficult. Partners in this service should note that we have been aggressively taking profits and removing positions off the table in the past two weeks, as well as general advice to raise cash levels a bit. Partners who are planning to stick around for the long haul should be aware that there are times in the market to be aggressive on the long side, and times to be high in cash and sit back for awhile. Right now, the evidence is to be more cautious and to have higher than normal cash balances while we wait for confirmation of market/wave patterns.

Other notes: Robert McHugh, is a very good Elliott wave forecaster and he is also beginning to make a convincing bearish cycle/wave case now. I often ignore his analysis as he has consistently been forecasting a top for 2-3 months now, and we have plowed ahead… but now I’m watching his work a bit closely to see if it mirrors my views. Eric Hadik is also a strong cycle and time forecaster, and again, not perfect. He is also looking for potential tops into latter February and early March. I also have not reviewed his work in 10 months or so, but am starting to review it again.

We need to be on our toes to be prepared to trim back positions if needed and to cut losses quickly if needed. This update is not to alarm anyone, as there is likely one more leg up in this up cycle to higher highs yet. However, let’s be on guard.

Here is the current IWM (Russell 2000 Small cap) index chart. It’s getting long in the tooth: Does this mean the market crashes from here? No, but again, it means we may need to be extra on the guard for an interim top and to again build higher than normal cash levels…and prepare to be defensive. Stay tuned.



Dave Banister is the Chief Investment Strategist and commentator for ActiveTradingPartners.com. David has written numerous market forecast articles on various sites (SafeHaven.Com, 321Gold.com, Gold-Eagle.com, TheStreet.Com etc. ) that have proven to be extremely accurate at major junctures. You can read more at
Active Partner Trading.


Share