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Option Millionaires was started in February 2008 to provide traders with information about option trading. Led by three career option traders, whose pseudonyms are JimmyBob, UraniumPintoBeans, and Vantillian, they started one of the most popular option trading communities on the web. Now, Option... More
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  • Lessons From Apple & Psychology Of A Downtrend

    The Psychology of the Bearish Earnings Beat

    In the 1980s, Peter Lynch continuously advocated the notion that "earnings drive the market." That appears true, as rising corporate earnings generally results in a rising stock price, and vice versa. So, from a pure binary standpoint, an earnings beat should drive prices higher and an earnings miss should send them lower. Correct?

    Unfortunately, fundamental analysis has two forecasts it must make. First, a fundamental analyst needs to forecast the future of a company (i.e. its earnings). Second, he/she needs to forecast how the market will react to those earnings. That second part is what caught so many Apple bulls off guard last week.

    To understand what happened with Apple's earnings, which beat estimates last week, we need to understand the psychology behind the stock's fluctuations. This method of thought can be applied to essentially any stock.

    It's almost like we have to tell a story about Apple's price history. At $700 dollars a share, Apple was the stock that everybody wanted to own. Few, besides us here (Elliott Wave was saying that $675-$700 was a danger zone) were neutral, let alone negative on the stock.

    So then the stock topped. As you can Volume Profile study, a lot of shares were exchanged within 15% of the top in the past two years. (On a quick side note, if one plots down volume into the April peak of AAPL, you'll see that there was tons of selling into that rally, while the September rally was actually halted by the lack of buyers, which could no longer push the price up.)

    (click to enlarge)

    Since there were a lot of shares exchanged near the top, there were many "weak hands" who were stuck with losses almost immediately. These weak hands are likely the majority of those who still hold the stock today, which is why every rally has been seen as a selling opportunity.

    So let's take Apple's most recent earnings, which was a slight beat. First, the weak hands, already discouraged, are likely swearing to themselves to dump any shares when they can get a small rally. Secondly, those who sold near the top see the stock's downtrend and hear about the company's lowered guidance, so they keep their hands off of it. Then, there are potential investors, who have never bought. A single news event is usually not sufficient to cause long term investors, the ones who really have the impact on price trends, to buy.

    Therefore, what is left? Buyers will not touch the stock, and the mass of sellers who bought at higher prices, while not short sellers (just around 2% of Apple's float is sold short), sell into a vacuum, able to continue to push prices down, regardless of the news. That is the anatomy of a downtrend.

    So what did we learn? Regardless of an earnings beat or miss, the psychology of the market is important. The only thing that will drive the price of a stock up is more demand than supply, and supply remains clearly dominant in Apple. To see when buyers are beginning to rush back into Apple, a simple relative strength line can be used. When the line turns back up, long term investing, earnings beat gambles, and bullish swing trades will have higher profit potential.

    To determine the trend of the RS line, I use a 30 and 50 day simple moving average crossover with the ratio chart. On Thinkorswim, type the symbol (AAPL/$SPX) exactly to retrieve the chart. In the picture below, the red circles represent negative crossovers and the green circles are positive crossovers.

    (click to enlarge)

    So until we see another crossover, Apple's downtrend is still intact. Caution advised!

    Apr 28 6:26 PM | Link | Comment!
  • Cotton Prices Breaking Out Of Multi-Year Base - Could Double In 2013

    The psychology of major bottoms in individual commodity prices often mirrors that of tops in equity markets. Nobody is panicking when gasoline, corn, and soybean prices are low, unlike . However, when each of those commodities rose to their historic peaks in the last five years, one could barely turn on the television and avoid being told about the new price highs, and people were scared. At equity market tops, the investing public is enthusiastic, and generally complacently bullish about their stock investments, while news supporting their collective, bullish views of stocks continues to cross the news ticker. It seems that this same complacency, which often occurs as commodities make their most significant bottoms, is evident in cotton right now.

    Articles such as this suggest that new cotton plantings will exceed this year's estimates, while this article notes that Indian trade with China should lower cotton prices. In addition, other sources declare that, in the event of any price rise, China will release some of its government stock piles to drive the price down to "normal" levels. All of this is occurring while the individual commodity trader or equity investor could presently not care less about cotton, perhaps one of the most boring commodities since fall of 2011.

    So why does the chart of (NYSEARCA:BAL), the cotton ETN, show a clear upward reversal, and why has cotton climbed almost 20% since January 1st? It's a textbook major Wyckoff bottom.

    (click to enlarge)

    First, what drive inflation of all goods? Of course, currency wars, but before those existed. Economic growth. It appears that the economic recovery is accelerating, or at least the trend in government and corporate bond yields suggests. The demand for loans (money) is increasing, driving yields higher, which will be spent on other commodities for business projects, driving demand and prices higher as well for all commodities.

    In addition, this bull market, pushing 48 months, is very mature. This is especially evident when considering the length of an average cyclical bull market, 39 months. According to business cycle theory, it is usually at these times in the 4-year Kitchin cycle, that capital inputs, such as raw materials and energy, begin to climb. Once again, this is generally due to improving overall economic conditions stimulating demand for more goods and accelerating business activity.

    The idealized chart of asset class leadership, presented by Martin Pring, is shown below. Note that commodities are often leaders in the later stages of economic expansion, which is fairly clear, given the length of this bull.

    So why choose cotton for the focus of this article? First, the complacency and bearishness on cotton makes it appealing for purchase. Secondly, most commodities, besides oil, tin, and cotton, are still in obvious, long term. Finally, to a working technical analyst such as myself, the price and volume relationships in cotton show clear accumulation and an upward trend reversal. For the complete video analysis and low-risk entry points, check out my screencast analysis on YouTube for . Remember, if you choose to take a position in cotton, since the commodity is quite volatile, I would suggest pyramiding into the trade.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Tags: BAL, commodities
    Mar 25 9:44 PM | Link | Comment!
  • Short Term, There's One, Small Cap, Chink In The Market's Armor

    By all means, on a longer term basis, the American market looks fantastic. However, in the past week, the risk of entering new into new long positions via ETFs (not single stocks) appears high. Why? Small cap stocks have been losing ground over the past few days, unlike the "major" indices. These "major" indices that investors generally look at are the Dow Industrials, S & P 500, and the NASDAQ Composite. The Dow and S & P 500 give a view of how the 530 largest companies' stocks are performing, ignoring the performance of smaller companies. The NASDAQ Composite, while comprised of around 3000 stocks, is essentially also a large cap index. To get a better understanding of why this is so, take a look at the index's top ten weightings.

    AAPL - 20.21%

    MSFT - 8.06%

    GOOG - 5.75%

    ORCL - 5.06%

    INTC - 3.62%

    AMZN - 3.59%

    QCOM - 3.44%

    CSCO - 3.14%

    CMCSA - 2.25%

    EBAY - 1.99%

    So, ten out of 3000 companies in the index represent about 57.12% of the index's movement. Even more surprising, the top 50 companies in the index are responsible for around 85.33% of its movement. Therefore, the smaller companies beyond the first few hundred in the index do not really affect it much. The NASDAQ is a large cap index.

    When monitoring the performance of smaller companies, my index of choice is the Russell 2000 ($RUT). Year to date, the Russell 2000 has performed exceptionally well, outperforming all of the large cap indices. See the chart below for a comparison of the Dow (black), S & P 500 (blue), NASDAQ Comp. (green), and the Russell 2000 (brown) since January 1.

    (click to enlarge)

    While it is typical to see small and mid cap stocks outperform their large cap peers in a bull market, these stocks are also the most sensitive to when the market mentality turns to "risk-off." Very often, small cap indices like the Russell 2000 start to underperform before short term tops and corrections. In addition, small cap stocks often enter bear market territory long before large caps during major market tops. As you can conclude from the chart above, with small cap stocks still dominant, the probabilities do not favor that a major market top will occur in the near future.

    So, while the Russell 2000 is an outperformer in the longer term, its short term performance tells a different story, which is why I'm not quite convinced that this current correction/sideways correction has concluded yet. Take a look.

    (click to enlarge)

    This chart shows that, while the roughly 630 largest stocks in America have trended sideways over the past week, in aggregate, 2000 smaller ones have moved lower, in aggregate. This short term weakness could spread to larger cap issues, which could cause the market to drift lower in the short term. I do expect a breakout to occur eventually, which should place the Russell back into its leadership role, but until then, investors should be aware of the potential for a further pullback.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Mar 23 4:37 PM | Link | Comment!
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