5 waves down last week; Expecting another similar move tomorrow

2:30pm 9-30-09 Link updated. Updated Count...3 leg down instead of 5 says something else is going on.


I was out last week, but noticed that the moves over the last 3 days last week seem to trace out an impulsive wave. Similar to my post back in June, this setup is looking comparable. I see a five wave move down off of a new high price of $1080. Initial five wave moves always have another five wave move to follow after a correction. So far it looks like today is that correction and thus I expect another five wave move south in the days to come. Pretty crazy to call a big down move after a hefty move up like today, but we are still in retrace territory and the waves say it so. A safe short would be right now with a stop very close above.

Options Index indicator topping point?

Quick post but this index is looking toppy. It has been pretty reliable confirming tops and bottoms previously. Something to watch out for...

Market Update 8-31-2009 Summer Almost over and so Might be the Rally?

It has been a month since I last updated and expected a 10%+ rally in the markets to the retrace zone. So far that has played out quite nicely. The corrective moves I expected in between haven't been the cleanest, but overall the continuation of the summer rally has not disappointed and has satisfied my expectations. Compare the attached chart to the one from last month.

Right now, though, there are reasons to be cautious. It looks like the market may be playing out a 4th wave triangle the last few days which would be a warning sign that the top could be coming soon.

There are also other reasons to be cautious such as the negative divergence showing between a few key indicators and price (see chart). Also, bullishness is at a peak as the Bullish %s are higher than they have been since 2006 and anytime since the rally began. Another item I continue to watch is the weak volume. It is expected over the summer and in particular August, but it has to raise a caution flag as the rally continues on less and less volume.

I have also attached a longer term chart of the markets below. Notice how miniscule the rally of 40-50% looks compared to where we were in 2007 as well as 2000. This rally is following very closely to what occurred in 1931 after the crash but before another huge brutal move down to the ultimate 1933 bottom which is another reason to be cautious.

Summary: I will be looking to get short before I get long, but will wait for more confirmation before I make that trade. Now is a good time to take any profits on longs as the risk reward is now high for those positions.

GMR June 2009 Quarterly Update - Warning Signs?

Blog links to transcript of earnings call...

GMR reported earnings July 30 for the quarter ended June 2009. Overall it was a little surprising...not necesarilly negative (yet), just a little surprising and cause for caution.

The one thing I had been banking on for at least another half year has ceased...GMR will drop its dividend policy significantly down to $0.50/year from $0.50/quarter. Or, from a 20%+ Yield down to a 6% or so yield. The CEO gave multiple reasons including 1) using that cash for other opportunities (acquisitions), 2) the market being terrible (spot rate market), 3) the yield being too high ("paying $2.00 divy on $8.00 share price is stupid" was his quote).

Here are my thoughts on this...

When I saw the earnings report the night before and read that they were dropping the dividend I expected a big sell off in the stock. After hours the stock peaked down 10%, but at the end of the next day (July 30) finished down around 7%, which honestly is not that bad considering its volatility. Also, the sell off was pretty much all after hours, not much happened during the day or while the conf. call was going on as far as price goes. More so, over the weekend and by the end of the day Monday, the 1st, the stock gained all of it back. It seems as though people updated their cash flow models and realized the fundamentals are still coming out positive and the only thing that has really changed is the dividend policy...which is all pretty much true.

That is exactly what should happen when you change just your payout ratio. In fact, many models will give credit for plowing back that cash into the business versus paying out (depending on discount rate used).

At the end of the day and if you read my investment philosophy, price speaks loudest and price has not said anything negative about their plowback decision, so the street obviously is not that upset about it and/or already had the news in their models.

But, here is the meat of my thoughts...

GMR has a history of buying back shares and doing acquisitions. The CEO also said it is "stupid" to pay a $2 divy on an $8 stock...which is debatable. BUT, just 3 to 6 months ago, the market, stock price, and divy policy were all the same and they chose to pay out cash in dividends versus keep the cash. So, why the change of heart so soon, when nothing has really changed at all since 6 months ago. My thoughts are they are going to try a different route with the cash such as buying back shares and/or they already are working on some target acquistions and would much rather use cash than equity to pay for it (especially with the stock price this low). It was comforting to hear the CEO say equity is the most expensive way to pay on the call. If one of these 2 routes is taken, I will be fine with it.

Buying back shares for a lot of people is the smarter thing to do because of the double taxation on dividends...again debatable (primarily true, but there is value in getting income streams versus relying on the markets for price). So, hopefully they will start buying back shares again. I will be able to tell thru the quarterly filings.

If next quarter they are not buying back shares and not hoarding cash and only paying down their cheap 5% debt, then I will have a red flag on my plate. It would tell me that they are more worried about their debt load than other uses for their cash...especially at their such low interest costs.

SUMMARY: I continue to hold, hoping that they will be buying back shares which should thoeretically lift the share price, but I am now cautious because of the surprise change of heart with seemingly little change in any of the 3 factors named by the CEO. Quick math: currently with 54MM shares, each $54MM of EBITDA should be worth $1 in share price...we shall see by October.

Let me know if any questions.

Market Update - The Bigger Picture

It's been awhile since I updated the current market status and after 3 months, it's finally doing something. The market looks to be making its final move up after a sideways correction. The sideways correction from May thru June can be considered "the pullback" I was waiting for. Now it is time for the final leg up.

An easy target would be to say A=C which would be about 33% or from $870, quick math around $1100. Another target is the fibo retrace zone between $1000 and $1200. I am waiting for a pullback then going to get slightly long. As with anything dealing with the markets, nothing is certain, and this initial leg up (when it completes), satisfies a minimum requirement. I am not saying that it is the top, just that the possibility is there. I will be able to tell based on the ensuing pullback.

Something else to notice is that all the markets are in a similar spot and we can look for clues based on them. As always the nasdaq is leading the way. Also, the bullish percent should show a topping point above 70, but look for possible divergence. One final indicator that is giving a clue is the RSI which is showing the first point since the bear above 70.

Getting ready to get long for a 10% or so move...

Good Luck.

Possible Head and Shoulders Top Forming Part 2

Two weeks later and the pattern continues to play out. We dipped down to test the neckline again, which was expected, at which point the media and everyone else jumped on the head and shoulders play (usually a sign that it won't pan out). I think it still has an outside chance to, though.

Here's what would need to happen...the market would need to stay below $930 (the previous right shoulder high), and once again it would need to dip below $880. With the neckline now changed, the target is actually lower in the $810 range.

The other option is that the market topped today as the former neckline's retest and we continue down to play out the original head and shoulders pattern I posted on the previous post 2 weeks ago (Absolute Strategies: Possible Head and Shoulders Top Forming)

Possible Head and Shoulders Top Forming

I have put most of the explanations on the attached chart, but the market may be trying to form a head and shoulders topping pattern. It is still too early to tell, but wanted to get it on the radar. It should take a few more weeks before confirmation.

If we fall below $880 again, where there is significant support dating back 6 months+, then this chart may be very valid. I have put in blue dotted lines showing the possible path the market could take to validate this pattern.

Ideally the market will fall below $880 and come back to retest the "neckline" trendline at which point would be a very high risk reward short around $890 with a stop above $900 and a target of $830.

Stay Tuned. You can click on the title link to see how the pattern progresses in real time.

Market Update 6-23; A turn for the worse update

Update 6-26: Bounce was larger than expected and any move above $927 will kill scenario 3 bear market.

Quick update and chart on my post last week. The move down has satisfied its initial requirements with two 5 wave moves down very similar to what I posted should happen on the 16th (see chart then and now). Therefore, I am taking some money off the short table and moving to wait and see mode.

Now comes the hard and sometimes frustrating part...how the ensuing correction looks will give me an idea if 1) this down move is over and we get another big move north, 2) just the initial decline before a bounce and then another similar move down, or 3) the start of the huge decline. So basically 3 possibilities 2 with near term upside, one with long term upside, and one with long and short term downside...so no clue at this point, which is why I am in wait and see mode.

But, last and this week is how you make money trading the waves!

Put Call Ratio - Fear creeping back into market?

The put call ratio has been one of my favorite indicators. It started to fail toward the end of the bear this year and not giving as reliable signals, but it looks like it may be coming back into play.

As you can see in the chart, the put/call ratio had bottomed out below its long term lower support of around .85 puts for every 1 call bought on the options market. The indicator is now in an uptrend and is quickly climbing back into its 2008 average range of around 1 to 1 puts to calls. This could be telling us that the market is becoming more fearful. On the chart I have also drawn vertical lines at market tops and bottoms. Historically this ratio has helped call these tops and bottoms as you can also see on the chart. Also, you can see that the indicator shows where ultimate fear occurred, which was in the October decline. It is rare for the market to be so complacent as it was the last 3 months, which could be a sign that the rally wasn't going to have the kind of fear it needed to continue indefinitely.

If this market is about to fall again, I expect this ratio's moving averages to approach the 1.25 puts to calls resistance as it did at previous bottoms.

Market Correlations - An essay on Oil Prices

In my Investment Philosophy (right side of the blog) I lay out a few examples of why markets are never fairly valued. In this blog post I will show another blatant example of this and explain what is the driving factor behind the rising price of oil.

In the chart below I have laid out the price of Oil ($WTIC) in black, the price of Gold ($GOLD) in gold color, and the price of the inverted US Dollar ($USD) in Red. The chart is over the last 3 month basis with daily closing prices. The first thing you should notice and the main point of this post is that since about April 20th these 3 markets have been eerily tied at the hip. As the US Dollar has fallen (inverted on the chart to show more clearly), the price of Gold and Oil have gone up.

As you can see oil, gold, and the decline in the dollar are all related somehow. The common denominator in the group is the $USD (since oil and gold are priced in US Dollars). Therefore, the move higher in both oil and gold prices is directly and this chart shows almost 100% related to the decline in the US Dollar's value. If you would have bought gold or oil in the past 2 months on supply and demand projections, peak oil concerns, China, or any other so called fundamental reason, you would have been wrong. The only fundamental reason to have bought those two assets is a play on the decline in the US Dollar; Any other reason and your gains are based less on a correct forecast, and more out of luck. This chart shows, at least lately, that if you want to know where the price of Gold and Oil will be, don't look to the fundamentals of those markets, look the the US Dollar market.

Market Update 6-16-09; A turn for the worse

Just a week and a half ago I was more bullish than bearish. And now I am more bearish than bullish! I will explain why below, but first some quotes from my June 4th market update post. I will follow that with a detailed explanation of why I have switched back into the bear camp giving you some insight into how I come up with some of my forecasts and why it seems I may flip flop so much. (I know some of you may not understand all my technical jargon, but hopefully it will give you some insight into how and why I make the decisions I do). I have a chart to help explain as well.

Quotes from 2 weeks ago...
"There is not really a reason to necessarily expect as large a rally as I previously laid out. The markets seem to have completed their first pattern up early this week with a good correction on Wednesday, possibly still playing out thru tomorrow (or completed Wednesday afternoon). What this could mean is that the first wave up is complete and the 2nd correction down is nearing completion (out of a total of 5) awaiting a 3rd wave up tomorrow or Monday."

"I will need to be nimble the next few weeks though, as this thing could turn on a dime, and when it does, that is all she wrote.

"The safest bet is to buy with a breach of $950 which if I am correct could come tomorrow or Monday/early Tuesday (I went ahead and bought because of personal reasons and because I know at which point to sell if I am proven wrong--right now $900). If $950 is overtaken then all liklihood we are in the powerful 3rd move up and price should not intrude below $950 until this summer rally is over."

So, looking back at these comments, they were pretty spot on with Thursday, the 4th a big up day and Friday a pull back just breaching $950 briefly. Some choppiness ensued Mon/Tues/Wed which I suspected was a 2nd wave correction, and then Wed midday and Thurs took off in my suspected wave 3 up above $950 (the move had a clean 5 waves up). All is well, so I thought. A correction after that move up was expcted, which occured Friday, the 12th, with a move back up by the end of the day. So far 3 waves up, two nice impulsive ones with one corrective choppy one in between--what I expected. But something happened over the weekend...the markets gapped down Monday morning with a continuation of the correction instead of up in a continuation of the 3rd wave up, and quickly made new lows below $927 which is possibly a major breaking point of the bull. At that point I became more bearish than bullish. With the bust of $927, the count is sufficient to call a top at Thursday, June 11th's $956.

The next question is will it be the ultimate top of the summer rally or just the end of the first major move up...that is still too early to call, but after today's completed 5 waves (see chart attached - a beautiful 3 day move down, actually), it is very likely the next few weeks will have at least a downward bias.

I have attached 2 charts, one is my normal wave count and expectation chart and the 2nd is a zoomed in view of the last week with what looks like a very clean 5 wave move down from a new high of $956. This implies the start of something larger to the downside. I will know more once the correction of the 5 wave move completes later this week.

Summary: Some major damage was done to the bull case over the weekend with prices not continuing their trend up from $927. If today's low was just put in at $912, then this first 5 wave move was $45 points which would put the initial target somewhere south of $890. I will know more as this down move plays out.

Volume Analysis and 2009 top warning?

Update July 29 2009: Volume is now at a level that previous tops have occurred. This may be a warning that going long right now is a risky endeavor. Click on blog post to see updated chart.

Attached is a volume chart I created to spot tops and bottoms during the 2008 bear. I decided to update it thru today to see what it shows...

As you can see since late March the volume of the total market has been declining as price went up. This is not a good sign for the market. Sustainable rallies occur when prices rise on increased volume, not on lower volume. What this is showing is that more people are losing interest as this market climbs and that any decent sized wave of selling can take the market lower pretty easy.

During the 2008 bear previous tops were confirmed when the 10,12, and 15 day moving average of volume approached the 1200 level on this chart. Unless volume picks up in the next few days as the market rises, we may be in a topping process right now.

On a positive note, in Early March the rally produced volume that was consistent with all the major down legs of 2008 (hitting 1900) showing that the rally was for real.


Watch the 1200 level on this chart. If prices start to fall as this volume curls up below the 1200 level, the rally may be confirmed over.

The title of this blog links to the live chart...

Learning from old charts; Hindsight Analysis

I have attached a chart of the Dow Jones Utility Average. This chart I created a few years ago to track the relationship between Utility stocks and Bonds. The old saying goes that the two move in tandem with the thought being that Utilities are highly levered and their prices move in tandem with bond prices. However, the chart evolved into more than that once the credit crisis hit in 2007.

You can see where I have drawn the vertical black line my original chart and annotations in blue and black on the left from early 2009 and prior. Everything to the right of the black line and in pink and green are the annotations I added today.

There are a lot of things we can learn from this chart that may also help us find the top of the current rally and retracement expectations for the Utility Average.

I will first speak of the original annotations and what they foretold...
1) Probably the most important thing on the chart is the very bottom text box that stated "Divergence will show bottom". Markets are notorious for showing momentum divergence from price at turning points. This is supplemented by the fact that third waves in elliott wave theory are almost always more powerful and faster than fifth waves; essentially thirds have more momentum. So, when I labeled that a divergence would show the bottom earlier this year, I was expecting the MACD to fall again but not make new lows even though the market should make new lows. Without a MACD divergence, it is usually not a good idea to call for a major bottom (or top), and even though the market was down almost 50%, there had yet to be a divergence and thus an ultimate bottom. This led me to believe there would be another fall in prices, before downside momentum had been worked out.

2) The Head and Shoulders top I saw back in June of 2008 was spot on. The target was hit 2 months after the breakdown and continued on to a parabolic fall. Head and shoulders are pretty mainstream now, but they still can work if all the correct rules are followed. This one worked wonderfully.

3) The triangle over the 2008 winter on the Utilities helped to count the waves of the overall market and also point to another decline in stock prices. Triangles are consolidation patterns and when prices break out of them, they are often in the direction of the original trend (which in this case was down). In early February when prices broke down, that was a sign the market was on its way to new lows.

I just pointed out three prime examples of a sub market within the larger market helping forecast the next move in the market's prices. Now, I will try to use what the chart is saying to project where this next rally could potentially end.

1) After bottoming in March, the Utilities have bounced in a countertrend rally up over 20%. That is significantly lower than the markets in general which are up over 40%. So, right there we have underperformance of the Utilities which means they may not be a very good sector to put money in to catch this bounce. However, they also did not fall as much during the bear, so they could be considered a safer, less volatile sector.

2) I have counted 3 complete moves in Pink from the March bottom to A. at $358. Typically countrend rallies will retrace to the fibonacci zone of 38-62% which right now is still 15% higher in the $390 zone. From an Elliott Wave perspective the 3 part move up to A. is satisfactory for the countertrend move. We will have to wait to see how prices pan out before we can tell if that A. is part of a larger A., B., C. (which the fibonacci retrace zone tells us should be true). If the utilities trade above $358 then that would be strong support for a move to $390.

3) Typically countrend rallies following a move with a triangle in the previous 4th wave will retrace back to that triangle. So this move should theoretically retrace back to the triangle (in black) region. At $358 it has sufficiently done that. However, the triangle also has territory in the $390 price area, so there is more room to go, if needs be.

Overall, this chart was a big help during the crash of 2008. It forecasted the initial fall with the head and shoulders top and breakdown, it showed no divergence at the October lows forecasting another move lower (which occured in Feb/Mar), and it now shows the potential for a move up to $380-$390. A move below $325 may mean this rally is complete, but right now all signs point to another move higher.

BMC Software

This is a request I received from a friend over the weekend...

I have a good amount of BMC Stock via my ESPP and I was wondering what I should use as an indicator to sell the stock. My concerns are:

1) The stock price is up near its 5 year high

2) I have netted about a 30-35% return over the past year, should i take some of my profit

3) Taxes for the ESPP, short-term cap gains, long-term cap gains, or the 2 year ESPP holding period taxes

4) Or should I just mirror what the corp officers are doing with their stock?

Thanks for the question. I have attached two charts at the bottom of BMC stock with my thoughts below and answer, but first I will comment on your 4 questions.

1) See charts below

2) The amount of profit you have in a stock honestly should never be a factor in your decision to buy more or sell more of a stock. Your return is a sunk cost; You have already committed and nothing you can do can change what has happened. A good rule of thumb is to remind yourself that everyday you own a stock you are also remaking a buy decision because every day you own a stock you have capital tied up in a security that could be used to buy something else. It is all about opportunity cost. So, although almost everyone makes their profit/loss a factor in their buy/sell decision, it really is a bad practice and should be avoided because it doesn't matter.

3) Taxes can and will play a role in profits and losses, but they should rarely play a role in buy or sell decisions. When you buy a stock you should always have a sell target predetermined. If a stock makes it to that target, it should be sold, regardless of the tax implications. I am not sure exactly what your question was speicifcally asking, but a sell decision should be made most of the time without taxes coming into play. Regardless, it sounds like you have owned the stock long enough that it would be in the lowest possible tax bracket anyway. My philosophy is if you are paying taxes then you are making money, and that is good.

4) I wrote about this in my investment philosophy. There are plenty reasons why an insider may be buying or selling a stock. Often the reasons have absolutely nothing to do with the company's expectations or performance. Another problem with following officers and directors is that the information becomes public later than when the purchases/sells actually happen...could be weeks later and in that time you could miss out on a valuable move. Many times officers are also required to make purchases on certain dates, for certain other perks such as options, or one of many other reasons. To understand potential pitfalls in following your officers you would have to do a lot of research on the public filings (10k, Def 14a, others) to try to sleuth through what reasons may be behind share purchases. Some people make money following this strategy, but there are a lot of caveats that could steer you in the wrong direction.

One other thing I would like to add is I am not a huge fan of owning a lot of (if any of) your own company's stock. If you are able to buy it at a discount or are given options or shares as reward, that is one thing, but generally speaking buying shares of your company with your own savings most likely will cause you to violate the important financial guideline of diversification. Your income, job security, livlihood, friendships, resume, and multiple other important things already depend on that job. If something were to happen to your company like a major lawsuit or economic downturn then you may be overexposed to that specific company risk (think Enron, Worldcom, etc). I would think about how much of your investments and assets are already tied up with your company before you make a decision to invest more of your future into it.

Now to your ultimate question...

I have attached two charts, one of the last 3 years and the other of the last 10 years. From a technical standpoint and on the first chart, the price is getting very close to a pretty good long term resistance zone of $37. From that perspective alone the risk/reward just isn't there since the stock is currently sitting at $35. Also the entire uptrend from October's lows will be in jeaopardy with a breach of $34 (lower support trendline). There are also a few other signs that tell me the stock is sitting at a pretty weak spot. One is it hasn't made new highs even though the markets have over the past few weeks. Also, its volume has kind of died off and the largest volume day in its history last month was a fairly big down day at a similar price point as Friday. And finally, at the bottom of the chart, the negative momentum is a pretty big sign that interest in the stock is waning.

From a longer term perspective (2nd chart), I would want to see prices breach and maintain above $37 before I look into buying again. The long term trend is intact, but the momentum has stalled out, so I would want to see that breakout as well. For now the shorter term chart trumps the longer term.

I would think about selling the stock, especially if it breaks down thru the trendline currently sitting at $34. Regardless, I do not think this stock has much chance of making and staying over $37. Another option as long as transcation costs are not too steep is to sell half now and then half if any of the other scenarios play out. That way you have peace of mind that you have at least locked in some good profits near the top. The stock is up over 50% from its lows and there will be a quick run for the exits if anything disappoints in the near future.

Let me know if you have any other questions. I hope this helps.

2009 Market Top - a chart to help know when to say when

Thanks to my friends at stocktock for giving me this idea.

I have attached a ratio chart of the Options Index put/call ratio over the Options Equity put/call ratio. I am not entirely sure of the reasons why it works, but looking at the chart you can see that it has helped confirm the downtrend of the last 2 years as well as the big rally we have had over the past few months.

Basically when this ratio is moving down, the index put call ratio is moving down quicker than the equities put call. The put call ratio is a contrarian indicator so I imagine this indicator is also a contrarian indicator. When it is moving lower you have less Index puts and more calls versus Equities which hav more puts and less calls. Exactly, very confusing.

The great thing about indicators is sometimes we don't even need to know why they work. Backtesting tells us that the indicator was valid and did work for the time frame analyzed, so it seems reasonable to add it to the arsenal as it may give a valid signal going forward as well.

I will be adding this to my watch list for the next major move. Notice the shorter term MA may be topping out as the market continues up currently.