Archive for May, 2010
Dow Headed to 9000, S&P 880
I am looking at the charts of the major indices and they do not look pretty. If we look at a chart of the DIA we can see an extended left shoulder, a head, and we are now in the process of completing a right shoulder. A similar pattern also exists on the SPY so I have only included the chart of DIA.
It is possible that what looks like the right shoulder may actually be part of the head as the large sell off on May 6 was quite abrupt. There are 3 possible scenarios that may occur:
1) Upon reaching the neckline the market will resume its rally and break out to new highs. Based upon current market conditions this seems the least likely outcome.
2) Upon reaching the neckline the market will retrace about 50% of the current sell off bringing the S&P to 1150 and Dow to 10,500. There will then be a decline to the neckline forming another right shoulder. At this point the market will either A) reverse to the upside thereby negating the head and shoulders pattern or B) it will fall through to the projected lows as stated in the title. B seems the more likely outcome.
3) The market will break through the neckline without any further rally. In all likelihood there will be a back test of the neckline and then further declines to the projected lows.
The target for the head and shoulders pattern is calculated as follows: The neckline – (the top of the head – the neckline). This is the same as 2 x the neckline – the head. On the SPY that is (105 x 2) = 210 – 122 = 88. On the DIA that is (99 x 2) = 198 – 112 = 86.
Interestingly enough, the neckline that defined the reverse head and shoulders bottoming pattern that preceded the rally from the March, 2009 lows is right around the level of the projected decline of the current head and shoulders topping pattern on both the SPY and DIA. That is where I believe the market will find major support and the bull market will resume. The mathematics of this situation works out so precisely it seems inevitable that it is going to happen. The projected time frame for this drop is approximately 2 months.
With Germany expected to ratify the Euro agreement to bail out Greece I anticipate that there will be a short covering rally that will bring the SPY to about 115 and DIA to 105. Therefore I am inclined to believe that option 2B will be the actual outcome.
Recommended Strategy: On any rally buy Sept 90 puts on the SPY. These are way out of the money and will be cheap especially after a rally. If the market drops as anticipated and these puts are at or near the money by July they should at least quadruple in value and could be worth as much as 10 times the premium paid for them. This is a highly speculative strategy that I believe has an excellent chance of succeeding. Determine your own risk profile before executing this strategy and do not bet the mortgage money on it.
A Play On Oil – Noble Corp. (NE)
While BP and Transocean are tied up trying to clean up the Gulf mess, stocks in the entire sector were dragged down on the news. This presents a buying opportunity in the right companies.
Noble Corp (NE), an oil and gas drilling contractor, has been trading in a well defined parallel channel ranging roughly between $39. and $45 since Oct., 2009. This looks like an extended bull channel and NE has just bounced off the bottom of the channel and is now trading at $39.27.
The slow stochastic has just given a buy signal and from oversold levels. There is also a doji candle stick that many times indicates a price reversal. The chart on NE looks bullish and the stock has been consolidating for 7 months. I believe NE could quickly trade to the upper end of the channel at $45 and then break through the top end to see even higher prices.
I don’t believe the Gulf situation will stifle world-wide oil exploration and NE has clients around the world. China and India are thirsting for oil so exploration will continue regardless of any mishaps. With rising oil prices and more equipment being tied up in the Gulf of Mexico I believe NE’s assets will become more valuable.
One could buy the stock here for a possible 15% gain. I would set a stop loss at $37.70 and look to take profits at or near $45. You are risking $1.57 per share loss for a $5.73 per share gain. Your reward to risk ratio on the trade is a healthy 3.64 or 364%. In other words you will make $3.64 profit per share if the trade goes well as opposed to taking a $1.00 loss per share if it doesn’t.
Another possible way to play this is to buy the NE June 41 calls for around $1.50. Your break even point is the stock hitting $42.50 before expiration. If NE hits $44. your options will be worth $3.00 and you will have doubled your money. You would probably want to sell your calls at a loss in order to preserve capital if the stock hits $37.70.