STOCK MARKET FOR BEGINNER | Stock & Option Guide

BACK TO BASICS WITH HIGHER HIGHS AND HIGHER LOWS FOR SPY – EQUAL-WEIGHT QQQQ VERSUS QQQQ – NET NEW HIGHS EXPAND TO JANUARY LEVELS – OIL CHALLENGES RESISTANCE

BONDS ROCKED BY BETTER-THAN-EXPECTED PAYROLLS… The Labor Department reported that non-farm payrolls declined 36,000 for the month of February, which was much better than the consensus estimate for a decline of 68,000 jobs. Positive news on the jobs front sent bonds sharply lower and yields sharply higher. Bonds are especially sensitive to interest rates and Fed policy. While the economy has yet to show any job growth, the decline in non-farm payrolls is certainly slowing and this could affect Fed policy down the line. Chart 1 shows the 20+ Year Treasury ETF (TLT) hitting resistance from the January-February highs and declining sharply in early trading on Friday. Notice that broken support turned into resistance in the 92 area. Also notice that a triangle may be taking shape with support in the 88-89 area. Chart 2 shows the 10-Year Treasury Yield ($TNX) with a mirror image of the TLT chart. Yields found support near broken resistance around 3.55% (35.5 on the chart). This means the December breakout is holding and rates are in an uptrend as long as the February lows hold.

BACK TO BASICS WITH HIGHER HIGHS AND HIGHER LOWS… Let’s step back with some very basic charts and a basic momentum oscillator. Chart 3 shows the Rydex S&P 500 Equal Weight ETF (RSP) as a 5-day SMA, which smooths the daily fluctuations. A 65-day SMA is overlaid for two reasons. First, dips below the 65-day SMA are deemed significant enough to be called reaction lows and qualify as support levels. Second, the direction of the 65-day SMA confirms the underlying trend. The trend is up when the 65-day SMA turns up and rises. The trend is down when the 65-day SMA turns down and falls. Notice that the 65-day SMA turned up in mid April and remains up. The green arrows show the last three reaction lows with the last low marking current support at 38. With nothing but higher highs and higher lows since April, the trend is clearly up. A move below 38 would break support and argue for a trend reversal.

A 65-day Aroon oscillator is shown in the indicator window to measure momentum. Developed by Tushar Chande, Aroon means “dawn’s early light” in Sanskrit. The Aroon oscillator is constructed by subtracting Aroon(down) from Aroon(up). It fluctuates above/below zero. A new uptrend emerges with the move above zero, while a new downtrend emerges with the move below zero. More details can be found in the ChartSchool. Notice that Aroon turned positive in mid April and remained positive until mid February, when Aroon moved to its lowest level since April. This makes the Jan-Feb decline the sharpest since Feb-Mar 2009. Aroon is flashing a warning sign, but we have yet to see confirmation with a downturn in the 65-day SMA and a break below the February low. One strike here. Two to go.

Chart 4 shows the same indicators for the S&P 500 ETF (SPY). These two ETFs are good for comparing the performance of large-caps and not-so-large-caps. SPY is based on the market-cap weighted S&P 500, which means large-caps dominate. RSP treats every stock equal, which means smaller stocks dominate because there are more smaller stocks. Like RSP, chart 4 shows SPY trending higher with higher highs and higher lows since April, which is also when Aroon turned positive and the 65-day SMA turned up. Based on this chart, the overall trend is still up with key support based on the February low. There are some concerns here as well because Aroon turned negative for the first time since April.

EQUAL-WEIGHT QQQQ VERSUS QQQQ… We can also compare the Nasdaq 100 ETF (QQQQ) against the Nasdaq 100 Equal-weight ETF (QQEW) to compare large-cap techs against not-so-large-cap techs. QQQQ is dominated by Apple (AAPL), Google (GOOG), Microsoft (MSFT), Intel (INTC), QualCom (QCOM) and other tech heavy weights. QQEW treats all 100 components the same. Charts 5 and 6 show both QQQQ and QQEW are in uptrends overall, but QQEW is holding up a little better than QQQQ. First, notice that Aroon turned negative for QQQQ. Second, notice that QQQQ is further below its January high. The February lows mark key support for both.

NET NEW HIGHS EXPAND TO PRIOR HIGHS… Net New Highs survived their third corrective period and surged over the last few weeks. Chart 7 shows Nasdaq Net New Highs surging back above +200 this week. Prior surges in October and early January hit the +200 area. Notice that there have been three corrections over the last eight months. Net New Highs dipped into negative territory in early July, late October and early February. These red areas are small as Net New Highs moved back into positive territory soon thereafter. In fact, notice that Net New Highs found support at or above -50. This means we should expect a trend reversal if and when new 52-week highs break below -50.

Chart 8 shows NYSE Net New Highs. Notice how this indicator bounced near the zero line in early July, early November and early February. Also notice that cumulative Net New Highs have been rising (above the 10-day SMA) for over 8 months. Even though Net New Highs are considered a lagging indicator, they have captured the current uptrend by staying largely positive. SharpCharts subscribers can click on these charts to see the settings and save to their favorites list.

OIL CHALLENGES RESISTANCE… Chart 9 shows West Texas Intermediate ($WTIC) challenging resistance in the low 80s for the third time in five months. Note that this is the 5-day SMA. Oil first hit 80 in late October and edged above 80 in early January. Even though the overall trend is up, some signs of weakness are starting to appear. First, Aroon moved into negative territory for the first time since mid March. Second, the 65-day SMA turned down over the last two months. There are two strikes so far, but West Texas Intermediate itself has yet to break support in the low 70s. A break below the Dec-Feb low would be strike three.

Chart 10 shows the Energy SPDR (XLE) trading flat since mid October, when the ETF first crossed above 56. There are similar signs of weakness appearing in XLE as Aroon turned negative and the 65-day SMA turned down. As with crude, XLE remains above support in the 54-55 area. A break below this level would reverse the uptrend. Chart 11 shows the Oil Service HOLDRs (OIH) holding up better than both crude and XLE. Notice that Aroon remains positive and the 65-day SMA has yet to turn down, though it has flatted in the last two months. Watch key support at 115 for a trend reversal here.

By Arthur Hill

STRENGTH IN RETAIL STOCKS IS A POSITIVE SIGN FOR THE MARKET — RETAIL BREAKOUTS ARE OCCURRING IN BIG LOTS, FAMILY DOLLAR STORES, AND TARGET — AVOID INVERSE ETFS WHILE MARKET IS RISING

WEEKLY EMA COMBINATION IS STILL UP … I’ve always advocated the use of the weekly EMA crossovers for “longer-term” signals. The daily signals are for “short-term” trading purposes. Weekly signals are always more important than dailies. Chart 1 overlays the 13-week (blue line) and 34-week (red line) EMA lines on weekly bar chart of the S&P 500 for the last three years. The last bullish crossing took place last July (blue arrow) and is still positive. The black line below Chart 1 is the spread between the two weekly EMAs. Crossings above and below its zero line correspond to the EMA crossings (see circles). Although the weekly bullish crossing didn’t take place until last July, the EMA spread (black line) actually turned up during March, which gave an early hint that the major trend was improving. The black line has dipped during the first quarter of 2010 as the two EMA lines have converged. So far, that signifies nothing more than a downside correction in an ongoing uptrend.

DAILY EMA LINES TURN POSITIVE… On Tuesday, I wrote about how the ability of U.S. stock indexes to close back above their 50-day averages had improved the market’s short-term trend. I also mentioned that a couple of daily EMA combinations were turning positive. I was referring to the 20-50 day EMA and the 13-34 day EMAs. Chart 2 shows the 13-day EMA (blue line) crossing back above the 34-day EMA (red line) this week. [The daily S&P 500 prices are plotted above]. That reverses the short-term sell signal given in late January. Unfortunately, upside volume has been relative light during this week’s price advance which detracts from the stronger price action. That suggests a couple of possibilities. One is that the correction is over and prices are starting a new upleg. A second possibility is that prices have entered a trading range between the January high and the February low. Moving averages need a sustained trend in order to function properly. While weekly averages are still bullish, daily averages have been “whipsawed” over the last month. That’s often a sign that the market is entering a period of relatively flat (and trendless) price action for awhile.

RETAIL STRENGTH IS A GOOD SIGN … One of the factors working in the market’s favor is the move to new highs by the Consumer Discretionary SPDR and retail stocks in particular. Chart 3 shows the XLY hitting a new 52-week high today after exceeding its January peak, while Chart 4 shows the S&P Retail SPDR (XRT) having broken out of “triangle” formed between October and February (see converging trendlines). Both consumer-oriented ETFs show rising relative strength lines (below charts) since mid-January. Given the importance of consumer spending to the economy and the stock market, the absolute and relative strength shown by both ETFs is a positive sign.

RETAIL LEADERS … Three retail leaders are showing a bullish combination of strong chart action combined with rising relative strength. The monthly bars in Charts 5 and 6 show promising bullish breakouts in the making by Big Lots and Family Dollar Stores. FDO is now trading at the highest level in six years. Chart 7 shows Target hitting a new 52-week high after having risen above a two-year resistance line. Its relative strength line (below chart) is trading at the highest level in three years. Target also happens to be the most heavily weighted stock in the S&P 500 Retail SPDR (XRT).

WHY I’VE AVOIDED INVERSE ETFS … The main reason is that I wasn’t convinced that the recent market dip was serious enough to warrant bearish positions. So far, that view has been justified. Chart 8 shows the ProShares Ultra Short QQQs (QID) nearing a test of its January low. It’s also back below its 50-day average (blue line). Inverse funds are not meant as long-term holdings. Their use is only justified when the market is in a serious downward correction or a bear trend. Some short-term profits could have been made in the QID from mid-January to mid-February, but only for very nimble traders. For everyone else, it’s back where it started the year. The QID is designed to trade in the opposite direction of the Power Shares QQQ Trust (QQQQ). Chart 9 shows that technology-dominated ETF trading a couple of points from its January high and well above its 50-day line. At the moment, the QQQQ is acting a lot better than the QID.

By John Murphy