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Where Has My Little DOW Gone?

 August 03, 2011 04:47 PM


Oh where, oh where, has my little DOW gone? The Dow Jones Industrials Average ($INDU) sold off 1,014 points, from its April 2010 top through the June bottom; this took 6 weeks. It has now sold off (as of this morning) 1,053 points in a couple of weeks, measuring from the July top to this morning's bottom. Sure, part of the recent selloff was a reaction to the prospect of U.S. default or downgrade of U.S. debt, and no doubt a signalling of market displeasure to Washington. Politics seem to be driving markets more now than economic factors.

Today, several major indices officially went into the red for 2011:

Nasdaq Composite ($COMPQ)
S&P 100 ($OEX)
S&P 500 ($SPX)

The Russell 2000 ($RUT) and Nasdaq 100 ($NDX) had already dipped into the red for 2011 but did so again today. Not the Dow Jones, though.

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In fact, all major indices broke below the magical 200-day moving average yesterday, a bad sign. When it became apparent late in the day yesterday that the mighty Dow Industrials would close below the 200-day average, selling accelerated hard in the late session. A break of the 200-day average is widely believed to signal a new bull market, which certainly was true in 2007. The Industrials and SPX touched the 200-d back in June but didn't poke below it (the others all did).

Though heavy reliance on this average has eroded much of the average's predictive power, this is a bad sign. And it will be positive if the market reverses and moves powerfully North. But first we have to get back above the 200-d. It's all eyewash until that happens.

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Whether the bull market is over is unknown and unknowable today. But the momentum we've enjoyed since the beginning of the year came to a dead stop. Make no mistake: until the major indices convincingly take out the May 2011 high and move higher, there can be no assumption that the bull still has legs.

CALL AND PUT WRITERS

One thing is for sure here: oversold does not mean a buying opportunity. We can take advantage of a strong drive back above the 200-d mark, should one occur, to place covered call and naked put trades. The cautious trader will want to see the major indices break back above the 200-d average and see some rising up candles above it, and some real volume. Yes, you miss some of the move, but the odds get a lot better. We want to catch big sure moves, not trade moves off pivot bottoms.

Caution: look at the June bottom. We had several white candles after the first bottom on June 15th, then a very quick and sharp retest of the bottom. That could happen here, easily. I will be surprised if it does not. If the indices rocket up for a few days, a retest will provide an opportunity to get in lower.

Assuming the trade weather looks good soon and only then, for a covered call I would leg in, maybe write a call later, maybe not. For a naked put, write it OTM under support, probably the 200-d. If you open a trade, close it at an acceptable profit.

If the market does move up strongly, I would be leery of holding equity or being short puts when (and if) the next test of the July tops occurs, about 12,720 on the Industrials.

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