After a 416-pt. selloff on Tuesday, the Dow Jones Industrial Averages ($INDU) sold off this morning down to 12,059, then ralled on good news from the manufacturing front to close at 12,234, down about 34 points. I’m encouraged by the market’s ability to recover this afternoon. But… tomorrow is Friday, and a lot of traders will want to be flat going into the weekend, which could provoke a selloff, in which case we could see a good morning tomorrow then a bad afternoon as traders get flat.

I always stress to covered call writers to look at the weekly chart as well as the daily. The following weekly chart for the INDU illustrates why. Note how, despite the stellar gains since June 2006, volume has been declining since April.

Also note the MACD - the fast and slow lines have been essentially flat since late October and the MACD histogram has been declining since August. Thus despite the DOW’s impressive runup since July, we are seeing some bearish divergences.

Notice how the 50-day MA is still a long way away - about at the 11,715 level, which is very close to the 11,730 50% Fibonacci level discussed in my Black Tuesday post. This suggests to me that the DOW is looking for the 50-day average.

The whole question is whether the worst is over or, as I suspect, we’re not through with the correction. The bigger question is why the selloff in the Shanghai market caused a selloff worldwide; this doesn’t exactly scream bull market to me. It could be that the bull market still has legs and this week’s action is just a needed corrective. It’s too early to tell, but I think the correction is not over and the market will find a Fibonacci level. In fact, we have almost hit the 12,000 (38%) level already, so I would think the 50% level is a more likely target. (I don’t know if a major bear market is beginning, and neither does anyone else.)

For longs and covered call writers, keep a close eye on the market and your stocks. If further weakness is demonstrated, consider buying protective puts, closing the positions or rolling the calls down and out (using multiple rolls, if necessary).

Some people are buying OTM puts for April or May on the logic that they protect against a serious market slide and, if the market recovers without much more hiccupping, the puts will still have enough time value in a couple of weeks to not produce a loss on selling the put. (This is why March puts make less sense - time decay will really kill you between now and March expiration if there is no further market decline.)

Protect Yourself:
In a sense, this correction comes at an opportune time. If you are truly concerned about handling this correction, you should be at my Orlando, Florida Prosperity Powerhouse Covered Call Seminar being held on March 10th and 11th - next weekend! We will be talking about how to react to this and other situations when good trades go bad. Truly, you don’t want to miss it. Details here…

There are two seats left, and they will be gone soon. Call us at 352-377-3500 if you have any questions. There may not be another opportunity this year to get this seminar. If you are concerned about this week’s market action - you need this seminar.

Now, a final thought about puts: the beauty of long puts is that, on a stock decline, you can always decide to keep a stock you think will recover and take profits by selling the puts.

This entry was posted on Thursday, March 1st, 2007 at 7:01 pm and is filed under Covered Calls, Markets/Economy, Technical Analysis. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.