The question on everyone’s mind: whither the market? Let’s see, the dollar’s tanking, the subprime mortage mess hasn’t even warmed up, the housing market is in trouble and it’s getting worse, the economy is cooling (that’s why the Fed cut the rate), etc., etc. None of these things fuel a bull market. I have been saying for some time, as have many others, that this bull market (now nearly 5 years old) will end when corporate earnings deteriorate, since earnings - driven by a good economy - is what starts a bull market to begin with. After all, why would anyone pay market-top prices arrived at during a strong economy once the economy cools and earnings ain’t what they used to be? Exactly! Actually, the market will tank ahead of the real earnings slide as the economy begins to cool in earnest.

But we don’t really want bull markets to end, thus they are tenacious. Does the chart tell us anything? Following is a daily chart of the DJIA. Note that in July the market went from an uptrend into a range as it corrected, the range being marked by horizontal lines - the range is actually kind of classic. But a range is often a congestion pattern, which could indicate an uptrend ahead. Have a look:

TREND
The red trend line could well indicate that the medium-term trend is continuing. Notice how it was thoroughly tested, twice in August, once in September, making higher lows. In this analysis, the market has pulled back again to test the trend line in late September and last week, the low of last week’s test being a tad higher than October’s test low - important because successive tests of an uptrend line should be higher. The Dow pulled back to the 200-MA in August, but except for that, the 200-MA has been out of the action, so it is not very reactive with the Dow.

TRIANGLE?
Note also how the trend line and the top range line indicate that an ascending triangle could be forming, which is generally a bullish sign. The Dow peeking above the range line does not necessarily invalidate the triangle, though it certainly is not a “perfect” ascending triangle. But, the Dow has made consistently higher lows, a hallmark of the AT. Note also how volume fell off as the high was reached in October, also a good sign for the AT.

NOW WHAT?
If the AT is valid, the market needs to break through the upper range line to new highs and hold them, which might not happen until 2008. Will the market continue to fight the increasing weight of negative expectations?

A breakdown below the trend line would invalidate both the trend and ascending triangle analyses. A breakdown would be a series of closes below the trend line indicating that the major uptrend is over and the market is moving into a range; or worse. If this breakdown happens, the market needs to find support at either the 200-MA or the range bottom at 13,000. Not holding the 200-MA would be bad, and a breakdown below the range bottom would be very bad news. One trip down to 12,500 was a correction; another one would be, well, disaster.

So we wait and see. The real question is whether there is enough residual bullishness to move the market higher, especially since the falling dollar isn’t exactly drawing foreign players like bees to honey.

Quite a Wall Street day, the DOW down 362 points. Worse, it trended down all day and ended very close to the low, which does not augur well for tomorrow. I said on Tuesday of this week that the market might sell off without a 50-point cut in the FedFunds rate. I didn’t really expect a one-day sell-off of this size, but the point of the post on Tuesday was that the market is quite volatile, and ahead of a rate cut - you just never know. And truth be told, it might have sold off no matter what.

Interestingly, there are almost always stocks that are up on days like this. Microsoft was up today; not much, but up. Regarding my “Witch Hat” post from yesterday, I think MSFT is going to stick at the higher price level. If it didn’t come down today…

A lot of covered call writers like to write on these pullback down days, because you can get an artificial pop as the stock snaps back with the market. The key is that the stock is down with the market. If the stock is down on its own, or the stock (like MSFT) isn’t down with the market, then the rationale for a down-day write is not present.

This pop is quite real and we see it on larger time frames, as well. Look at just about any chart over AUG and SEPT this year. From the market bottom, stocks commonly rose with the market although volume didn’t increase for most stocks. That is, the stock pricess rose as volume fell, normally a bearish divergence. But when the market comes roaring back, divergences be damned - they just don’t mean much, because most stocks have then become lighter than air.

Which brings us back to down-day writing: when the market snaps back, good stocks will spring back with it. If you have been buying back short calls with the market’s fall, and you should be spanked if you haven’t, don’t rewrite the stocks just yet. Wait and write at a higher point. The down days are also a great point to get into a stock (some covered call gurus believe you should only write on down days), since you can either 1) write an OTM call and expect an easy assignment, or 2) leg in by purchasing the stock and writing calls at a higher stock price.

Now to the fun part: wait to buy the stock until you see the whites of the market’s eyes. Tomorrow could be another down day, so get a feel for market direction before doing anything, especially since the afternoons tend to be sell-off prone. And tomorrow being Friday, I don’t expect an up day, but it could happen. Better to wait for confirmation that the market volatility is occurring in a more heavenward direction - even this means not getting in at the “bottom.” (The bottom may be yet to come)

Did anyone buy protective puts on Wednesday? If so, I would like to hear from you - please post a comment with the gory details. The anti-gloating rule is suspended for you.