A reasonable percentage of my posts are about the market, partly because I enjoy it and partly because that is what seems to be consuming everyone these days. I noted in recent newsletter articles that the stock market agains appears to have found the bottom trendline of the channel it’s been in since October 2007. On a weekly chart, the Dow Jones Industrial Average (INDU) indeed seems to have bounced off the channel bottom. It now must test the 200-week simple moving average (SMA), which is at about 11,712:

Note first of all that the upper channel line is almost the same as the (now declining) 50-week SMA. If the market rises that far, it will be simultaneously testing that average and the upper trendline. The prospect of a breakthrough there is not great, as I have discussed. The gray circle on the upper trendline indicates a possible point of intersection for that test. But will the market even advance that far?

The INDU nudged the 200-week average not so long ago and has pulled back. I nevertheless expect a full-on test of the 200 soon, in large part because so many expect it to occur and because a convincing failure there has not yet occurred. If the INDU breaks above the 200, a further advance to test the 50-week average may reasonably be supposed.

The market may, however, pull back to again test the lower trendline, as it did in March, which is noted on the chart above by the green circle. Another leap at the upper trendline is therefore quite likely.

To date, the INDU’s intraday low of 10,827 this year represents nearly a 24% selloff from the intraday high of 14,198. Put differently, the Dow has in less than a year lost nearly a fourth off its all-time high level in October 2007.

A fair question, one on many minds: if the current market is a correction to a major uptrend, when will this correction be over? No one knows, and the technical factors - while helpful - ain’t the whole story. There’s inflation, the economy, and other factors discussed at length by me and many other commentators. I think more selloff is necessary would be necessary to convince everyone that the correction has bottomed - a clear point of capitulation needs to occur.

But truly resuming a new uptrend will require a healthier economy and stronger corporate earnings. Will they be there? If so, the question of whither the market answers itself.

I am bearish now, as most of you know, but the market will in coming months - say by the end of October - make clear whether it is merely correcting a major uptrend still in place or if more bear is to come. I think a resumption of the bull this year or early next year is quite likely, especially given the election. We’ll soon know.

Quick Historical Note:

1. The correction of 2000-02 retraced approximately 38.2%, then later hit 50%, of the rise from 1990. Both are Fibonacci retracement theory numbers. In fact, the Dow declined to previous market top (support) levels from 1998.

2. The current correction already has hit 38.2% of the rise from the bull market’s 2003 beginnings. In fact, the first week of July 2008 saw a fall to 10,827, which is a 50% retracement. The current correction has already hit 2005 support (the INDU’s 2005 top) and has almost hit the 10,752 top from early 2,000.

3. Also on a positive note, the 200-week SMA has not yet turned downward. That downturn will be negative news. should it occur.

Feel better now? I know one thing: the more bearish more people become, the better I feel.

For call writers, of course, all of this is merely an attempt to answer the question of when is best to write covered calls. Right now is good, since the market has hit a (probably) temporary bottom and is gathering for a spring at the upper trendline.

Important Note: If we get another pullback testing the lower trendline, as in March 2008, don’t panic. It is not unlikely. Today’s pullback may indicate a retest of the lower trendline or may just be noise. And don’t forget: we’re in the doldrums time of year, and a lot of traders are on vacation now or not working their hardest.

This entry was posted on Thursday, August 7th, 2008 at 3:26 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.