I’m writing this from the road, heading for this weekend’s seminar venue. The market continues stuttering. Yesterday was a big day up for the Dow Jones Industrials and saw it close both back into its trading range and above the 20-day moving average. Other major indices also had a good day yesterday, if not quite so strong.

Today, jobless claims first went over 10%. And since we all know the real jobless rate is much higher, this has seriously dampened today’s action - which should have been a great day.

I put on a long call trade in the QQQQ yesterday for fun, just 30 contracts, and closed it today for a 51.6% profit. Not a lot of money, but a nice return. As I write this the Dow is up 12, the Nasdaq Composite is up 5 and the SPX is up a measly 1. Best case is a positive close above yesterday’s close.

I am not putting on any covered call trades today. I want to see what Monday brings. But if the market continues stuttering, I have some trades in my back pocket of companies that lately have been strong despite the market’s pullback in the second half of October. Yes, they are out there. (Hint: I find them on our lists by sorting the list by our proprietary MADI indicator)

I hate making this post, but it must be done. After being up nearly 150 points today, the Dow Jones Industrial averages settled back for a close at 9802, just 30 points above yesterday. Other indices are looking as bad or worse: SPX, COMPX, NDX, RUT.

Chart 1 below of a few weeks of action on the S&P 500 illustrates my concern. Last Friday the market had a huge down day, the one marked on my chart as “engulfing candle?“.

Usually, a huge red candle like Friday’s after a several-weeks pullback signals a possible reversal in the opposite direction (North). But engulfing is as engulfing does. For that hoped-for reversal to happen, a series of rising white (positive candles) would be needed. The close of one of those white candles above the top of the engulfing candle would be the money candle! Note what happened at the August, September and November lows in the uptrend: engulfing candles followed by a series of up candles (the market went up):

Now, let’s turn attention to the three candles following Friday’s big red. Two advancing candles and then the long shadow. Today’s candle made a very long upper shadow than fell back to close almost at the day’s open, which indicates weakness. This could very likely be the “shooting star” pattern, which is bearish. These often show at the end of a move up. Is two white candles in a row enough of a move up to call this 3-candle pattern a shooting star?

We’ll soon know.

I don’t trade these candlestick patterns. I’m just trying to size what up is happening. I don’t know what’s next, anymore than you do, but price and volume are all we have.

Covered Calls and Naked Puts

Candlestick analysis is by no means foolproof. To paraphrase Ebeneezer Scrooge, they show us what may be, not what will be. But for now, unless and until we see more up candles and a close above Friday’s big red (which could also be a close above the 20-day moving average and back into the primary trend), there will be no entry signal for those who trade with the market.

Do not put on a covered call or naked put position now. Even if you are eyeing a stock that sneers at the market, its behavior could change if the market heads south.

Following up recent posts about the very real possibility that the market may be about to reverse to the upside, here is another Dow Jones Industrials chart from today, 11/3/09. Compare today’s green-circled price action to that of the retracement bottom in July:

A positive day today would have been lovely, but look at the resolution of the last touch of the major trend line, in July. Similar, wot?

So, another indecisive day… but notice that the DOW opened a just a couple points under yesterday’s positive close. And despite struggling all day, the market closed almost back at the open. Yesterday closed at 9,789, today’s open was 9,787 (I said a couple points) and today’s close was 9,771, almost 9,772. That’s 17 points off yesterday’s close. This little chart helps you see today’s bar better:

Covered Calls

If you are waiting, like me, to hammer some covered calls when the tide turns, the time is not quite yet. Keep watching. Remember, confirmation would be a close inside the primary trend, a little over 9900.

Yesterday’s post early afternoon suggested that we are at a resistance level and that the market will pull back to test the lower trend line or even its 50-day average. Today I’m no more bullish. I offer into evidence the following:

1) Last Thursday, the INDU touched the upper trend line, followed by small congestion candles, after a nice run up. The market usually stalls at this point.

2) Yesterday was lousy, and yesterday’s open was almost the same as Monday’s close. If there was any strength there, it would have opened higher than Monday’s close.

3) The INDU opened low this morning, below yesterday’s close - and yesterday was a down day, too, remember. In fact, the market opened today below Monday’s close, also.

4) The market shot up briefly today to a higher level than yesterday, but intraday highs on a bad day like this only mark a high point in irony… what might have been.

5) In candlestick analysis (see the free chart school on Stockcharts.com for lessons on this), Monday’s white candle was important. In order to continue the trend, even briefly, the market needed to break above it and not below it. Although it doesn’t look much like much of a candidate for an engulfing candle, it’s all we had.

Okay, the little devil on my left shoulder whispers that the market could come back after just a couple of punk days. But the problem isn’t just yesterday and today, but the context. Look at the second week of August for an example of the market topping at the upper trend line and coming back - but that comeback lasted only two days.

Covered Calls

My thoughts for covered call writers in yesterday’s “futile” post still stands. If we are wrong to close positions now and the market rockets right on up, we’ll have taken a loss for nothing. If the market does pull back to support, we’ll feel kind of silly to ride it down.

We always want to trade WITH the market, because any other approach makes less sense. But because we are neither psychic nor in possession of tomorrow’s newspaper, the timing of trade entries and adjustments inevitably involves making educated guesses. You have to ask yourself: what are the odds favoring now?

We can’t always be right. We’ll misjudge weakness and have a stock collapse on us that we could have gotten out of. Or we underestimate strength and get out at a needless loss. These things WILL happen. But that just means our timing was off. Once we have a feel for direction after being wrong, we know when to ride the bronc again (with the market), and those can be some of the best profits.

As far as I’m concerned, the current market action is the rattler’s rattle.

Well, the old market is at resistance again. It made a nice run up after bouncing off the 50-day average. However, it hit the upper trend line on Thursday of last week and has been inching up the trend line hand-over-hand ever since. When this happens, it has tended to signal another down-leg in the trend. Here’s a daily chart from about 1:40p ET today:

The market could break higher, but the 10,000 mark is a choke point, and I expect another run down to test the bottom of the trend line.

Interestingly, the tech indices - Nasdaq 100 and Nasdaq Composite - are showing even less strength, after having shown more strength than the INDU and SPX since March.

Yes, the market could be making a head-fake preparatory to a fresh advance. But these crux points are not a good point to buy stock.

Covered Calls

This is not a time to be putting on covered call positions. The market has to break higher before justifying a long stock position. Advances and declines since March of this year have tended to be of short duration, just a few weeks. My approach this year has been to trade with the market, getting in at support points and writing OTM calls. Please don’t ever feel as though you just have to find a trade at any point in time. Like a sniper, pick your shots.

If the market does pull back, then wait until it finds SUPPORT at the lower trend line or 50-day average before putting on any more positions. Higher-than-normal volume on the INDU (and your stock) at the lower trend line will be a signal for a new advance.

If you have open positions, be prepared to close them if the market starts pulling back and get back into the stock when SUPPORT is found - let the market do the lifting.

We just had a CallWriter members’ trading lab conference last night and I talked (among other things) about how the market needs to break conclusively above 10,000 in order to keep the 2009 uptrend intact. Well, the DOW’s close at 10,015 today was a good start, because the even-thousand numbers are very important, whether the index is northbound or southbound.

In fact, the DOW closed just 10 points south of the day’s high today. Very nice, but we need to see more of this action. One close above resistance doth not a continuation make. The daily chart below indicates how the index stuttered at the 9,830 resistance level yesterday and Monday, then made a strong upmove for a close above resistance today.

The weekly chart below shows the strong 2009 trend since early March. It took about 3.5 months to get the June/July correction. At some point we can expect another correction of equal or greater magnitude, though the recent pullback should have bled off some steam. Notice also how the upper and lower trend lines are converging toward each other,

The same thing is of course happening with the SPX and NDX.

I intend to give the market a day or two - at least - of time to consolidate before writing any calls, since I like to write with the market. We may see some irrational exuberance now, but many don’t believe the DOW can stick above resistance. There may be a little more stuttering before the market moves up, assuming it can live in the above-10,000 stratosphere.

My plan upon confirmation of the break in resistance will be to pick strong stocks off CallWriter’s Global Select list that are following the market (or even stronger) and write OTM calls. This allows a very profitable close early - if the stock moves up as expected - due to the OTM call’s low delta.

There certainly is no shortage of opinion about whither the market! I have CNBC on all day in the background, which is mostly useless - it’s for news. I certainly wouldn’t make any judgment calls about the market from any of the commentary featured.

It is interesting how some of the biggest email-based promoters differ. For example, one commentator is breathless about China. Another also breathlessly extols China and points out how they are buying up raw materials, and then in the bottom part of the same email says China is an ecological nightmare (true) and has stopped buying raw materials. So which is it?

This last pundit, whose name rhymes with Dick Young, also says the dollar is a dead duck and warns of an impending crisis of such immense proportions we will be nostalgic for the Great Depression - but don’t worry, his time-tested stock picking strategies will save us. Well, the dollar is in deep doo for a number of reasons, probably unfixable. But it’s the only dollar we have. Who else’s currency would you rather have? Brazil’s? The Euro?

He makes the coming crisis sound like the Zombie apocalypse so beloved by Hollywood. But, if this crisis is imminently upon us, should we be buying stocks? Maybe items like guns, ammo, water, non-perishable food would be more practical. I don’t have anything against fear-based marketing, but come on. If American ever turns into the dog-eat-dog apocalypse world of the old movie Escape from New York, I’m guessing stocks will be the last thing on our mind. (Honey, there are armed and hungry men outside, I think they want our stocks…)

Jon Markman, on the other hand, points to some more upbeat facts. Domestically, housing sales are up 7.2% and new housing sales even higher, unemployment has peaked at 9.8% just missing the magic 10, corporate profits are up 24% in the first six months of this year and durable goods orders are up 4.9% month over month. Internationally, industrial production and manufacturing numbers are up in Singapore, the Philipines, Spain, Germany, Japan the UK and in many other countries.

But the trend does not care about pundit predictions. The thing we must remember is that trends remain intact until they end. And until it clearly ends, you play the trend.

The major indices recently rebounded beginning on October 5th. My philosophy is to write covered calls with the market. When the market is pulling back, I tend to close open positions - so I can repurchase the stock lower and ride the rip. I don’t usually write calls on market pullbacks.

However, the market has to reach higher highs to keep the trend intact. For example, the DOW recently hit an intraday high of 9,917.99. We have to move above this high to keep the uptrend intact. The DOW closed at 9,786 today. Breaking through this might not be pretty, but if it does, this trend may last a while.

After hitting a high of 9,437.71 very recently, the DOW has had two sell-off days, closing yesterday at 9,135.34, closing near the low of the day - not good. So far today the DOW’s low is the open, a good sign.

Is this where the market goes over the falls?

Hopefully not, but no one really knows. I think we all can agree that with 10% unemployment (which does not even include people who have stopped looking for work), the prospects for a bull market are not good. Nil, in fact. If this advance off the March bottom is not a new bull market, it is a bear rally and must fall back to earth. Of course, the market could just be looking for its 50-day average, but that is 8,773 on the DOW. Since March, the market has shown some strength, pulling back to the 20-day average repeatedly, which it did today.

Instead of worrying about whether this is the dropoff, the first thing is to close our short calls, which adds slightly to the trade debit. But only do this if the call value has fallen 50% or more - it must be economically worth the repurchase cost. If the market snaps back in the next week or so, we can sell more calls. Imagine that you write a call for $4 in premium, repurchase it for $1.85 on a stock pullback, then write it again for about $4. Now you have more than $6 in net premium, but the person who didn’t repurchase the calls on the pullback only got the original $4 in premium. That is a BIG difference in return. As I write this on Tuesday morning, it still is possible to advantageously repurchase calls on many stocks.

If it does not snap back, our decks are cleared for selling the stock. I am not a big believer in holding onto the falling stock. And rolling down when the market has pulled back to the 20-day average is just a guess as to what it might do next. With the market poised at the 20-day average, it is on a knife edge. If tomorrow is another down day, I would consider selling s stock falling with the market, looking for a chance to repurchase it lower.

My SuperPut protected covered call (calendar collar) strategy really shines in times like this. If the market doesn’t go off the cliff, we remain protected and continue selling calls profitably. If it does continue down, we can sell the stock and hold the puts, which will gain in value.

Ah, what a day! As my post of yesterday foreshadowed, the market is selling off. The Dow Jones Industrials (INDU) lost 299+ points to close at 6,763.29 points, while the S&P 500 (SPX) lost 34.27 points, finishing at 700.82. Well, we’re off, as they say. But to where?

DOW:
The DOW took out the 6,933 low from October 1997, but good. The next “support” level is 6,315, reached in Q1 and Q2 of 1997 - just another 450 points to go. After that, the next support level would be at approximately 6,000, seen in October and November of 1966. Below that - let’s talk about that another time, if it comes into play.

SPX:
It’s not holding up quite so well. Today’s 700.92 close is below the lows of both April (733) and January (729) of 1997. The next stop would be a support level of approximately 600, from late 1996.

Some seem to be assuming that those lower levels - 6,000 and 600 - will be THE bottom. Maybe. But I’m not assuming that. There is very little interest in the market, and it’s human nature that most people would rather jump on an officially pundit-sanctioned market rally than buy on the way down, even though one might pay more on the way up. So, buying has not kicked in yet.

Also, the murderous ultrashort funds (which don’t actually have to sell stocks short, using equity swaps instead) are pounding the market relentlessly. They are a force that we didn’t have to contend with before.

Blame Bush, blame Obama, blame AIG. Whatever. The point is that the bottom will form only upon a consensus that stocks have become bargains. We’re not there yet.

Covered Calls

Obviously, don’t put on any covered call trade when the market is selling off. If you have open covered call trades, consider ITM writes that you will CLOSE as the stock pulls back further. In this environment, I like to write ITM calls and then close them opportunistically when the stock loses enough value to yield a reasonable profit. If you are writing at a call strike below your cost basis in the position, be wary of being caught if the market snaps back.

The S&P 500 was, as of Friday, down over 18%, year to date. This is the index’s worst JAN & FEB decline on record. The question on the minds of everyone who follows the market is when will capitulation occur and result in a market bottom? Capitulation is the point at which everyone throws in the towel and the market sells off to the level where buyers come rushing off the sidelines. More on this below, but this question can only be asked in the context of news known to be on the way.

On Monday, May 2nd, the ISM index will be released. This index is based on the Institute of Supply Management’s survey of purchasing executives at manufacturing firms. It may be the best single indicator of whether a recession has bottomed, reflecting as it does new orders by manufacturing firms. December’s number was 32.9%, a number only achieved in major recessions, but in January the number had rebounded to 35.9%. An improvement in Monday’s number would be good news, since a pullback to 34% is widely expected; even a slight drop would be good news - of a sort.

Tuesday - we’ll see data on February auto sales and pending home sales for January. The Fed’s Beige Book report will follow on Wednesday.

On Friday, May 6th, the jobless number for February (employment and nonfarm payrolls) will be released. The consensus number expected is a loss of about 630,000 jobs (January’s number was 597,000), though some estimates put losses as high as 800,000.

And the bad news will continue for awhile. The most optimistic forecasters don’t see a recovery beginning until late 2009, and many don’t see it until well into 2010. Some don’t see a real recovery until the housing market stabilizes and starts moving again, widely expected to occur in 2011.

MarketWatch quotes S&P analyst Alec Young, who wonders if the March data might be the catalyst for real market capitulation, if even “the most bullish people” give up. He considers those buying on dips to be bullish, though many of us are doing that, simply trading stocks with market pulses.

Note that the long-term average P/E (price to earnings per share) ratio for the S&P 500 is approximately 18 through good times and bad. It now stands at approximately 12, so much starch already has been taken out of the market’s shorts. But like many, I don’t think the market has bottomed. Why would it have? The news keeps deteriorating, corporate earnings in particular.

More to the point, we need true capitulation in order for a consensus to arise. We should not be dreading that but rather looking forward to it. Upon the expected market swoon, those sitting on impaired stocks should not be panicked into unloading them. The good ones will recover, and capitulation will provide the biggest buying opportunity in more than a generation.

Covered Calls

For now, consider using my SuperPut (protected covered call) strategy and sticking to the best companies with the least impairment to earnings, which are far less affected by market pullbacks. Despite the market’s continued weakness, the stocks I have mentioned (on our monthly online trading labs for members) as covered call trades worthy of CallWriter member consideration have done quite well. Making money with covered calls in this market can be and is being done.