Daily Form July 25, 2007

Profit Patterns and Risk Management For Active Traders
Trade successfully without having to be right about the underlying market direction
WEDNESDAY JULY 25, 2007       07:15 ET

Today’s commentary will focus on some major trendline violations that occurred during yesterday’s aggressive sell-off. Selling was most acute in the mortgage related financial services and investment banks but several other high fliers came under the hammer including Apple which dropped more than six percent.

The Russell 2000 (^RUT) came down almost three percent and violated two lines of support.

I would construe this action as the interruption of the major bullish trend that has been in place since the early March recovery. Having said that I am hesitant to write any obituaries for the longer term bullish scenario since the market has proven itself remarkably resilient especially when the bears have become too enthusiastic. However if the short squeezes are not accompanied by genuine new accumulation by fund managers the warning signals that were set off by yesterday’s notable under performance by the small cap index should be taken as notice that the market appears to be in a phase transition to intermediate bearishness that may not find its full expression until the fall.

The monthly chart for the banking index (^BKX) below is more troubling as it shows that as of yesterday’s close the index has violated the long term trendline through the lows that extends all the way back to the bull move that began in the spring of 2003.

The S&P 500 (^SPC) fell by two percent in yesterday’s trading which makes it the largest one day decline since the three percent plus decline on February 27th which was when the market became preoccupied with the concerns from the sub-prime mortgage sector and credit derivatives.

As can be seen from the daily chart the 50 day EMA was decisively crossed and the upward trendline since the March recovery appears to have been transgressed. As previously commented I would not be surprised to see a dramatic recovery in coming sessions but in the longer term the market will need more than short squeezes to sustain the underlying constructive dynamics for long only fund managers.


The patterns identified below should be considered as indicative of eventual price direction in forthcoming trading sessions. None of these setups should be seen as specifically opportune for the current trading session.
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LEH  Lehman Brothers Holdings Inc.  

Lehman Brothers (LEH) has been acting poorly for several weeks and after registering a new 2007 low in Monday’s trading the stock lost a further 3.6% yesterday. It was another rough session for the investment banks as anxiety about the integrity of certain areas of the mortgage related derivatives markets refuse to go away. Pricing of some of these complex instruments that have been devised by financial engineers is becoming a contentious issue

Illiquidity and opacity can be an advantage to hedge funds and banks that are holding these asset as a lack of a transparent pricing mechanism for them often means that these derivatives are marked to the model rather than as in the case of most assets, marked to the market. But when some sub-prime portfolios are effectively being written off as worthless there is growing anxiety that there may be more emperors wearing no clothes than asset managers are likely to feel comfortable about.

BAC  Bank of America Corporation  

Another graphical depiction of a trend violation is apparent in the weekly chart for Bank Of America (BAC) which shows in more vivid detail than the daily chart the unhealthy congestion that has been forming since March and which partially concealed the distribution within the banking sector that I alluded to in yesterday’s commentary.

BZH  Beazer Homes Inc.  

One more chart, in this case more of an individual story but still related to a sector that is in the midst of a major distribution, relates to Beazer Homes (BZH). The weekly chart shows the period back to the spring of 2003 and highlights the roller coaster ride that an "investor" whould have taken with the stock. The ride took the price above $80 in late 2005/early 2006 and has now returned to earth and actually below where it stood four years ago.

AMCC  Applied Micro Circuits Corporation  

Selecting individual stock setups within the current environment is more problematic than usual and I would suggest that a cautious approach be followed until the markets have come to terms with the anxiety over credit derivatives (which may not be any time soon).

Applied Micro Circuits (AMCC) avoided yesterday’s selling and the chart pattern looks as though the stock is preparing for a possible hurdle above the 200 day EMA.

BHI  Baker Hughes Incorporated  

In the oil services sector Baker Hughes (BHI) has a chart pattern which suggests that the sellers may be waiting for an entry close to $85 for another assault on the stock.