FSU Editorial: "Net Commercials and Back to Basics" by James West 02/20/2007

NET COMMERCIALS AND BACK TO BASICS
by James West
buythebottom.com
forever a student of the markets
February 20, 2007

Volatility Index

VIX [ http://www.buythebottom.com/vix.html ]
Commercials were sellers of volatility once again, which for now is telling me that the VIX is not ready to break-out (above 13). And if that is indeed the case I would not expect the stock market to do any major damage on the down-side just yet.

Broad Markets

However, even though the VIX is a great indicator as to when volatility is most likely to make a come-back and potentially mark a top in the stock-market, it is critical to understand that price remains the primary timing tool with COT setups. From the SPX chart above it is very clear that since the June/July lows the trend has been UP.

So what is an uptrend? The classical definition of an uptrend is a price pattern with higher-highs and higher lows. Notice from the chart above that after the SPX bottomed in June, every subsequent low (marked by the blue lines) has been higher than the previous; and similarly every subsequent high (marked by the red lines) has also been higher than the previous.

So let's recap, the trend is clearly pointing up. And we all know that �the trend is your friend�, so why should we fight it? We shouldn�t.

That is not to say that there is no reason to worry about this marketing topping, as recent COT data has been clearly bearish. On the other hand, it is a dicey strategy (in terms of risk-reward) to front-run the market. A trend is a very powerful indicator; it shows you the path of least resistance in a particular market. There are exceptions, but usually it does not make sense to guess ahead of time when a market might reverse, instead it is much more prudent to look for reversal signals. Reason being: even though markets may be setup one way or another from a COT perspective, these setups may take some time (a day, a week, a month, more?) to translate into price action. Hence, it makes sense to trade reversals in a market that is setup to reverse. Playing the market before any signals are even present will not yield a high percentage winning-strategy.

S&P 500 [ http://www.buythebottom.com/spx.html ]
Looking back at the S&P 500 chart above, if this market broke below 1431 that would probably mark the top for this index. A confirmation of this top would come if the SPX subsequently failed to make a higher high above 1458.

With this idea in mind, let's look at the other markets.

Dow Jones [ http://www.buythebottom.com/indu.html ]
The Dow Jones (INDU) looks virtually identical to the SPX. Both charts have a tight up trending channel, so if/when the top is in, the breakdowns should be easy to spot. The most recent-low for the INDU is 12530 and the most recent high is 12780. Similarly with the S&P 500, a break below 12530 would be indicative of a top, and then a failure to move back above the 12780 high would serve as confirmation.

Russell 2000 [ http://www.buythebottom.com/rut.html ]
The RUT has very significant support in the 800 range, a break and close below this level will be very negative for this index. A confirmation of a top would then come if we fail to move above recent highs at 819. (These highs were broken today, so whatever the new high is, that is the high to go by for future reference)

NASDAQ 100 [ http://www.buythebottom.com/ndx.html ]
The Nasdaq-100 is still struggling to confirm recent-highs made on the other 3 indexes, as they race to new yearly-highs. For all I know the trend for this index may have already reversed as there has been repeated failure to take out the high of 1848 set in mid-January of this year. This non-confirmation cannot continue indefinitely, we will probably see a resolution - either to the upside or downside - within a few weeks.

As I'm typing, I see that the markets had a big reversal today - to the upside; some are challenging their recent-highs. This confirms this week�s VIX setup in the short-run, and more importantly demonstrates why it is so critical to respect the trend of a price-pattern on a chart. It is the gravity of the markets, and it is a wise practice to adapt to markets�not the other way around.

Commodities

Crude Oil [ http://www.buythebottom.com/wtic.html ]
Oil has been consolidating for two weeks now, with resistance just below 61 and support at 57. I maintain that this market is setup to go higher, as long as support is not broken at 57. It is important to note that commercials were sellers last week, nothing too major�for now, unless the selling persists.

Gold [ http://www.buythebottom.com/gold.html ]
Gold has been trading sideways last week, meanwhile commercials were sellers for a fifth consecutive week. This market is setup to decline; I think a break below 665 could mark an intermediate term top. Important note: gold has very strong support at previous reaction-lows: 605, 570, 550 & 540. (This market broke support at 665 today, so quite possibly we just saw a top, as long as we do not move back above this level)

Currencies

US Dollar [ http://www.buythebottom.com/usd.html ]
The dollar is starting to show signs of weakness as price breaks below 84.5. The setup remains to the downside.

Regards,
James

Contact Information
James West
www.buythebottom.com
Toronto, Ontario, Canada
Email: westjam @ gmail.com (Remove the space before and after @ when sending your email)