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Written and copyright © 2008 by Thomas N. Bulkowski. All rights reserved.

Tuesday, 10/6/2008. Dow Utilities: More Down?

The bailout issue of the last week or two took the markets and I by surprise. I waited for the dust to settle and markets to rebound after passage of the bailout bill, but they didn’t. I was hoping that Monday would begin the long march higher. Instead, the Dow plummeted 800 points and then clawed its way back to half that. Based on the Dow industrials, I expect Tuesday to see it continue lower due to overhead resistance at round number 10,000 and because it appears the Dow was moving lower going into the last few minutes. I am leaving my price targets for the indices alone for now pending a review.

The chart of the utility average shown above makes me pause when trying to predict a new target. The chart shows the average on the weekly scale and price is resting on a support zone (B). The average should move higher tomorrow (Tuesday), but I have been hoping that would be the case for weeks now. Thus, I show possible turning points should the average continue lower.

Point B is at the current low of 377. Below that is line C, drawn in beneath the congestion area of early to mid 2005 at 350. Line D takes us back to November 2005 at about 300. Any of these areas could act as support and see the average bounce off it. Whether that would lead to a lasting upturn is anyone’s guess. Perhaps tomorrow will give a better feel for the direction in the coming weeks. If so, then I will adjust Tom’s targets accordingly.

Monday, 10/5/2008. Time to Stop the Losses?

Imagine that you bought the stock Chicos (CHS), pictured above on the daily scale, at point A. You received a fill at the high of the day, 27.70, but that is fine because this is a momentum play and you know price will move higher. The all-time high for the stock is 49.40, set back on February 2006, and you expect the stock to form a very wide double top at 50.

As you hold the stock, each week it drops a little more, nibbling away the hope of a profit bit by bit.

Price hits 20 and you know it is a support zone (round numbers often are). You have lost, on paper, 28%, which is huge, more than triple your usual loss. What should you do?

"If I sell then the stock will bottom, and I will have missed the recovery. If I hang on then the stock will continue lower." That is often how I justify making a bad decision. Let’s parse that statement.

The stock can move in three directions.

1. Sideways. If it moves horizontally, it means that you just lose time. Price will eventually move higher or lower.
2. Upward. If it moves higher, you will have dodged a bullet, but that will setup a bad habit such that every time you are faced with a losing position, you may decide to hold on a little longer because it worked the last time you held onto a losing position. That leads to the last choice.
3. Downward. If price continues downward then you have only postponed your sell decision. Imagine that price is now at C, 10. The loss is a massive 64%. Should you sell or hold on? That is the same question you asked yourself at B. Price can recover after you sell or continue lower. You still have to make a choice. Instead of giving up time and a lot of money, clearly it pays to make the choice sooner.

Perhaps making the sell decision well before the stock drops to B is what separates professional traders and investors from amateurs. But even the pros make mistakes. We "know" that this quarter is going to be a good one, so we hold on and suffer as the stock continues to drop. When the quarterly report comes in and it is better than hoped, the stock drops because the market was expecting even better. So you sell for a loss larger than planned. Amateurs would hold on and ride it even lower.

In the final analysis, which would you rather be? The pro that sells before the stock drops to B or the one that rides it all the way down to C, knowing that it may take years to get back to break even?

Friday, 10/3/2008. Patterns for the Weekend.

Please note that for archived blog postings, this list reflects the most recent securities, and not those posted originally.

Weekly screen for chart patterns ending between 09/25/2008 and 10/03/2008.

Here are the chart patterns that appeared within the last week, many are unconfirmed (still in development and may not be valid). If no securities appear, then I have not identified any new patterns.

Industry: Homebuilding

Industry RS rank: 31 out of 46

Stock RS rank: 460 out of 554

Latest close as of 10/02/2008: $16.02

1 Month average volatility: $1.78. Volatility based stop (assuming an upward breakout): $12.21 or 23.8% below the close.

Change year to date: -36.58%

Volume: 6,866,800 shares

3 month average volume: 7,571,429 shares

 

Chart pattern: Triangle, symmetrical continuation pattern from 09/19/2008 to 10/02/2008

Performance rank: 16 out of 23.

Breakout is upward 54% of the time.

Average rise: 31%.

Break-even failure rate: 9%.

Throwbacks occur 37% of the time.

Price meets the measure rule target 66% of the time.

Industry: Homebuilding

Industry RS rank: 31 out of 46

Stock RS rank: 386 out of 554

Latest close as of 10/02/2008: $12.08

1 Month average volatility: $1.32. Volatility based stop (assuming a downward breakout): $16.01 or 32.6% above the close.

Change year to date: -8.28%

Volume: 8,898,100 shares

3 month average volume: 9,581,443 shares

 

Chart pattern: Diamond top reversal pattern from 08/29/2008 to 10/02/2008

Performance rank: 7 out of 21.

Breakout is downward 69% of the time.

Average decline: 21%.

Break-even failure rate: 6%.

Pullbacks occur 57% of the time.

Price meets the measure rule target 76% of the time.

Industry: Oilfield Svcs/Equipment

Industry RS rank: 38 out of 46

Stock RS rank: 328 out of 554

Latest close as of 10/02/2008: $13.23

1 Month average volatility: $2.13. Volatility based stop (assuming an upward breakout): $8.52 or 35.6% below the close.

Change year to date: -39.37%

Volume: 1,636,600 shares

3 month average volume: 286,503 shares

 

Chart pattern: Dead-cat bounce from 10/02/2008 to 10/02/2008

Industry: Retail (Special Lines)

WARNING: This industry is within the top 7 that Dead-cat bounce often.

Industry RS rank: 17 out of 46

Stock RS rank: 16 out of 554

Latest close as of 10/02/2008: $14.74

1 Month average volatility: $0.76. Volatility based stop (assuming a downward breakout): $17.24 or 17.0% above the close.

Change year to date: 21.82%

Volume: 152,900 shares

3 month average volume: 327,134 shares

 

Chart pattern: Head-and-shoulders top reversal pattern from 09/08/2008 to 09/29/2008

Performance rank: 1 out of 21.

Breakout is downward 100% of the time.

Average decline: 22%.

Break-even failure rate: 4%.

Pullbacks occur 50% of the time.

Price meets the measure rule target 55% of the time.

Industry: Petroleum (Integrated)

Industry RS rank: 41 out of 46

Stock RS rank: 531 out of 554

Latest close as of 10/02/2008: $14.42

1 Month average volatility: $1.70. Volatility based stop (assuming a downward breakout): $19.84 or 37.6% above the close.

Change year to date: -69.77%

Volume: 8,204,400 shares

3 month average volume: 9,437,743 shares

 

Chart pattern: Broadening top, right-angled and ascending reversal pattern from 07/15/2008 to 10/02/2008

Performance rank: 19 out of 21.

Breakout is downward 66% of the time.

Average decline: 15%.

Break-even failure rate: 20%.

Pullbacks occur 65% of the time.

Price meets the measure rule target 32% of the time.

Industry: Homebuilding

Industry RS rank: 31 out of 46

Stock RS rank: 126 out of 554

Latest close as of 10/02/2008: $23.77

1 Month average volatility: $1.93. Volatility based stop (assuming a downward breakout): $29.77 or 25.2% above the close.

Change year to date: 18.49%

Volume: 4,158,600 shares

3 month average volume: 5,428,703 shares

 

Chart pattern: Diamond top reversal pattern from 08/28/2008 to 10/02/2008

Performance rank: 7 out of 21.

Breakout is downward 69% of the time.

Average decline: 21%.

Break-even failure rate: 6%.

Pullbacks occur 57% of the time.

Price meets the measure rule target 76% of the time.

Industry: Retail (Special Lines)

WARNING: This industry is within the top 7 that Dead-cat bounce often.

Industry RS rank: 17 out of 46

Stock RS rank: 480 out of 554

Latest close as of 10/02/2008: $15.14

1 Month average volatility: $1.15. Volatility based stop (assuming an upward breakout): $12.70 or 16.1% below the close.

Change year to date: -41.54%

Volume: 793,000 shares

3 month average volume: 1,892,125 shares

 

Chart pattern: Broadening bottom reversal pattern from 08/04/2008 to 10/02/2008

Performance rank: 17 out of 23.

Breakout is upward 53% of the time.

Average rise: 27%.

Break-even failure rate: 10%.

Throwbacks occur 41% of the time.

Price meets the measure rule target 59% of the time.

Industry: Petroleum (Producing)

Industry RS rank: 40 out of 46

Stock RS rank: 417 out of 554

Latest close as of 10/02/2008: $41.90

1 Month average volatility: $3.44. Volatility based stop (assuming an upward breakout): $34.54 or 17.6% below the close.

Change year to date: -18.42%

Volume: 14,463,600 shares

3 month average volume: 14,606,729 shares

 

Chart pattern: Broadening bottom reversal pattern from 08/20/2008 to 10/02/2008

Performance rank: 17 out of 23.

Breakout is upward 53% of the time.

Average rise: 27%.

Break-even failure rate: 10%.

Throwbacks occur 41% of the time.

Price meets the measure rule target 59% of the time.

Thursday, 10/2/2008. What is the Wash Sale Rule?

I think that there is a lot of confusion about the wash sale rule. I am not a tax expert, but I have a book titled, "J.K. Lasser’s Your Income Tax 2008." I would like to share with you some passages from the book regarding wash sales. This does not apply to everyone. As the book says, "The wash-sale rule applies to invetors and traders. It does not apply to dealers."

I mentioned in yesterday’s blog that selling a security for a loss and then buying it back within 30 days means the loss would be barred. If you plan to sell a security for a loss next week, for example, but you still like the stock, you cannot buy twice as much now and then sell half next week. The loss deduction would be barred. The 30 day window extends from 30 days before you take the loss to 30 days after the sale, a 61 day window.

According to the book, "If you sell at a loss and your spouse buys substantially identical stock within this period [the 61 day window], the loss is also barred."

The book also gives examples of how the tax loss is actually deferred. Here is what they write, edited for space.

"1. You bought stock for $10,000 in 1993. On June 21, 2007, you sold the stock for $8,000, incurring a $2,000 loss. A week later, you buy the same number of shares in the same company for $9,000. Your loss of $2,000 on the sale is disallowed because of the wash-sale rule. The basis of the new lot becomes $11,000. The basis of the old shares ($10,000) is increased by $1,000, which is the excess of the buy price of the new shares ($9,000) over the selling price of the old shares ($8,000).

2. Assume the same facts as in example 1, except that you buy the stock for $7,000. The basis of the new lot is $9,000. The basis of the old shares ($10,000) is decreased by $1,000, which is the excess of the selling price of the old shares ($8,000) over the purchase price of the new shares ($7,000)."

Clear as mud, right? Consult a tax attorney. I had a wash sale this year on a day trade I made, so I am interested in seeing how my tax preparation software handles it.

Wednesday, 10/1/2008. How to Make Your Life Easier.

I downloaded my quote data again this morning and discovered that yahoo!finance changed the quote information of the Dow industrials. The new candle did not show a black marubozu but an opening black marubozu. The opening black marubozu candlestick is a continuation 53% of the time in a bear market and price reaches the measure rule target 70% of the time.

If the government really wants to help the little guy, I have a few suggestions.

• Get rid of the wash sale rule. The wash sale rule disallows a loss if within 30 days of a losing trade, you buy the same or substantially the same securities and that includes a put or call option on the securities. The 30 days apply to before and after the sale (61 days total). See J.K. Lasser’s Your Income Tax 2008 book, page 510. My reading of their trading example says that the loss is deferred and not really barred.
• Quit treating traders as outlaws. Why not allow quick in and out trades that violate the wash sale rule? Why do we need to qualify as professional traders and when we do so, why do the exchange fees for quotes go up?
• Insure money market funds. Since few funds break the buck, this would be a low cost option to boost the market and soothe investors. Make the insurance permanent.
• Index FDIC deposit insurance for inflation. Forget temporarily raising the $100,000 level to some other number. Go back to when the government first instituted bank deposit insurance and index it for inflation from that time forward and then make inflation indexing permanent.
• Get rid of short and long term treatment of capital gains. Treat them all as long term capital gains.
• Decrease or eliminate the capital gains tax. Ok, so I am dreaming but it sure would be nice not to have to pay taxes on my stock gains. If you can’t do it for everybody, how about eliminating it for those 65 and older? Give our senior citizens a break.
• Stop treating "Wall Street" like a four letter word. With tens of millions of Americans (I heard 50 million) invested in the stock market either directly or through 401ks and such, Wall Street is really Main Street. Sure, limit CEO compensation when they do wrong and poke some holes in their golden parachutes while you’re at it, but leave Main Street alone.

To pay for these changes, do the following.

• Kill the earned income credit. So you probably disagree with this one, but I do not like having to subsidize people for making babies. If you want to become a baby factory, fine, just stop reaching into my wallet at tax time.
• Kill tax deductible interest on homes. And my guess is you disagree with this one, too, but I should not have to subsidize your Mc Mansion. A guy I know is buying a home just for the tax deduction. Why should my tax dollars go to help him pay for it?

My last suggestion really covers them all. Politicians: Stop spending my money!