Weekly Stock Options Trading Tips: October 5, 2009

Option Trading Idea of the Week

Testing a Statistical Rule of Thumb From TerrysTips.com

  We have always held the position that we had no idea which  way the stock was headed in the short run (but over time, it has gone up about 10% a year, so we should lean a bit in the upside direction).  This assumption seems to have served us well over the  years. 
 
 However, a time-tested rule of thumb in the world of statistics is that  for almost any curve of economic activity, the direction of the change  in the next period is more than twice as likely to be in the same  direction as the direction of the change in the last period.  This  rule of thumb supposedly applies to all time periods, whether they are  daily, weekly, monthly, or annually.
 
 For sure, if you examined a moving average curve for a stock or index,  every subsequent change is almost always in the same direction as the  last change.  Very rarely does the curve hit a bottom or top and  reverse direction.
 
 I wondered if we could use this rule of thumb to predict the direction  the market might be headed based on what it did in the previous  month.  If more than twice the time, the change was in the same  direction, we could benefit considerably by setting up risk profile  graphs which had more room for the stock to move in that particular  direction.  If this statistical rule of thumb held true, maybe we  should change our basic assumptions and the strategy as well.
 
 To check out the idea with SPY, I checked the monthly changes in SPY  over the last 10 years.  In exactly 60 of the months, the stock moved in the same direction that it had in the previous  month.  In exactly 60 of the months, it moved in the opposite  direction that it had in the previous month.   A perfect tie.
 
  The only conclusion that we could make from these numbers is that  our original assumption that we just don't know is probably about as  good as we are likely to get.  The statisticians are not always  right when it comes to the real world, at least when it comes to  monthly fluctuations of SPY. 

 Any questions?   I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth,  give him a jingle at 800-803-4595 and either ask him your question(s)  or give him your thoughts.
 
 You can see every trade made in 7 actual option portfolios conducted at  Terry's Tips and learn all about the wonderful world of  options by subscribing here.   Why wait any longer to make this important investment in yourself?
 
 I look forward to having you on board, and to prospering with you.
 
 Terry

Andy's Market Report

The market  experienced the second straight week of broad-based declines. The week  started out with a bang for the bulls, but the positive sentiment was  short-lived as the bears took the reigns and continued to push the  market lower as the week progressed. The wave of poor economic data  left many market participants puzzled over the economic turnaround and  its sustainability.

 The S&P 500 (SPY), Dow (DIA), Nasdaq 100 (QQQQ) and Russell (IWM)  declined 1.8%, 1.8%, 2.0% and 3.1%, respectively. For the year, the  S&P 500 is up 13.5%, the Dow has advanced 8.1% and the Nasdaq is  leading the way with a 29.9% gain.

 On the technical front, the major market indices have all moved in a  short-term "oversold" state which is typically a good thing,  at least for the next 1-3 trading days. However, the S&P moved below a key support level this week at 1020. This could be an ominous  level going forward particularly if the broad-based index is unable to  push through what is now a key area of overhead resistance. One thing  is certain I will be watching this area closely to see if the  short-term oversold conditions will lead to a pop over the next few  days. Furthermore, I will be watching to see if the bounce punctures  the 1020 area on the S&P. If so, I want to see the S&P hold the  1020 area. We shall see soon enough.

 As for economic data, well, things could not have been worse for the  bulls. Poor employment numbers led the way as early indications from  the ADP foreshadowed what would be a less than stellar number on  Friday. Specifically, the ADP number showed a decline of 254,000 on  Wednesday versus economists' expectations of -200,000. This led many to  wonder how the Nonfarm Payrolls report would turn out Friday. Well, as  most expected from the ADP report it wasn't pretty. The employment  numbers for September came in well above economists' expectations at  -263,000 vs. -175,000. As a result, the nation's unemployment rate  ticked up to 9.8% in September, its highest level in 26 years.

 "I think you've got an economic recovery, but I think the pace of recovery is very disappointing relative to what a lot of people expected," said John Silvia, the chief economist for Wachovia, a large national bank based in Charlotte, N.C.

 But it wasn't just the sour employment data that was poor this week.  The market moved lower on disappointing Consumer Confidence, Chicago  PMI and ISM Manufacturing reports. All three were worse than predicted.

 The calendar is thin next week so we shall see if the short-term technical conditions play out as they should. If a lift occurs remember, watch to see how the S&P reacts around the 1020 level. It  just might be the telltale sign of what the market has in store for us over  the next few months.

 Andy

Overbought/Sold Condition Report

Overbought/Oversold as of October 5, 2009

Major Benchmarks

• S&P 500 (SPY) - 23.1 (neutral)

• Dow Jones (DIA) - 21.5 (neutral)

• Russell 2000 (IWM) - 22.4 (neutral)

• NASDAQ 100 (QQQQ) - 23.1 (neutral)

Testimonial of the week

"I am very, very pleased with the ROI thus far.  One  of the exceedingly reassuring / attractive things about your service is  that because I travel a great deal (I'm currently in Seoul, after  working in Hong Kong last week, etc) I don't have to constantly monitor  the emails from you and make trades all the time. I just couldn't focus on my work and sustain my travel schedule and have to worry about time  zones, micro-market movements, etc. etc. in order to mimic your trade  patterns. It's a huge relief, and the fact that it seems pretty  consistently profitable is even more amazing. I just don't want to have  to monitor the markets daily, and if need be, even weekly.

I want to acknowledge you all for your good work, and your willingness to improve upon your model mid-stream as you did a couple  of months ago.  As my other assets become free, I will be moving  more of them to your service."  - John C.