Dow “Officially” Breaks its High. Now What?

Hold Our Water

By Bryan Bottarelli
Tuesday, October 03, 2006 1:18 PM EST
Tue, 3 Oct 2006 18:18:00 GMT

Dear Bottarelli Research Member,

It’s now official: The Dow has broken its old high of 11,750.28 and set a new intra-day high today of 11,754.55. Here’s the chart to confirm today’s upside action:

DOW

The catalyst for this upside move is being credited to the fact that oil has once again dipped under $60 a barrel and is now trading close to a 10-month low. To my eye, it appears like the name of the game is buying oil stocks when oil is under $58 a barrel and selling oil stock when oil is above $63 a barrel. This choppy trading pattern can be seen in virtually all the oil-related stocks I closely follow. With oil now at $59.15, it appears we have another $1.50 to $2.00 of downside left before triggering the next round of call buys on names like Marathon Oil (MRO – NYSE) or Transocean (RIG – NYSE). For example, here’s the chart of RIG.

RIG

As you can see, it set a double-bottom at $65 in mid-August and early September, followed by nearly a $10 jump to the upside. Now that RIG is once again approaching the $67.50 level, it’s attempting to call that level the new bottom, which would effectively set a higher low than August/September. If that’s the case, I’d expect the next upside move to near the 200-day moving average at $76, and that’s why I’m waiting for the next opportunity to buy calls. But until this conformation happens, the bias is certainly down.

But I’m getting ahead of myself. First and foremost, we must understand what’s next for the Dow. Now that we’ve officially hit the highs, I think we’re going to start hearing a lot about the averages being in “overbought” territory, which could lead to the early stages of the October selling pressure I’m calling for. That’s why I have us selectively holding call positions in a consumer staple company like Groupe DANONE (DA – NYSE) and a basket of big pharma companies in the Pharmaceutical HOLDRs (PPH – AMEX) alongside the two stocks I consider the most “overbought” on both the NYSE and the NASDAQ in the form of Nike (NKE – NYSE) and Research in Motion (RIMM – NASDAQ). Throw in some puts on Overstock.com (OSTK – NASDAQ), the weak online retailer, and we should be in position to capitalize on whatever the market throws our way in the coming weeks.

But for today, let’s allow the Dow to have its day in the sun as it relishes the fact that it’s set a new all time high. But here’s the thing. If you look at the last time the Dow hit new highs in early May, it’s clear to see what could potentially be lying on the horizon (a 900-point sell-off, to be exact). While I don’t think this upcoming sell off will be as severe, you better believe that every technical analyst out there is very aware of this pattern. On top of that, you better believe that every trader who loaded up on stocks the last time the markets hit new highs in May still remembers the pain they incurred over the next month. So despite OSTK, RIMM and NKE’s little jumps, let’s hold our water.

Lock and load

Sincerely,

Bryan Bottarelli

Bryan Bottarelli
Editor, Bottarelli Research

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