Market Summary

The markets staged a mild recovery on Friday following the release of benign inflation data, improved retail sales figures and strong quarterly earnings from General Electric. The recovery was moderated, however, by a fall in the University of Michigan's consumer sentiment index to well below expectations. Friday's recovery, the second positive move in succession for the NASDAQ Composite, was insufficient to lift the indexes into positive territory for the week. The DJI slipped narrowly by 0.05% while the NASDAQ fell more steeply with a 1.22% loss and the S&P 500 gave up 0.78%.

Thursday's turnaround in the downward advance of the NASDAQ was a welcome relief, and it was reassuring to see the turnaround continue on Friday. The NASDAQ was at levels not seen since early July after falling through the 2050 resistance level we discussed last week, and a further fall to below 2000 looked possible. Two positive days don't mean that a recovery is in progress, however, and we must wait for a confirmation day before we can declare the recent slide to be checked. The requirements for a confirmation day were discussed in last weeks newsletter.

The number of confirmed breakouts fell to seventeen this week and most had difficulty keeping their head above water. Those that did make substantial gains, Monolithic Power Systems (MPWR ) and On-Line Reservation Corp. (ORCC) had both shown considerable strength while in their handles as they resisted the general downwards pressure to make positive price moves on above average volume. We have often indicated that this kind of price/volume action in the handle can herald a coming breakout.

Our ShortsaleWatch service confirmed 20 breakdowns this week of which six fell by more than 5%.

Using Bollinger Band 'Bands' to Detect Trend Reversals and Sell Signals

We first discussed Bollinger Bands in our newsletter of 8/27/05 shortly after we introduced our Technical Analysis Charts (T/ACharts) service. Two of the points we emphasized was that a move outside the bands did not necessarily mean it was time to sell (or buy) and that stocks tend to walk-up (or walk-down) the bands. In view of this, how can Bollinger Bands help us with our sell decisions?

This week we added a new option, 'BB Bands' to our T/A Charts that goes some way towards answering that question. When you choose BB Bands as a Price Band option you will get a chart with Bollinger Bands drawn at the 1 standard deviation level as well as the normal 2 standard deviations. To illustrate how the BB Bands can serve to confirm trend changes, here's an example of Imperial Oil (IMO) the top ranked stock in the top ranked Oil and Gas Canadian group that has performed so well this year.

• Trend A shows the stock tracking between the lower two bands with a possible change in trend signaled as it crosses the inner band to the upside. This is labeled 'Buy Alert'.
• Trend B begins when the stock crosses out of the inner band to the outer band. This is labeled 'Buy Confirm'.
• Trend B continues until the stock closes within the inner band for the first time. This is labeled 'Sell Alert'.
• The stock now consolidates in area C. Notice that it never closes below the lower inner trend line but re-crosses the upper inner trend line at which point the sell alert is cancelled.
• The stock now walks up the outer band until another Sell Alert is issued at the start of area E.
• Another period of consolidation begins (E) and the Sell Alert is cancelled as the consolidation is completed and the stock moves out of the inner-band to the upside.
• Trend F now begins as the stock again walks up the outer band. A brief Sell Alert is issued in late September which is cancelled the following day (not shown). Another Sell Alert is issued on October 4 and confirmed on October 5 as the stock closes below the lower inner band.

The strategy shown is a conservative one where a confirmation is required before the buy or sell alert is confirmed. A riskier strategy is to buy or sell on the initial alert but in that case it is desirable to have confirmation from other non-correlated indicators such as the RSI (or MACD) and On Balance Volume. (Note that the RSI and MACD should not be used together as they are both derived from closing price data alone). Using the BB Bands in conjunction with these indicators can help us determine when to sell a breakout that we might be holding. Here's an example of a recent breakout (9/16) that rose 53.5% in twelve sessions.

Following breakout the stock walked up the outer band but a sell signal was given on 10/5 when the stock closed within the inner band. This sell signal was confirmed on the same date as the RSI dropped below the overbought line and the On Balance Volume (OBV) was clearly in decline.