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IN THIS WEEK'S ISSUE:

1.  THE PRIMARY TREND
2.  THE INTERMEDIATE TREND  
3.  THE SHORT-TERM TREND  
4.  TRADING IMPLICATIONS
5.  PICKS OF THE WEEK
6.  UPDATE ON PREVIOUS TRADES
7.  STOCKS TO WATCH IN THE COMING WEEK
8.  INSIDE THE BLACK BOX: TECHNICAL ANALYSIS MADE CLEAR AND SIMPLE

We urge all readers to print out this newsletter each week for maximum benefit...

1.  THE PRIMARY TREND

Longer term, the S&P 500 is sending its most bullish signals in three years. Shorter term, there are numerous technical signals that this rally is running into resistance and that the S&P 500 may soon be forced into a tactical retreat so it can later mount a strategic advance.

Let's talk about the big picture first.

Since July 2002, the S&P has been in what appears more and more likely to be a sideways, or stage I, base. The trading range of this sideways movement has been approximately 200 points, from roughly 765 to 965. The midpoint of this range is 865 and, as we have previously discussed, 868 has served as a key support and resistance level.

The key definers of long-term trend are the 30- and 40-week moving averages. These moving averages are near the center of the trading range and are moving sideways. Currently they are within two points at 883 for the 40-week (green) and 885 for the 30-week (majenta). The 10-week moving average (red), describer of the intermediate-term trend, is sloping strongly upward and now sits at 882. Therefore, it is within just about one point of crossing back above the 40-week moving average. When the 10-week penetrates above the 40-week, technicians term the crossover a "golden cross." Typically the golden cross is a very bullish technical signal, although its effects are not always immediately seen. Moreover, if the 10-week moving average continues on its path, then by early next week it will bullishly cross the 30- and 40-week moving averages. That would mean the 10-week will be above the 30-week, which will be above the forty week -- a very bullish signature.

This next point is worth verifying for yourself by closely looking at the chart. IF THE BULLISH MOVING AVERAGE ALIGNMENT JUST DESCRIBED WERE TO OCCUR, THEN IT WOULD DO SO FOR THE FIRST TIME IN THE THREE-YEAR BEAR MARKET!

Several weekly chart indicators are also positive. MACD is on a buy signal. The histogram is expanding, showing positive momentum. The index is well above its rising trendline. The rate of change indicator continues to trade well above its uptrend line. Stochastics, while overbought above 80, has not turned downward and is in fact still rising.

Given the positive longer-term picture, why then do I think a tactical retreat may be necessary? There have been three important rallies in this basing period, and all have started from the upper-700 area. The July advance, which began at 775, peaked in its sixth week. The October rally, which was mounted from the 768 mark, lasted ten weeks until its top. And the current March 2003 rally, which began at 788, is currently in its ninth week. It may be getting long in the tooth.

This week's candle is not quite a doji and might better be labeled a star. It has a small, positive real body; it shows a pronounced lack of momentum, particularly after the large real body of the previous week. The entire trading range of the past week (May 5th to May 9th) has been within the bounds of 920-940. This tells me that after a strong rally, the bulls have grown cautious. The upper end of the Bollinger band is now just about 942. With a close on the Dow Jones Industrial Average at 8,605, the market is at a key resistance level. As I said in my Mid-Week Update on May 7th, I think upward progress from here will be tough slogging.

If the S&P is going to better 940 and challenge the 965 area, then I think it will need to do so very early in the week of May 12th. Assuming we do hit a short-term peak, then I am looking for a grudging, orderly retreat to somewhere in the mid-800 range over the next few weeks. The 30- and 40-week moving averages should provide some support at around 880 and there is strong horizontal support at 850.

These price levels are well above the S&P 788 March low and would provide the second point on an uptrend line (should this scenario play out as I am describing it). From there, the market should be on stronger ground to mount another assault on the major 965 resistance. As previously stated, if the index can close above 965, then it is very likely the three-year bear market of 2000-2003 is over.

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2.  THE INTERMEDIATE TREND

The majority of technical messages on the daily chart are positive.

With a close above 933, the S&P remains well above its uptrend line, which now intersects approximately 910. The four-day moving average remains above the nine-day, which is above the 20-day -- a bullish signature. The 50-day moving average is well below all of these and is sloping upward. The moving averages are in bullish alignment. So far, so good.

However, I am concerned with the momentum indicators, as they are now showing bearish, or negative, divergence. The daily rate of change indicator peaked in mid-March and formed an "M" shape above "5" on its own scale. Even though the S&P is now more than thirty points higher than its mid-March peak, the 12-day Rate of Change oscillator is just over 1. It has consistently hit resistance at 5, which was the bottom point of the "M." Furthermore, Rate of Change has broken its own trendline, which goes back to late January. Since momentum typically precedes price, this negative action has me worried.

The MACD trend is also weak. With the histogram at .43 a decline in the index would quickly result in an MACD sell signal. The histogram also shows bearish divergence (readers may want to review my series on MACD and the histogram in our StreetAuthority Swing Trader newsletter archives). Stochastics is at an overbought level and appears poised to give a sell signal. Only RSI, which is trendless, is not giving worrisome signals.

Below are "blow-ups" of the last two important tops in the S&P 500. The first occurred in very late November 2002. I have circled the part of the chart to which I want to draw your attention.

For five days, the S&P traded in a narrow range with support at about 915 and resistance at -- guess where -- 940! On the 6th day, there was a small-range star candle at just below 940. On the 7th day (that sounds kind of biblical), the index rallied strongly at the open. After penetrating 950 and going outside the Bollinger band, it then created a candle resembling a long-legged doji. Fourteen trading days later, the average was back to 880.

The second top occurred in January 2003. Again, I have circled the relevant part of the chart. The index went sideways for seven days in a narrow range between 910 and about 935. Dojis occurred on both the fifth and sixth days. Finally, on the 8th day there was a negative engulfing candle. Less than two weeks later the S&P was trading below 850.

I am not suggesting history will repeat itself exactly here. In addition, it's worth noting that the technical picture as I have described above is much stronger now than it was in the Fall or early Winter. Also, the Iraq war is behind us. Still, I am going to watch alertly -- and suggest you do the same -- for the following to possibly occur on the daily S&P chart the week of May 12th:

• One or more dojis
• A negative engulfing candle
• An inability to close above 940 by Wednesday, May 14th.

A key support level for the S&P is 920. Below that is the support of this past week, 910, where the trendline intersects, and 900, the psychological support level. A close above 940 would be most welcome, although I think the index would then encounter resistance at 950 and 965. I give the S&P no more than a 10% chance of breaking 965 at this time.

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3.  THE SHORT-TERM TREND

The week of May 5th witnessed a range-bound S&P 500 with support at 920 and resistance at 940.

On Monday, May 5th, the average traded sideways within about a nine-point range from 925 to 934.

Tuesday saw a brief-lived uptrend that took the index off support at 925 to a peak near the close of trading just a tad below 940. At this level, it went outside the Bollinger band and then left a long upper shadow.

By early Wednesday the average had retreated to just above support at 925. It then rallied, hit resistance in the upper 930's and fell sharply.

Thursday saw an early decline. The S&P found support at 920 and then drifted sideways for the last part of the day.

Friday's better than 13-point rally brought the average back into positive territory for the week, up a miniscule three points. As the week ended, the S&P was again confronting hourly resistance in the high 930's and then at 940.

Hourly momentum, like daily momentum, is just barely positive. MACD is on a weak buy signal and stochastics are just becoming overbought. The 20- and 30-hour moving averages are flat.

An upside penetration of 940 and a downside penetration of 920 should provoke strong trending action.

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4.  TRADING IMPLICATIONS

Trading ranges are typically resolved sooner rather than later. By mid-week this coming week I expect the market to have made up its mind.

Several of our recent recommended long positions are already starting to show nice profits and I have tightened trailing stop losses to protect these gains if the market does break 920.

My goal in running visual scans this week was to find stocks that are strongly underperforming or outperforming the averages. In my Mid-Week Update on Wednesday May 7th, I recommended shorting AT&T (T) at the open on Thursday and put a limit on the trade of $16.20. Because of a brokerage downgrade, the stock gapped down to $16.02, well below our limit, and the trade was not executed. I've analyzed AT&T (T) in great detail in our INSIDE THE BLACK BOX section of this newsletter (see below), where I have used it to illustrate area versus breakaway gaps. I am going to try this short trade again on Monday, May 12th.

Dell Computer (DELL) is acting very well. The company had a strong week, breaking through and then holding above the key $30 level. I like it from a long viewpoint.

Meanwhile, AOL Time Warner (AOL) has been weakening for the past several days, providing us with an opportunity to sell short. It closed Friday at $13.02. While there is some support at $12, it seems likely the shares will not hold there if the market weakens.

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5.  PICKS OF THE WEEK

SELL SHORT:  AT&T (T, $16.51)
EXECUTE AT OPENING:  MONDAY, MAY 12th, 2003 (order good for the day)
LIMIT:  $16.20
TARGET PRICE:  $13.50
STOP LOSS:  $17.55

I gave a thorough analysis of AT&T in my Mid-Week Update on Wednesday May 7th. I will also discuss the stock intensively in our INSIDE THE BLACK BOX section of this newsletter (see article #8 below).

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SELL SHORT:  AOL Time Warner (AOL, $13.02)
EXECUTE AT OPENING:  MONDAY, MAY 12th, 2003 (order good for the day)
LIMIT:  $12.85
TARGET PRICE:  $10.85
STOP LOSS:  $14.25

AOL has underperformed the market over the last several weeks. After bottoming just under $10 in mid-February, the stock had a nice recovery, moving in a stair-step fashion first to resistance at $12 and then to $14.

At $14, AOL was overbought, closing for one day outside the Bollinger band. At the same time, RSI was over 70 and stochastics over 80.

Since then the shares have drifted steadily lower. While the market was up slightly last week, AOL closed down approximately 60 cents, or about -4.5%.

The Rate of Change indicator is falling very sharply. Daily MACD has given a sell signal. Stochastics is heading sharply lower, but has not come close to the overbought level of 20. RSI has declined sharply and is trending down. It is just about at the technically important 50 level. On Balance Volume has formed an "M" top and has broken below its moving average. The stock, after briefly outperforming the market, has weakened against it as shown by price relative to the S&P.

AOL has some support at $12, which served as resistance during the mid-March through early-April time frame. The daily Bollinger band is also at that level. If the overall market sells off, however, then I'm not sure that support will hold. I've set a target of $10.85, which marks the next level of support if AOL does break below $12.00. As the trade evolves, I'll adjust this target price if necessary.

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BUY:  DELL COMPUTER (DELL, $31.09)
EXECUTE AT OPENING:  MONDAY, MAY 12th, 2003 (order good for the day)
LIMIT:  $31.45
TARGET PRICE:  $34.50
STOP LOSS:  $29.35

Dell has broken out of a six-month inverted head and shoulders pattern going back to November. The measuring principle states that the stock should hit an eventual target of approximately $37.00 a share.

Since its bottom in early February at $22.59, Dell has been in a strong uptrend. Starting in early March, the stock has been holding above the rising 20-day moving average, which is the midpoint of the Bollinger band. This is a sign of great technical strength. The stock is above its rising four-day moving average, which is above the nine-day, which is in turn above the 20-day -- a bullish signature. On Balance Voume is breaking out to new highs, confirming the move.

Dell broke through the psychologically important $30 mark on Tuesday, May 6th. Volume on the day of the breakout was almost 40 million shares -- roughly double the normal average daily volume. Strong volume on the day of the breakout is a bullish sign, suggesting buyers are willing to pay up to acquire the stock. On Thursday, May 8th, the stock retreated to, but did not pierce, the $30 level, suggesting that previous resistance had become new support.

Despite the strong advance, Dell is not yet overbought. RSI is, however, approaching 70 and I will watch that carefully. Although I'm projecting an eventual target in the high-$30s, I will play for a smaller gain and have set our target at $34.50.

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6.  UPDATE ON PREVIOUS TRADES

Stock:  Avon Products (AVP, $57.09)
Position:  Long
Entry Price:  $56.40
Target:  $61.50
Stop Loss:  Revised to $56.60
Return:  +1.2%

I am not happy with Avon's technical action. The follow-through on its breakout should have been strong, but instead the stock is moving sideways. I am raising our trailing stop to $56.60 -- just below the recent support level on the hourly chart. If this stop is hit, then we will exit the trade essentially at breakeven.

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Stock:  Halliburton (HAL, $23.70)
Position:  Long
Entry Price:  $21.74
Target:  $24.95
Stop Loss:  Revised to $22.95
Return:  +9.0%

Halliburton broke out beyond the key $22 level, but did so on less-than-exceptional weekly volume. The last two daily candles have been a bearish doji and hangman. If the S&P can rally back toward 940, then HAL should overcome short-term resistance at $24 and move toward our $24.95 target. If the market weakens, however, then HAL could become vulnerable. I've raised our stop to $22.95. $23 represents good support on the hourly chart. Even if the stop is hit, we will still exit this position with a nice profit.

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Stock:  General Electric (GE, $29.00)
Position:  Long
Entry Price:  $28.35
Target:  $31.95
Stop Loss:  Revised to $27.40
Return:  +2.3%

GE appears to have broken out of a multi-month base completed above $28.00. It is finding resistance just below $30. I think it should have good support near $28.00, and that will give our position room. I am raising the stop to $27.40, which should allow for market weakness.

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Stock:  Business Objects (BOBJ, $22.51)
Position:  Long
Entry Price:  $20.61
Target:  $24.85
Stop Loss:  Revised to $21.85 in our Mid-Week Update on May 7th
Return:  +9.2%

BOBJ traded close to $24 early in the week of May 5th and then succumbed to profit taking. In our Mid-Week Update on May 7th I raised the stop to $21.85. The $22 level should provide support, but if the stock breaks that I want to exit quickly. If the stop is hit, we will still exit with a good profit.

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Stock:  Biolase Technology (BLTI, $11.05)
Position:  Long
Entry Price:  $11.50
Target:  $14.50
Stop Loss:  $10.80
Return:  -6.1%

Biolase was hit with a lawsuit based on patent ownership late in the week of May 5th. On Thursday, May 8th, the stock gapped sharply down and took out our stop loss at $10.80, plummeting all the way to $10.26 before recovering. While overbought, the chart still looks great and the company's fundamental story is intact. I will put this stock in our watch list and will seek another buying opportunity in the coming weeks.

THIS TRADE IS NOW CLOSED

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Stock:  Nextel Communications (NXTL, $13.26)
Position:  Long
Entry Price:  $14.85
Target:  $17.95
Stop Loss:  Revised to $13.85
Return:  -7.0%

Nextel was hit with two separate analyst downgrades the week of May 5th. The stock retreated below its breakout level, hit our stop, and then headed even lower.

THIS TRADE IS NOW CLOSED

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Stock:  Cisco Systems (CSCO, $15.95)
Position:  Long
Entry Price:  $15.71
Target:  $17.95
Stop Loss:  $14.35
Return:  +1.5%

We entered CSCO through a buy on stop order. After the firm announced earnings mid-week, the stock sold off because sales were lower than expected. CSCO has since recovered and closed very close to its high for the day on Friday, May 9th. The chart pattern looks positive. I am holding my stop loss steady. A close above $16 would be highly bullish.

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7.  STOCKS TO WATCH IN THE COMING WEEK

Long candidates:
Many of the long candidates on our watch list have gone into consolidation patterns. I'm going to prune this list this week and will add stocks that are currently more exciting. Many of the pruned stocks I will continue to watch personally.

QUICKSILVER (ZQK, $17.15) -- ZQK split 2:1 on May 9th. It doesn't seem to be giving us a good entry level, so I've decided to take the stock off our watch list.

FLUOR (FLR, $34.10) -- I am looking for an entry point close to the $30 level. The stock appears to be weakening. $30 is certainly possible on market weakness.

3M (MMM, $122.81) -- MMM has retreated back into its base under $130. The stock is consolidating after several brokerage downgrades. I am taking it off our watch list.

OMNIVISION (OVTI, $28.64) -- OVTI continues to move strongly, but is getting very extended technically. I have decided to take it off our watch list.

ADOBE (ADBE, $36.55) -- Adobe has pulled back from its highs. I will be more interested in trading this one from the long side in the mid- to low-$30s, which is where it has more support.

MCDONALD'S (MCD, $17.58) -- MCD closed at $17.58 and formed a long-legged doji on the week, a very bearish candle. There is good support at around $15, which would be a more attractive entry point.

CONTINENTAL AIRLINES (CAL, $11.29) -- CAL broke out of a multi-month base above $10 on Friday, May 2nd and did so on enormous volume and with a breakaway gap. It is very overbought and I would like a pullback to around $10 for an ideal entry point.

PERKINELMER (PKI, $11.09) -- PerkinElmer completed a multi-month inverted cup and handle pattern in late April. The chart is intriguing. The cup was completed at just above $9, but I don't think PKI will pull back that far. The $10 level might provide an interesting entry point.

BIOLASE TECHNOLOGY (BLTI, $11.05) -- I would like to pick BLTI up on a pullback caused perhaps by general market weakness, but I'm not sure if the stock will cooperate. It is worth watching very carefully. I have a feeling this stock will be a big winner in 2003.

Short Candidates:
Readers should generally be cautious when shorting as long as the S&P closes above 910. Still, I am tracking the stocks below as possible short candidates if we hit a top in the week of May 12th.

CLEAR CHANNEL COMMUNICATIONS (CCU, $39.60) -- CCU trades in a very volatile range between about $32 and $40. There is very strong resistance at $40. I am close to pulling the trigger on CCU, but there is not enough weakness to short it yet.

LENNAR (LEN, $58.30) -- Lennar is close to a breakout level. Split adjusted it is trading above $64. If it can close above $65, then I will no longer consider it as a short, despite the pronounced momentum divergence.

BMC SOFTWARE (BMC, $15.35) -- BMC is in a descending triangle. Support is approximately at $14.50. A breakdown through this level should send the shares sharply lower.

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8.  INSIDE THE BLACK BOX:  TECHNICAL ANALYSIS MADE CLEAR AND SIMPLE

GAPS

Several of the trades I have recommended in the StreetAuthority Swing Trader involve the analysis of gaps. A gap is a "hole" in the chart -- a space or a vacuum that is empty, at least temporarily, of price action. When I teach seminars I find that traders are often very confused about gaps and generally assess them too mechanically.

Someone will usually make the point that "all gaps are eventually filled, aren't they?" The answer to this is a resounding "No," as all gaps are not filled. The purpose of this week's installment of INSIDE THE BLACK BOX is to dispel some misconceptions about gaps. In today's issue I will write on two of the gaps associated with the western perspective on gap analysis -- the "common" gap and the "breakaway" gap. Next week, I will discuss the "runaway" gap and the "exhaustion" gap and will introduce the treatment of gaps from a Japanese candlestick perspective. Finally, in the following week I will explore the Japanese perspective in detail and will synthesize key swing trading principles by combining both western and eastern gap trading techniques. I have not encountered any technical theory attempting this synthesis in any of the volumes of books and web sites I have read.

First, what causes a hole or gap in a chart? There are several reasons why a gap might appear in the graph of an individual stock. One of the most common causes of a gap is an earnings release that is above or below Wall Street's expectations. Closely related is an upgrade or downgrade by analysts in the stock. In addition, a product announcement or other major news item will often create a gap. A major overnight move in the S&P futures can create in many individual issues a move that is not related to any specific news about the stock. Small gaps can also occur for a variety of reasons -- a stock going ex-dividend, for instance, can create a gap.

The daily chart reflects the price action of a stock within the market's normal trading hours -- 9:30 AM to 4:00 PM Eastern time. Many stocks, however, trade in the pre-opening and after-hours markets. A stock that has had an after-hours earnings announcement or an analyst upgrade will often trade at a dramatically different price from the "official" close at the end of the previous trading day (this is the figure you'll see printed in this newsletter or recorded on the Internet). When the stock opens in normal hours the next morning, this price movement will be reflected on the chart.

An up gap is created on the daily chart when the high of day one is lower than the low of day two. A down gap is created when the low of day one is higher than the high of day two. The larger the gap, the more significant is the message about supply and demand. A downside price gap of several dollars, particularly when it is associated with high volume, reflects urgent selling. An upside price gap of several dollars, particularly when it is associated with high volume, represents urgent buying. This sense of urgency is seldom played out in a single trading session.

Western technical analysis distinguishes four main types of gaps. These kinds are the "common" or "area" gap, the "breakaway" gap, the "runaway" gap and the "exhaustion" gap. As an astute swing trader, as soon as you spot a gap on a chart you should immediately ask yourself which type of gap it is.

In this week's INSIDE THE BLACK BOX I will focus on the contrast between a "common" gap and a "breakaway" gap. For both of these discussions I will use AT&T (T) as an example.

A "common" gap occurs within a specific trading range or price congestion pattern. If a stock is in a triangle or a rectangle, then one can expect these gaps to occur periodically.

The alert swing trader can use a "common" gap to spot a short-term trading opportunity. Since the stock is within a trading range, it is likely that prices will eventually trade back into the gap. These are the kinds of gaps that conform to the popular wisdom about gaps being filled. You can see an example of a very small common gap in the AT&T chart during January 2003. For better visibility, I have presented a blow-up of the time period the gap occurred.

In contrast to a "common" gap, which occurs within a price pattern, a "breakaway" gap completes a price pattern such as a rectangle or a triangle. A good example of a downside "breakaway" gap is also found in the AT&T chart.

Between November 2002 and January 2003, the stock traded in a near rectangle formation with resistance near $29 and support just above $25. With the release of fourth-quarter earnings in mid-January, the stock plummeted. Although the candle is hard to read, AT&T opened the day just over $22, declined to slightly under $20, and then rallied on the day to close just over $20. The breakaway gap interpretation was certainly reinforced by the enormous volume on that day. Whereas average daily volume had been under 10 million shares, the day of the breakaway gap saw over 50 million shares traded.

For five straight days after the gap, and 12 of the next 14 days, selling pressure persisted. Note that at no time did AT&T even come close to filling the gap between $22 and $25. Instead, it met resistance at $19, consolidated briefly, fell to $15, consolidated briefly, and then hit a low of $13.45 in mid-April.

In mid-April, the second very large gap appeared on the chart, coinciding first with a period of strength in the S&P 500 and with an above-expectations earnings release from AT&T. This time the shares traded more than three times the normal volume at about 30 million shares. Now traders are left to decide whether this gap is a "breakaway" gap that ended AT&T's steep downtrend or it is a huge "common" gap in what will ultimately be a sideways basing formation between $13.45 and just under $17.50.

The jury is still out on whether the latest gap will be a "breakaway" gap that will lead to higher prices, but everything about the chart suggests the opposite to me.

First, AT&T has hit resistance at $17.50, the previous support level. It has not been able to break through that level and has dropped back to the mid-$16 range.

The moving averages are uniformly negative. The 150-day is sloping bearishly down. The four-day is above the nine-day -- a short-term negative signal.

Momentum indicators are flashing sell signals. Stochastics has had a negative crossover after having become overbought. RSI is just about to cross the 50 line. The MACD histogram has steadily deteriorated and MACD is about to resume its downtrend. The stock very briefly outperformed the S&P, but is now slightly underperforming that index.

A key level of analysis for AT&T is the top of the gap, which is at about $15.70. Any trade below that level is likely to lead to a rapid price decline, as it is likely stop losses will be triggered at that point. If my interpretation is correct and this gap is an unusually large gap within a trading range, then it should be filled. That creates a target of around $13.50, the top of the gap. Shorted at say $16, AT&T would provide approximately a +16% return if it filled that gap -- enough to fill a hole in any pocket.

Next week I will continue with "runaway" and "exhaustion" gaps and their swing trading implications.

Good trading in the week ahead!

Dr. Melvin Pasternak
Editor
The StreetAuthority Swing Trader

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