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Trading the Dow

Please note: This study assumes you have a studied the two following books.(i) Charting the Stock Market: The Wyckoff Method by Jack K. Hutson(ii) Point & Figure Charting: The Essential Application for Forecasting and

Tracking Market Prices by Thomas J. Dorsey

To fully master Dow Projections you will need very good command of the construction and operation of Point & Figure charts at your fingertips. You will find details of both books in our recommended reading list on www.oexoptions.com.

It makes no sense for us to repeat the work of these two authors here and with good understanding of the information provided by them, you will readily absorb all that follows.

We advise the best way to work with this presentation is to take the overall understanding from it. Read it many times and draw your own notes from it. Then watch our Dow Projections in the Daily Pre-market Alert. Find these points on the charts yourself. Note the Signal Bias – the count-strength for the day and also the intraday pivot/support/resistance points (which are intraday sub-sets of the major S/R points you see on the charts).

None of these elements stand alone. They all work together to give you the snap-shot you need of “today’s” moves – which is what you are trading.

Summary Overview

The following bullet points are the skeleton of how we trade:

• The Dow Jones Industrial Average (DJIA or $INDU) rises and falls in identifiable cycles of approximately 21 days duration. This is 21 days

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duration from a Dow high to a Dow low, and a separate 21 days duration from a low back to a high.

• These cycles take place throughout a Bull Market general uptrend for the market and a Bear Market general downtrend.

• These high and low points are not the same for each cycle but could easily be. The 21 day cycle merely identifies that there is a trend downwards from a point to a lower point followed by a trend upwards to another higher point which could be higher or lower or the same from which it fell.

• The 21 day downtrend and 21 day uptrend are not 21 straight days of fall and 21 days of rise. In either trend direction there will be fluctuations so that a down trend can be seen as a series of falls and rise recovery giving “Up days” as well as “Down days” but approximately 21 days from the start of the downtrend the Dow will be trading significantly lower. The opposite applies for the uptrend.

• These “Up” and “Down” days can also be seen to be cyclic in nature. That is that these “Up” and “Down” days can have “runs” of generally no longer than 5 days. i.e. if the Dow is seen to be trading up starting “today” within no more that 5 days it will be seen to be trading down – despite the overall trend up of a Bull Market or overall downtrend of a Bear Market.

• On these “Up” days of the Dow we trade Calls on the OEX. On the “Down” days of the Dow we trade Puts on the OEX.

Objectives

If we are to embark on any study with a view to applying the information we gather during the study we should have objectives. What we are doing and what we are doing it for? In studying the movements of the Dow our objectives are to estimate:

A. Direction: what direction is the market heading at any one time? B. Levels: at what levels will it stop and reverse direction? C. Time: how long will it take to reach these levels from where it is now?

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Why study the Dow when we are trading the OEX?

We use the Dow as our measured Index because it has more weight in the economy. The Dow is taken as a piece of data showing the state or health of the economy and thus leads the market. There is much more detail shown and published for the Dow than other indices. As a small example, many online broker services do not show volume traded on the OEX but they all show volume for the Dow. Therefore we know that by studying the Dow we are also studying other major indices for their trading patterns and movements.

While there is no direct equivalent correlation between the trading position (price) of the Dow and that of the OEX , e.g. it is not possible to say that if the Dow is trading at 13450 that the OEX will be at, say, 695, the OEX directly tracks the trading patterns of the Dow, see Figs. 3 & 4.

Fig. 3. Daily Price moves of the Dow Jones Industrial Average

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Fig. 4. Daily price movements of the OEX, identically tracking the pattern of the DJIA shown in Fig 1.

We use this direct tracking relationship to know that when the Dow turns – up or down – the OEX will turn in the same way at the same time. We can always know where the Dow is NOW and where the OEX is NOW. If we can evaluate, with a high degree of confidence, in which direction in the very near future the Dow will move, and to which level, we are then in a position to assess the turning points of the OEX and also its possible range of travel. We then trade these OEX turning points.

For example, let us say that the Dow is trading “now” at 12850, with the OEX at 660 (18th August in Figs 3 & 4) and we project a continuing steady rise in the Dow, in stages over the next approximate 21 days to say 13800. We would know that the OEX will rise in the same manner. As you will see later, we do not need to care what that exact OEX value will reach as we do not select the exact OEX strike price options which we trade from these projections. We can, however, “feel” that should the Dow reach that projected level the OEX will not have reached, say 850 and that selecting such a strike price option would be an unreasonable trade and certain to produce loss.

This gives us our framework for selecting the OEX option to trade. If we can see that the Dow is likely to move up 950 points in our example above we can simply trade the OEX “up” from its position now.

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Evaluating where the Dow will reach gives us our “bounds of reason,” our outer limits – Resistance and Support where the prevailing trend can be expected to falter, hesitate, test to move through or reverse - but, as stated earlier, there will be fluctuations along the way which we intend to trade. For the moment we are concentrating on our first two major objectives from above (a) what direction the market is heading? (b) at what levels will it stop and reverse direction?

Setting the Scene

First, a word of guidance: In studying the Dow Projections we use them as the building blocks of our trading. These projections translate the mood of the stock market.

It is precisely because the stock market is an ever changing and almost fluid environment that makes describing its operation on a daily basis an extremely difficult task. If you can think of cycles within cycles or perhaps more accurately expressed, trends within trends, then you will immediately see the difficulty of expressing the “operation.”

Stock market psychology is a subject for a complete book in itself but we should bear in mind that we are in fact trading the mood and sentiment of the major influencers in the economy – let us call that “Big Money.” No-one explained this better than Wyckoff, as précised in Hutson’s book. As they say in poker, “you do not play the cards, you play your opponent.” Big Money cannot be moved without leaving evidence and it relies on most people not looking. Our task as astute traders is to train ourselves to look and then ride piggy back on the moves. Studying the projections helps us interpret this mood to see the turning points in its ebbs and flows.

Read our article on “Wyckoff, The Composite Man” in conjunction with Hutson and you will see the Dow and the OEX as the “composite” described by Wyckoff. Since the Dow, and then by default, the OEX, feature the leaders in the range of business sectors they are the “basket of stocks” as defined by Wyckoff. Trading these two indices is trading a ready made basket of stocks.

As such, we do not actually make a trade selection against the projections of the Dow. We use the projections as temporary, coarse detail, limits of the direction (up or down) which we are going to trade. As very short-term “fruit stall” traders (as distinct from longer-term investors), we need to fine tune within these limits to make profit and avoid loss. The finesse of trading for profit within these limits is a separate topic but this study is devoted to

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calculating and understanding our temporary and changing trading limits – the Dow Projections.

In “travelling” from one Dow Projection point to another there will be the long-term overall trend deriving from the type of market prevailing, Bull or Bear, e.g. the Dow rising from 10500 in mid-2006 to over 14000 in 2007 – Bull Market. Also there will be far shorter-term fluctuations with higher highs and higher lows along the way. The Dow will trend up and down in accordance with cycles of approximately similar duration - generally 21 days.

These 21 day cycles act as barometers for us, are we seeing a dull patch in a bright summer (bull market) are seeing a patch of clear skies in a dull winter (bear market)? They help us define where the Dow will move to over the next 21 days where it will almost certainly meet resistance, albeit temporary, in a bull market and support in bear markets, again, albeit temporary support. This phenomenon of the market forms our Dow Projections

As we stated in our opening summary, these 21 day moves will also not be straight climbs or falls but will themselves be subject to fluctuations, ebbs and flows of highs and lows to reach these areas of resistance of support. It is these shorter-term fluctuations (generally no longer than 5 day duration) within the 21 day cycles which we trade on the OEX. In other words, in any Bull Market there are up and down cycles within it. In any Bear Market there are similarly up and down cycles within it. An investor wants to buy at the start of a bull market and hold until the peak of it and sell just as the bear market starts. A trader simply wants to sell higher than he bought and ideally in as short a time as possible. We are thus less interested in (to indifferent to) whether the market is bull or bear.

We use the Dow Projections to interpret the mood on a daily basis, the temporary mood swings, and to set our limits to the cyclic trends evident in either type of market.

See Fig 1 and Fig 2. These two illustrations are to show fluctuations in a trend. They are not presented here for the reader to count 21 days of up trend followed by 21 days of down trend. They simply show fluctuations within trends.

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Fig 1. Fluctuations down and up in an overall trend up (Bull Market)

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Fig 2. Closer detail of fluctuations of the overall bull market shown in Fig1 above.

Up and Down Days – the basis of our 4 day stop loss method.

In our introduction we presented the notion of trends within trends. In this section so far we have presented approximately 21 day up and down cycles in any long-term market condition such as bull or bear market. However, let us now introduce the notion that the market extremely rarely moves in any single direction for more than 5 days. This is the basis of a move from trading Calls to Puts or vice versa.

Charts and Indicators

What tools are we going to use?

The Dow Projections are in fact Support and Resistance points in index price level as can be found on any stock chart. There are three major types of trading charts in popular use offered by most charting software or online broker - bar, line, and candlestick. Those same “packages” will then provide almost limitless indicators to place onto the charts to “assist” the user in interpreting them. This speaks more for the inadequacy of the chart to provide

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what you really want to know and about the marketing pitches of the software vendors than anything else.

There is a fourth type of indicator methodology= Point and Figure Charting (PnF); Invented by Charles Dow in 1880. This is the only form of chart we use. We cannot extol the virtues of PnF charting more eloquently than Thomas Dorsey in his book Point and Figure Charting, supported in Hutson’s book as it was also the key tool used by Richard D. Wyckoff, the famed trader of the 1920’s that focused a version of “PnF” as his core methodology.

Having said that, some of the early Figs. used in this document show candlestick charts but these are for illustration and example only. The charts we use for our calculations are strictly PnF.

The common theme to all charts is Support and Resistance lines. Standard “chartists” select obvious and clear support and resistance lines from stock charts using bar or candlestick charts then trade long and short accordingly. Many do this very successfully, you can read book after book and follow training course after training course to follow the plethora of techniques.

Generally speaking however, how soon the trade needs to come to profit is not important in such trading style. Quite correctly if a stock trader, or even options traders of longer-terms, can sell for more than they bought, the time, within reason, for this trade to make a profit is irrelevant. Such traders are indeed quite happy for the price of their purchase to fluctuate up and down to reach their profit goal. Provided a trade does not lose value sufficiently to trigger their stop-loss orders and the trade increases in value above their buy price they are achieving their objective even if it takes months.

We too use charts, PnF, to show the support and resistance lines to trade within. The prices of our trades will also fluctuate but because we are trading the single vehicle of current month index options, and day trading at that, we are in fact trading against the clock. In terms of income we want to do exactly as the longer-term trader or investor does; we want to buy low and sell higher, we just simply want to (and, forced by time constraint, need to) do it more quickly – time is ticking on every trade we make. It will be important to bear in mind that the closer our option is to expiry the faster and further the underlying needs to move in our required direction to overcome loss of time value.

Further, we use our Dow projections as the first indicators, and then calculate support and resistance during the market day using our calculation models of H

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(high), L (low), O (open) and C (Close) to fine tune the exact support and resistance lines.

It is worth pressing this point at this stage. While we recommend that you study Dorsey’s book in order to fully master the structure of the charts, we use them in a distinctly different way from traditional PnF when it comes to buy and sell signals and price objectives.

Almost all descriptions of the use of PnF are relevant to stock trading or longer-term options based on the moves of the stock. Used in such an application the PnF can show, say, a buy signal for XYZ stock. It can show a projected price target to sell at. The trader can wait for the sell signal to appear (happy to give some of his profits back in order for that signal to appear which by default will be at least 3 points). How long he then waits for the sell signal after the buy does not need to feature. Stock purchases are not against the clock. The price may have wobbled or fluctuated several times on say a move up (up days and down days) between his buy and his sell points but it is not his objective to capture profits on these interim moves. His objective is to sell higher than he bought and to catch as close to his top sell as he can. His PnF chart may well show him that he is in loss at some point while he holds the stock but if a sell signal is not given, and his stop-loss has not been triggered, it is still all right for him to hold the stock and hold out for the sell signal in order to maximize his profits.

In trading OEX index options based on moves of the Dow we want to capture and trade the fluctuations and we use the PnF (interpretations) to show us the outer limits of the fluctuations. So we use "turning points" - hesitation points - tests of support and resistance levels of the Dow (both pivots and peaks/troughs) to switch from Calls to Puts and need to be quick about it because we are on the clock. We could actually trade the OEX based on PnF chart buy/sell signals of the Dow exactly as Dorsey trades stocks if we bought options several months out to remove our concern of time. Of course we would also need to be able to not care about the huge cost of such options nor care about the scary swings in price difference while we waited for our sell signals. So, trading front month index options we use PnF charts to show our outer limits for our 21 day cycles but we actually trade the price fluctuations which occur within these cycles – fluctuations which occur daily, hourly or, in some cases, within minutes.

This fine detail does not show on charts and we use a combination of two other mechanisms to fine tune. These are “The Daily Count and Daily Pivot Points” – see below.

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When the price of our trade fluctuates we want to trade those fluctuations, buying low, selling higher, to capture profit as it is available and not simply wait for the price to be higher “in the end.” Our objective is to sell very quickly after buying, in general, as soon as we see profit.

Projecting the Dow

What are Dow Projections? Support and Resistance lines; that’s it. We could actually trade the Dow without projecting. We could simply work to support and resistance lines. At support lines the market will move up and at resistance it will move down right? The shortcoming with that is that charts are full of support and resistance lines. Don’t forget the 21 day cycles are moves in stages and thus exhibit S/R lines throughout and also the market not moving in just one direction – to call or put – for more than 4 to 5 days will also exhibit S/R.

Thus, most of them will be weak and not actual market reverse points. So which support would you choose to buy at with confidence? Is it strong enough not to fall further after you buy? Which resistance would you hold through to maximize profits at a stronger resistance above? The Dow Projections build experience of past trading behavior into today’s expectations to help us evaluate the strength of the S/R lines.

The most uncertain and uncharted area of the cycles is the initial rise after the fall. We could just wait for the market to come up off the bottom and start finding former S/R levels which the market will find in the up cycle. The drawback with that is that we waste valuable trading opportunity from the bottom of the upside until these former lines are reached which could take 100s of point of move up.

We want to know where the bottom is so that we can pick out the hesitation points on the way up. Our calculations are mostly about that. Once we have the ball rolling on the way up we can use former S/R lines as they begin to be reached.

In projecting the Dow we study what has gone before. What has happened before will happen again, the sequence and the timing of it may change but as most elements of the stock market are pretty much fixed – number of companies, quantity of stocks on the market, same trading players - repeats of the past are also pretty much guaranteed.

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This provides us with the facts. We study these facts to give us the skeleton and then apply our intuition to fine tune these observations. Intuition is based on experience and thus once you have the mechanics in place you will need to build up your experience in applying them.

Our main source of information is the PnF chart facility of www.stockcharts.com. Before embarking on calculation of the projections, be fully conversant with how the charts are created, understand how to read them and in particular find all resistance and support lines.

Start by watching the drops in the market

We start by arming ourselves with information from the preceding trading year. This will give us a decent feeling of what emotions in traders in the past have allowed the market to do. This will change from year to year but as we are writing this in July 2008 we will refer to details from all of 2007. It is quite quick and very easy. On the stockcharts website, set up your PnF chart for the DJIA – Ticker for this on stockcharts is $INDU. From this PnF charts webpage you can collect Historical Data as shown – you need to be a subscriber – this facility allows you to download high/low details for periods you specify – select all of the previous year and whatever you can of the year you are in.

You will recall that the downward 21 day cycle falls in steps or works its way down in stages – we refer to the fall from the top of the cycle to the bottom, where the down turns to up as “the cyclic downturn.” – again the reminder, as you see numbers coming up below please do not take them to be taken as exact numbers any more than the 21 day approximation.

The information you want from this historic detail is the “feel” from these downturns: So, counting from highest high to lowest low find:

A. The ten largest one-day drops – then take the average. For 2007 it was 326 to 340 points.

B. Note the larger one day drops of these 10 – in 2007 you will see that they were over 600 points – averaged down to 326 by one day drops far less although they are still in the top 10

C. The very top large one-day falls tend to be larger than the entire cyclical downturn.

So, here you have your framework for the size of the down cycle. In this example from July 2008 the maximum cyclic downturn is a bit below 600 – to

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keep this approximation check as close as possible you can do this exercise every couple of weeks to refine the anticipated size of the cyclical downturn. In 2007, for example, the cyclical downturn averaged 584 points in totality.

When we now see that the market has fallen in the order of 600 points we know that we are approaching the bottom of the cyclic downturn. If we have reached 550, 600, 650 we still do not know that we have reached the bottom but we know it is close and we will be incorporating other references. The use of the 21 day cycle gives us our framework - See the article on our website “Watching Drops in the Market”.

Verifying the Dow Bottoms

So how do we know that we have reached the bottom of this cyclic downturn?

Our first true confirmation comes from when the Dow has moved up 100 at least and held. What do we mean by held? This is that the Dow has closed 100 points or more above the low of that day and that trading the subsequent day supports that move up by continuing it.

This move up will be characterized by the following type of framework of testing it:

A. The move up will be over 100 points and hold – pay attention to this. A move up less than 100 cannot yet ready to be trusted as reversal – thus full bottom OR the bottom has been reached but may yet be tested again before reversal is assured. This will become especially important if this is occurring close to current month expiry date. This testing may take another couple of days and in late days before expiry time erosion can erase moves in intrinsic value. The move may well be coming but ensure that time is not of the essence by moving to next month issue Call if this is taking place with less than 10 days to expiry.

B. The reliable move up will be over 100 points minimum. During this total move, but above the 100, expect some retracement of up to 50% - e.g. If this total burst up is 130 points off the last lowest low, the Dow will retrace approx. 65 points. This retracement takes the form of whipsaw during the day’s trading, swings up and down in the same day.

Example: 12540 bottom. First move up = 130.

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12540 plus 130 = 12670 subtract (130/2). The Dow retraces to 12605

Expect this retracement. Do NOT enter a call simply on the 100 plus point move, it is certain to retrace quickly, possibly next day. The entry to the Call would be at the 12605 level

This is bottom and reliably bottom because the Dow has moved up from it and test it in one of its two forms of test.

At this stage it is worth pausing and re-reading Hutson describing “accumulation” by the big players as taught by Wyckoff. This “uncertainty” and “hesitation” at the bottom area is often due to accumulation in preparation for large moves up in price. This area here is prone to sitting in a trading range. Your visibility of the overall 21 days downturn obtained from B above (Start by watching the drops in the market) which lets you know that you are in the area of bottom and provide you with patience for the turn.

Now we are in a position to calculate up.

Calculating the Dow upwards

Please bear the following in mind as you follow the example below:

We use averages in order to gain the “magnitude” of the moves – this helps us guesstimate when a drop in the market is due and approximately what the first move up will be. This helps assist us from being too optimistic. The size of the one day drop will vary and the more out of date the calculation of the average the less accurate the estimation of the first move up. E.g. If it is July 2008 and your average one-day drop figure is based 2007 data for drops only, you can expect to be less accurate in you first move up calculation than if you took the one-day drop average from, say, January 2007 and included one-day drop figures up until the day you are calculating, your “today”.

Therefore the calculations below are an example based on 2007 one-day drop figures. The value of 100 point we do use as a sound indicator minimum, moves less than this are not reliable. The move of 100 is a measure of intent by the market. Indecision does not usually extend this far up and hold. However, this first burst up is likely to be 100 plus half the average fall – Fibonacci effects seemingly play a part in this. In our example here, the average one-day drop is 326-340, let’s use 340, so our initial burst up will be a minimum of 100 (less

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than this not trusted as reliable) plus an additional 170 (half 340) so a total of 270.

However, the important figure in this is the 100 minimum to show intent of the market, the additional move up (half the initial drop) may or may not take place depending on economy conditions. What we are watching for is sound indications that the drop has completed and upside has begun. Other than the sound intention signal the market gives by the minimum and holding 100 points move up, all other figures are indications and not exact guaranteed calculations.

In our example we are able to have confidence in taking entry to the Call, whipsaw is coming to an end and bottom has likely been tested twice or more. It is our task to estimate where the Dow is likely to move to in its first move to the top of its up cycle.

Please note:

A. The move up will be similar to the move down – 21 days of overall gain but with steps, hesitations and slight retracements along the way.

B. Due to the way the bottom formed and approximations of timing the trip back through 21 days (approx.) to a Dow top will not necessarily, almost certainly not, return it to the point from which the downside began. It is this feature which keeps the market fluid and looking completely bafflingly unstructured to those who do not study the intricacies – i.e. most players in it; an element which the big players driving it rely heavily upon for their profit. It is also this feature which adds approximation to the 21 days cycles – the duration of this accumulation.

You refer now to the data you collected in A above (Start by watching the drops in the market) – here you calculated the average of the top 10 one-day drops. In our example from 2007 we reached a figure of 326 - 340 – you can fine tune this for your point now in the current year i.e. the average for all of the preceding year up to “now”. - or you could work with the actual value of the first day drop of the down cycle. We will use 326 – 340 as the average drop (take 340).

The confirmation that the 21 day cycle is beginning to the upside is a move of 100 points minimum which held. We would anticipate the first stage in the move up to reach (i) the average one-day drop 340 plus (ii) half of that 170 (iii) both added to the bottom reached, 12540 = total 13050.

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This is our projected first top – bear in mind:

This calculated figure is not necessarily going to be “in no man’s land” on the chart. It is highly likely to be near, quite close, to an existing S/R level, all the way back to the beginning of the previous year. If that is the case, this more established S/R is likely to be the level for this new first top depending on how strong it was. If this calculated first stage up is significantly distant from a previous S/R then it will take its own strength. See Continuing Moves up in the 21 day cycle – below. If we could see on a PnF chart that there was support or resistance at say, 13080 we would tend towards that as our first stage Dow top.

Even more strongly, in our case of calculating 13050 we are extremely close to a magic figures of 000s (13000, 12000, 11000) and the market pays homage at these points and thus you will almost always find quite strong S/R here. 13000 then is almost certain to override our 13050 as a first top level.

Price Objectives

We have referred you to Thomas Dorsey’s book, Point and Figure Charting, there are many good books to study on this. Dorsey simply has an easy to follow style. Dorsey’s book gives you an overall flavor of the power of PnF Charting to show supply and demand in action in the stock market.

In such books you will see the technique used for calculating price objectives. Dorsey has a section showing vertical and horizontal counting of the X columns in order to define where a stock price is likely to reach when coming off a bottom. This experience and expertise is not to be criticized but it must be borne in mind that this work is mainly aimed at investors in stocks. Time to maturity in these signals does not feature. Investors simply wish to receive more back than they laid out and will see weeks or even months (depending on the size of the gain) as being relatively quick.

We are trading index options – already different from stocks by the time element and by leverage price movement against us as well as for us – and we compound that risk by trading the current month – we have less time to be right and less time to recover if we get it wrong. A stock investor may, if the worst comes to the worst, just hold and wait. We must sell our fruit quickly before it rots on our hands.

You will note that the price objective estimations as explained by Dorsey, for stocks actually only begin after – and are based on - the retracement we show

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in our example above. The retracement must take place for these calculations to begin forming – this is actually a bit more supporting evidence that this retracement we show as part of the beginning of the first move up will take place.

When trading index options, while that is happening not only are we are losing time within our valuable current month we are also losing trading opportunity. See Fig. below.

These two chart segments show the same period, ending on 2nd May. The point we wish to convey here is that price objectives calculations take no account of time – but which is vital to us - and whilst PnF shows overall supply and demand outer limits we wish to trade many times within those limits.

The Price Objectives calculations performed on www.stockcharts.com are reached in a similar way – click on the link “About Price Objectives” below any PnF charts for an explanation – similar to Dorsey’s.

In above Fig. you see a price objective of 13800 (green figure) given on the PnF chart. The chart also shows a rising trend, so, in seeing such a PnF chart you would not be unreasonable in expecting a higher level to be reached. However we show you below why you can significantly and objectively doubt this Price

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Objective figure and thus not only avoid optimistic expectations – leading to purchase unrealistically high Call options – but also be aware of the Put trade opportunities which will present themselves during this uptrend.

Continuing Moves up in the 21 Day Cycle

We have found our first move off the bottom of the 21 day cycle and have been able to find a good approximation of where it will reach in its first stage move up. The calculation, estimate, which we made, will be modified by any resistance line at approximately that point.

At this point, please note the phenomenon of support becoming resistance. As the Dow moves back up from a bottom it will reach not only former resistance points but also former support lines which may also act as at least temporary resistance. Such a point will act as a slight retracement point to slow the rate of ascension. We recognize these points as threats to the increasing value of Calls and also opportunities to trade Puts.

In this Fig you can see that columns of Xs have stopped their upwards movement at positions determined by the base of previous columns of Os just as equally as at the top of previous columns of Xs. These give clues for

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hesitation points in either direction and will equally apply to hesitations in the down cycle.

You can see from the Fig above and Fig below how suspect the Price Objective of 13800 calculated by www.stockcharts.com must be treated. The fig above shows a chart in 50 point moves, the one below in finer detail at 20 point moves.

All the above is the basics of Projecting the Dow, estimating at what points it will hesitate or change direction.

• We have established when our 21 day cycle is to end to the downside and the Dow level for that.

• We have established the first approximate point it will hesitate on the way to upside and the closer to a previous support or resistance line that calculation is, the more confidence we can have in it.

In both directions up and down, the Dow will hesitate at points, support and resistance lines it has hesitated at before.

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How do we then assess whether the Dow will break through a resistance or support line? Of course so much relies on market conditions and what is happening in the economy generally. Is there stamina in the economy for it to break previous resistance lines for example?

In our charts above, traditional Price Objective calculation methods showed us a potential Price Objective of 13800. Even if this objective is to be reached we can see from the chart above that there will be hesitation at several points on the way to that 13800. That hesitation can result in the market testing that line several times before breaking through or even testing several times and failing, thus turning back. An investor will wish to simply hold through these points hoping his Price Objective will be reached, being disappointed if any market current market conditions add strength to a formerly weak resistance point(s) along the way. Traditional price objective take little notice of them, placing more emphasis on the overall price objective. We on the other hand not only need to be aware of them we even wish to trade these points by either Call or Put as the testing of these points plays out.

The same principle applies on whether a support line will hold.

We do have one more indicator, which can assist before we turn to full intuition of assessing the overall economy. That is intuition, which will take some time to build the experience for but with our Dow Projections and understanding of the Count, following, we are a lot closer to feeling what is highly likely to happen next. From the Dow we now know where to find the direction and recognize that the OEX has reached a limit of that direction. The OEX is the options trading vehicle for the market, it exists as a hedge market to the underlying stock trades thus pricing on the OEX can show us price sentiment and from that we can gauge the strength of the move.

The OEX Count

We will not detail the work on “the count” here. There is the automatic calculator on the website and details of how that works in the manual, so here, we will simply apply it.

The “count,” however, is a simple Bell Curve Analysis utilizing out of the money options as the calculator for “interest and value” that defines the “bias” to the call, or the put, and can be used as general indicators as to profit goals as to how far the market may move in that direction.

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We are using the Dow Projections as outer limits of travel for the Dow. When the Dow has reached a limit in either direction, wherever the OEX is at that moment, it is also at the end of its travel in that direction. This link covers the gap in lack of direct correlation between a specific value of Dow to specific level of OEX. We simply need to know that the OEX has the same pattern as the Dow, calculate the Dow on buy and sell the OEX to those Dow levels.

We use a concept similar to that of Dorsey in assessing overbought and oversold and we use the same terminology – the Bell Curve. In Dorsey’s discussion of the Bell Curve you read of sectors and pricing within them. The OEX is in fact a composite of sectors as defined by Wyckoff and thus the analogy is valid.

The feature of a Bell Curve is the X-axis. In our case we place Zero in the centre with a scale of +1 to +10 to the right to represent high price and the limit of overbought. To the left we have -1 to -10 representing depressed pricing and the limit of oversold – the major elements of supply and demand.

As the Dow trends, let’s say up, price will ebb and flow up and down but in a general uptrend. Despite the trend being overall upwards there will be days of retracement, days we would wish to trade Puts rather than Calls despite the overall trend to up. Recall, again, we are short-term trading within longer-term trends and we wish to trade the short-term ebbs and flows. We have stated that, even in an uptrend, the market very rarely, to almost never, trades in a single direction for more than typically 5 days – the basis of our 4 day stop loss.

This ebb and flow will register in the strength or the bias of the Count. With a Count strength of say 3 to 5 to the Call, we can see that the trend which gives that bias is strong enough to continue a while. Bias above 7 to the Call suggests it is tending to overbought and will in all probability turn very soon. A more neutral count of zero, 1 or 2 suggests indecision – lack of bias. Here, a neutral-ish bias, price will fluctuate, slight whipsaw will occur and fast action 2 way trades are possible. Fast action because this state will pass quickly, possibly within the day until a new short-term (5 days approx) is established.

This lack of bias will occur more strongly and of longer duration, possibly days, at absolute Dow tops and Dow bottoms and the Dow level will whipsaw more strongly in its swing from one direction to the other as the traders who wish to push price up find fewer buyers and are forced down in their asking price. Shortly after, they will try to push up again and perhaps succeed for a few points and so on. At these points the Dow is seen to trade in a tight range even

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alternating in the same trading session. At Dow bottoms this can be seen as accumulation by the big players and market movers by their buying and selling power, at Dow tops this can be seen as distribution.

However, as stated, the Dow only tends to move in a single direction for generally no longer than five days the strength of bias will also change from, say, to the Call, through flat or zero bias to the Put. This will take place several times during the 21 day cycle. The bias will swing from Calls to Puts. We will on occasion state in our alert “we may be a little early on this” in suggesting a move from trading, say, the Call to trading the Put.

This will also be seen in the pivot point calculations for the day – minor support and resistance lines valid within the day only.

At minor resistance lines in an uptrend with a strong bias to the Call that resistance line is likely to be surpassed. Should the bias be weak to the Call or even have shifted to the Put it is likely to hold. This would be time to sell the Call – opposite for Puts.

So, an important question can be asked here for major resistance lines (and opposite for support lines).

Is it possible for the OEX Count bias to be, say, 7 to the Call but then the Dow reverses BEFORE the top projection has been reached? OR is it possible in reverse, the projected high has been reached and the count is still quite neutral say 2 to the Call?

Answer - If the Count is 7, but the projected top (seeing strong resistance on PnF) is very close, it’s likely that’s the end of the count bell curve and is coinciding with the Dow as you would expect. However if the count is 7 and the projected top is still far off, it could mean the Dow will now slow, and reverse and not reach the projections we made based on past data or resistance we see on the chart.

The Count is giving us live leading data. In circumstances such as these where the count is at odds with our projections we would be well advised to give more credence to the count than our expected projections.

Does any of this go wrong?

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The short answer is “Yes.” We are after all trading on the economy, or more accurately on the sentiment of the economy, the perceptions trading institutions and investor institutions have of the market.

During the end of 2007 an almost 10 year run of cheap money, low interest loans was coming to an end. It gave us news of the credit crisis and investors turning to commodities as failing money was causing the financing of manufacturing and finance companies to struggle immensely; seeing even big names in the banking sector going bankrupt. This quickly gave rise to a commodity bubble, led by oil. The economy perceives that if the price of energy is high it affects profits thus it affects investors and thus affects what price stock (and therefore options) can be traded at. The beginning of a Bear Market.

Let us state that the above mechanics and techniques are as valid during a Bear Market as they are during a Bull Market. It is simply that the prices will be lower and the weight of emphasis will be placed on Put trading rather than Call trading and we will be more aware of support lines than resistance lines.

The grey area is in the transition from a Bull to a Bear Market. Optimists will not believe a Bear Market is beginning; Doom Sayers will wail that it is well established and sentiment will swing from one to the other. We saw this affect take place in the latter part of 2007, old lows were touched again in March 2006 but with recovery on both occasions. In June 2008 the Bulls could no longer hide it, the economy was in trouble.

Overall drop had far exceeded the 2007 average and support lines which had held and could be relied on well in the past were collapsing and the stampede effect of this meant others below them would too.

All this led to an (over) extension of the 21 day cycle to the downside. The pattern was broken due to fear and due to indecision. Traders could no longer raise prices at points they had used in the past. Under these circumstances the 21 day cycle would remain in an oversold position with long days of bias to the Put well beyond what had become the norm.

This is not to say all is lost and all is changed forever, the market simply finds a new bottom and the pattern establishes itself at a lower level. Trading institutions still need prices to go up, profit is still required and thus stocks and options will be traded for profit.

Whilst this transition was going on it was still possible to trade profitably, using the Dow Projections and PnF charts. The only difference was that the scope and

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history needed to be widened to find the trading lines – the market has a long memory and will still find its level in the same way.

In the Fig above all major support lines shown were not holding. This chart from July 2008 shows the Dow well below previous support lines marked by red lines, with the lowest at 11650. Once below this 11650, how would one see where the bottom would be and what levels one could trade to on the way down?

Incidentally – a side note here. This chart snap-shot is used here to show failing support lines but as the market is in slight recovery at the moment this snap-shot was taken, there are sufficient moves to trigger a Price Objective from the chart calculator. The Price Objective, green figures in the scale, reads 12850. With all you have just read concerning support and resistance as shown by PNF charts, do you believe the objective of 12850? Given current economy conditions do you see that possible? Can you see the possibility of the strongest lowest support line, 11750, easily becoming potential long-term strong resistance with the possibility that new 21 day cycles establish themselves below this “ceiling”? The food news is that with so many lines of resistance along the way there will be many hesitations and retracements there will be many Call/Put trade opportunities.

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Returning to our question of how to find helpful detail and data on what lies below the chart bottom of 11650 - The answer lies further back in history. When you set up a chart such as this on www.stockcharts.com it is set up by some standard settings. The chart above is a daily chart set to traditional with 50 point scale on 3 box reversal. See what new information and clues you receive by switching to a weekly setting and the end date setting in the chart below. It is the same chart with “weekly” data selected instead of “Daily.”

This chart takes us back from July 2008 to February 2006 – arrow show Januarys. Going further back in time and shows far deeper levels of support - where the market may catch its breath or hold – than the standard chart presented on www.stockcharts.com. Changing the settings provides us with more detail.

Now, in order to see the workings of those older support/resistance lines we can set our chart to show an end date of , say January 2006 and study what was happening through 2006 to give us indications of the moves around S/R points. The market needs this term of reference too. Nothing will be random and the market is ultimately traded by people. People are mostly creatures of habit and will almost always do what they have done before.

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Here, below, is a daily chart showing end date January 2007, i.e. showing from July 2006, very left hand side up to January 2007, very right hand side. Scale is set to 20 point box size, scaling method, User Defined.

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This support lines shown here, summer to autumn 2006, were all used by the market as support attempts in the descent into the Bear Market beginning throughout June 2008.

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Projecting the Dow

There are patterns around the Dow that are useful in all trading that mirrors the Dow, or leads the market. The OEX® perfectly mirrors the Dow in movement, and we use the Dow to know the historical patterns that typically influence market behavior.

Traders will often ask if the OEX, in correlating, can be defined for the best “sell points” based on the Dow projections. They cannot, as the pricing of options is dependent upon FEAR and GREED, and the traders’ reactions to market tops or bottoms.

Even though actual OEX option final sell prices can’t be established, a rough order of where and what will occur can be.

For years, subscribers to both oexoptions.com and bluechipoptions.com have tried to develop formulas for our short term Dow projections, and this is the most asked question we have: “How do you calculate and determine your Dow projections?”

We calculate the Dow both factually, and intuitively. You can do this too.

• The ten largest one-day drops of 2007 have averaged 326 points. If the average one-day drop is 326-350 points, this means that a cyclical downturn may now be averaging just over 600 points. The larger one-day drops tend to mean more than the entire cyclical downturn. Sharp traders can update these numbers constantly to fine-tune the average large drop days.

• Whipsaw begins (two way trades) whenever the market moves 100 points in the opposing direction to the trend, as this shows the bell curve bias (the “count”) may be changing.

• Typically there is large upside burst, a slight retracement, and then upside that averages 170 points up from the lowest downside. The total move up, after the whipsaw begins and confirms, is an upside bias that can average 450 to 580 points.

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• This means that if the market drops 326 points, and then drops further, typically up to the 600 point move just defined, the first true confirmation to the call will be at 100 points up. When the bias is shifting like this, it is likely to then have more upside of 170 points. This can be EITHER a total of 270 points (100 points or 170 points added to 100 points) OR a total of 170 points, all based on market conditions and support and resistance lines.

• Here’s an example of trading using this thinking: As the market completes a drop watch the first upside. Whenever this upside reaches 100 points or greater UP, find the exact number of upside and deduct 50%.

Example: 12,540 bottom. First move up 12,640= 100 points. Subtract 50 points, or a total of 12,590. Using Dow patterns this will be a good place to take first entry to a call.

• Assuming the trader buys at 12,590 (the entry point) we would calculate the first day of the initial drop (the 326 to 350 points) and 170, the average upside. In this case that is 326 + 170 or 496 points. (Remember it can vary to up to 600 points). We would take the 12,540 bottom and add 496 points, or a total of 13,072. Now, knowing that the market struggles at 0000’s (13,000, 12,000, etc) and that market conditions may be filled with “news” we would adjust our Dow top to correlate with key resistance lines. And, that’s part of how we would find a Dow top.

• We also find that we can define a true “phase” or bias beginning when the market makes downward turns of 240 points or greater. Most downturns that do not total 240 points in a several day period will not last. If the moves are 240 points or greater, however, it means the bias is “holding” and more downturn is highly possible.

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Here’s a classic Point and Figure Chart on the Dow where we calculated using a 1:1 view with a .50 increments, using Bollinger Bands, and a 20 day and 50 day simple moving average.In this chart the next support line is 12,400, then 12,350, and then 12,350.The 20 and 50-day simple moving average have both just been violated in this chart. Noting that these have been violated, and that the support lines that show are “minor” (meaning support has not occurred here often before) shows the trader that the bias remains to the downside. However, we are right at the bottom of the Bollinger Bands on this chart, a sign that an upturn might occur after testing this bottom Bollinger Band support line.Next, let’s view the same information a different way. This is the SAME chart, just now with user-defined settings in www.stockcharts.com (.50 box/1 box reversal spread). This chart shows a bit more “close” to the downside and shows the 20 and 50 day moving average, around the Bollinger Bands.

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Each day of the week we calculate the support/resistance and pivot points for the OEX in our Pre-Market Alert. We recommend traders go to the password protected area of our website to re-calculate OEX during the day, AND this same calculator model can be used for analysis of the Dow. Here’s how it looks. You can find this right on the websites and calculate at any time.

Pivot Point Calculator High Low Close R3 R2 R1 Pivot S3 S2 S1 FIBONACCI 38% 62% 50%

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The pivot points and support/resistance lines are meant FOR a trading day, just as is the information we provide in the daily alert.

The Dow projections we track over a 21-day average period, market days. Let’s put this simply: the market typically reverses direction every three market weeks.

Chartists and the analytical will now study and want this to occur exactly; it does not.

It is a very inexact calculation and an “average,” so do NOT become so analytical and detailed that you use “must be EXACTLY this.” As Floyd teaches in his Dow projections, fully 70% of the accuracy of our projections is off an “intuitive read” of facts, NOT facts and calculation models. In other words, we take the core facts, and use averages around the number of days in our projections, factoring in economic data reports and news, or the price of oil, and the strength of the current market.

Much of our work at oexoptions.com and bluechipoptions.com is centered around a very simple 10 point bell curve count. We have a calculator for the count in the password protected area of our website, and also provide the exact count we calculate with the Pre-Market Alert.

As an example, if the count is 7 to the put, the market is becoming overbought, or “extended,” if 10 is the maximum to our bell curve axis and the count is at 7 it is reaching a point it could soon reverse. At 8 or 9 it’s more likely. At 5 it’s less likely.

To prepare a count we utilize simple High(H), Low (L) and Close (C) prices of a trading index instrument, such as an out of the money OEX or DJX option. This is a form of reviewing open interest, bid/ask, and real price valuations. It helps give us the axis for the Bell Curve.

Here’s another view of a Point and Figure Chart that shows “no noise” at all. That means: No Bollinger’s, no moving averages, just simple trend lines on a standard 3:1 chart.

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In a chart like this, one can easily see we are at 12,511 and that there are a number of simple support lines down to 12,000. Barring any unusual market conditions (hurricane, war, FOMC meeting, oil hitting new highs or lows, etc.) it shows, with a count of 7 to the put currently, that downside risk may be minimizing, after the extensive move from a high of 13,100, to 12, 511. In fact, do the math: 13,100 minus 12,511= 589 points. To Floyd math, this means we may be approaching a bottom.

Assuming this is true, and that the “end of a 21 day cycle is occurring” soon, I would begin calculating up to 600 points UP from the bottom. 12,511 + 600 =13,100. This is a higher top that the last top, and in a tough environment, so I would begin calculating DOWN from there to what are strong resistance lines that will move the market.From here I would use the pivot point calculator to study the Dow.

Using the calculators on the website I would study the Dow, and in the circumstances of the above chart would find a High of the day of 12,555.60, low of 12,463.19, and a prior day close of 12,479.63.

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With proper calculation I could see:12,627-R312,591-R212,535-R1Pivot of 12,49912,442-S112,406-S212,350-S3

It is from this daily information, reviewing the various “views” of charts, and the historical stopping points for prior support or resistance lines that “Floyd” numbers would begin.

Here’s what I look at as I begin to project:

1.How strong has the count/bias been?

2.What market conditions are taking place that could skew the numbers and have them “hold longer”? (Rising oil, FOMC data coming out, war, etc).

3.What is the overall market mood?

4.How many times in the past have support or resistance lines held? How much psychological relevance does this have to the market?

5.What market manipulation could take place? Institutional traders buying or selling near the end of a quarter? Elections coming up? Massive fear or euphoria in the market that might prompt the FEDS to “say something”?

Armed with facts, I intuit. This is an important part of how Floyd reads the Dow, and what is impossibly hard to teach. I consider myself a tape reader, simply watching the moves of the Dow and the S & P 100®, the OEX®. The same read can be done for any stock, any option, or any market. Your goal is to understand the short-term trend of something; how the law of supply and demand creates cause and effect, and to profit from it.Too much information creates chaos, and the way to watch the market breath is “be part of” just watching the Dow, or just watching your specific option (also known as “falling in love” with an option) and seeing how it breathes around Dow moves.

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The Dow moves and Floyd sees with Bollinger Bands, simple moving averages, different views of supply and demand, and an intuitive read to just “knowing” where stopping points are in the Dow, from daily “watching the market breathe.”