VOLATILITY CONTRACTS FOR QQQQ - RIG AND BHI LEAD OIL SERVICE HOLDRS LOWER - OIL FIRMS AS DOLLAR SOFTENS - POUND ETF BREAKS RESISTANCE - YEN ETF FIRMS AT SUPPORT - BONDS WILT AS SUPPLY ISSUES HIT HOME

VOLATILITY CONTRACTS FOR QQQQ... Link for todays video. After a surge in mid July, the advance has slowed over the last two weeks and volatility has contracted. Chart 1 shows the Nasdaq 100 ETF (QQQQ) surging above 39 on July 23th and working its way towards 40 the last two weeks. This pattern looks similar to what happened in mid June. QQQQ surged above 36 on June 1st and then worked its way towards 37 over the next two weeks. The bottom indicator shows Bollinger Band Width (10,2), which is a measure of volatility. Notice how Bollinger Band Width narrowed into mid June (blue dotted line). The subsequent support break at 36 and upturn in Bollinger Band Width foreshadowed the June-July correction. The rational here is that volatility contractions are often followed by volatility expansion as prices make a move. Currently, Bollinger Band Width is near its mid June low, but QQQQ has yet to break support at 39.4. Like mid June, a support break and upturn in Bollinger Band Width could foreshadow a long overdue correction in QQQQ.

Chart 1

EARNINGS WEIGH ON OIH... Negative reactions to earnings reports from Baker Hughes (BHI) and Transocean (RIG) pushed the Oil Service HOLDRs (OIH) lower on Wednesday. According to www.holdrs.com, these two stocks account for around 25% of the ETF. Chart 2 shows Transocean forming a lower high over the last two weeks and gapping below 80 today. This is the second high volume decline from 82.5 in as many weeks. The bottom indicator shows the price relative with a lower high as well. Notice that the price relative broke its up trendline in June and formed a lower high in July. RIG is showing relative weakness over the last two months.

Chart 2

Chart 3 shows Baker Hughes with an island reversal off resistance. The stock failed around 42 in June and again at the end of July. There was a gap up on Monday and a close above 42. However, a gap down and move below 40 today countered the prior gap up. The two gaps created a no-trade zone. Buyers on Monday and Tuesday are trapped on the island with loosing trades. The reversal is further validated with a surge in volume and downturn in the price relative.

Chart 3

Unsurprisingly, the chart for the Oil Service HOLDRs looks similar to the chart for RIG. Chart 3 shows OIH running out of steam just below its June high. Notice how the stock gapped up three days ago, but did not follow through. Instead, OIH fell back and this gap is now under threat. A close below 103 would fill the gap and we could then be looking at an exhaustion gap. The price relative is also forming a lower high as OIH starts to lag the broader market.

Chart 4

OIL HOLDS ITS GAINS... Oil is not to blame for selling pressure in the Oil Service HOLDRs. Chart 5 shows the US Oil Fund ETF (USO) surging to 38 and firming the last few days. USO looked like it was breaking down with sharp decline below 34 last week. However, a sharp decline in the Dollar sparked a sharp rally in crude. USO surged from 33.5 to 38 in just three days (over 13%). Even though USO has yet to take out its June high, the surge is still holding and I would now mark support at last weeks low.

Chart 5

The bottom indicator window shows OIH and USO together. As expected, these two are positively correlated with both rising and falling together. Sometimes, however, OIH leads USO. The yellow boxes show periods when USO moved to a new low, but OIH held above its prior low for a positive divergence. Currently, OIH is lagging USO, which could be setting up a negative divergence. OIH met resistance from the late July high, but USO surged above its late July high. Further weakness in OIH would hold negative connotations for USO.

DOLLAR REMAINS BELOW SUPPORT... I featured the Dollar Bullish ETF (UUP) last week as RSI tested resistance at 50. Well, RSI never broke above 50 and UUP never followed through on its bounce off support. Instead, chart 6 shows UUP breaking below its June low with a sharp plunge last week. The greenback remains under pressure today, which continues to help oil and other commodities. Chart 7 shows the Euro ETF (FXE) moving above its June highs this week. While RSI for the Dollar continues to meet resistance at 50, RSI for the Euro continues to find support near 50 (blue arrows). A trend change in the Euro is unlikely until there is a clean break below 50.

Chart 6

Chart 7

POUND BREAKOUT... Elsewhere in Forex (Foreign Exchange), chart 8 shows the British Pound ETF (FXB) break ascending triangle resistance with a surge on Friday-Monday. This move reinforces support around 160. Notice how RSI met resistance in the 50-60 zone during the downtrend. On the flipside, the 40-50 zone now acts as support during the uptrend.

Chart 8

YEN HITS SUPPORT... The Yen ETF (FXY) is perhaps the most interesting of the currency ETFs right now. Chart 9 shows the ETF firming around 104 after a sharp pullback in the second half of July. Notice that this decline retraced 50-62% of the prior surge. Also notice that the ETF has a series of higher highs and higher lows working since the April low. In addition, the rising 50-day and 200-day moving averages mark support around 104-105. And finally, 14-day RSI is trading in the 40-50 zone. This is a great spot for a bounce. Stay tuned

Chart 9

BONDS FAIL TO HOLD BREAKOUT... The 20+ Year Treasury ETF (TLT) was featured last week with a wedge breakout on Thursday-Friday. This breakout failed miserably as the bond market turned its focus to next weeks auction. Earlier today the Treasury announced plans to sell a record $75 billion in bonds next week. A whole lot of supply is going to hit the fan. Whats more, bonds fell even as stocks came under pressure on Wednesday. Chart 10 shows TLT falling back towards its July low. Watch what happens around 90-91. I have seen wedge breakouts and then a successful support tests on a sharp pullback. A lot may depend on the stock market. Should stocks remain strong, then bonds may continue to move lower as supply concerns dominate trading. Chart 11 shows the 10-Year Treasury Yield ($TNX) with channel support around 3.5% (35 on the chart).

Chart 10

Chart 11