10/18 update:
There are 3 main technical reasons I remain cautious.
1)The MACD histogram on a monthly basis remains bearish
2)The RSI on a monthly basis shows a lower low while the market shows a lower high, and the lower low also failed to reach oversold levels in the RSI. This means the higher low in the market is a false sign of strength and that likely if you take anything at all away from RSI it is bearish.
3)the parabolic SAR on a monthly chart also remains bearish
However, with this being said, sometiems you have to recognize when to get out of the way. This is no time to play hero as seen by the giant blast higher through resistance and what some people believe is a bottom. I don’t buy it, but there is no clear set up yet where I can really confidently bet againststocks and the technical patterns may even be suggesting the opposite even though the 3 core indicators that I watch are saying be bearish. This is a time for patience and caution.
The technical side aligns with the macro understanding and fundamentally there is an argument to be made about where estimates are and where they should be but the real macro picture is about capital flowing into the US bonds which has occurred so far. The hot money in the short term may be pulling out of bonds, and perhaps a shift is in the process of occurring where the big guns/long term money is going to be moving large amounts of capital out of bonds at some point, but for now it looks like that is not happening. We will have to see how “Europe’s QE” as some people are calling it will work. I believe people will flea the Euro dollar and into the dollar, and the fear of default will cause capital to flow into the one place where they can always print more money to pay debt denomonated in their own currency, the US$. The reserve currency provides the protection that we can inflate more than others as well without it being problematic because other countries have to hold dollars. So the move will continue to be into the US$ I believe while gold remains a hedge for the central banks who move trillions and can only go into the largest, most liquid market, and hedge with a smaller amount of capital in smaller markets. The US treasury bond market is where capital has to go to when there is lots of inflation. When there is deflation it probably goes there as well because cash and promise to pay cash that is guarenteed remains king. The difference is that when the economy gets the European monkey off the back, and when all that capital has flowed into treasuries and bond markets around the world marking a panic low in stocks, THEN finally we will see a transfer back into the stock market. But for now, I believe the trend is still downwards.
Although all 3 of these (those mentioned above) are longer term monthly trends, they are very important and are my top 3 ranked indicators for accurately determining significant trends. Don’t try to catch ski jumps on a mountain downwards unless you have mastered the craft, and even then, bet on the larger move. You may be able to catch a brief jump higher, but you may not get as much air as you expect and come tumbling down. Unfortunately, the set up really isn’t ideal to get short stocks either.
This is where cautious allocation models with extra weightings in treasuries and less in stocks come in handy. This is usually the tool of a long term investor though. However, as a short term trader, you have to be somewhere. So Cash/bonds or stocks/gold, or both? The reason you might want to have a little of both but more in cash/bonds is because having a balance lets you take money off the table and rebalance and profit from volatility in sideways but volatile market, or during one with large countratrend moves. If we go higher, you can more aggressively move to bonds as the set up gets more ideal, while taking money off the table in stocks, and if the set up gets even better, you can enter short like in the July-August phase where the stock market made a clear head and shoulders and the puts skyrocketed in value. There is a difference between adding to your bearish bet (long treasuries) vs adding for rebalancing purposes. If you are 50% stock and 50% cash with $1,000 in each (to make things simple) if stocks rally from 100 to $110 and you go from $1000 to $1050, rebalancing is moving to $1025 in each. You don’t want to do this with small moves unless you have a lot of capital, because of the transactional fees of buying and selling. However, if the moves are large enough, you can rebalance. But if you were to instead recognize that as stocks rallied, conditions remains the same, and stocks now become overpriced, and now you want to conservatively bet on a decline without shorting, you should get more defensive, perhaps to $60% bonds/cash 40% stocks/gold. In the above example, you have $2050 after the move, so you would move to 1230 bonds/cash and 820 in stocks/gold. This strategy is dangerous with options because of time decay, but if you go really far in the money with your options and you can get a good enough fill without a wide difference between the bid and ask, and you own the longest term contract possible and roll over the options several months before expiration to continue to buy time, you can mitigate a very large percentage of “theta” (time decay) and this will allow the strategy to have some success. However, due to leverage and the possibility for changes in theta and in the value of the option even if the value of the stock(s) remain the same, and the slight loss in theta, you still will have to hold a fairly significant amount of cash, above and beyond the allocations even if you say own options in the IWM (russel etf) and the TLT (20 yr treasury bond etf).For now, it’s better if you just keep your options strategies separate from this one. As a shorter term trader, you are looking for the ideal conditions to make the drastic switch, and to possibly even start betting against stocks. Some say that 120 was that spot, I say 125-127 looks to be pretty ideal except that that could perhaps reverse the 3 indicators mentioned above. I perhaps could even say higher. The thing is, there is a large volume gap if stocks go much higher. Then there is the retest of the head and shoulders pattern around 126 that we hit. We could still go higher and stay within a downtrend line created connecting the head and shoulders to form resistance. 129 would not be unusual. You see, this is the problem, we could rocket higher like we have been doing and slice through the lack of volume, so if you bet against the market you have to be very quick and an overnight move could still hurt you significantly. This is why you sometimes need to let other people fight it out. It’s too bad there was such an explosive move to the upside that was missed, but you can’t catch them all, especially on both sides. Be prudent and patient.
The other thing to do, allowing you to deploy more capital is to have both long and shorts but on different time frames using different signals. I don’t like to do this because it gets too complicated, requires multiple stops for partial positions sometimes, and is a lot to watch, but if you for example are long based on daily chart signals, and short based on long term signals, the volatility won’t hurt you as much, and you can take profits on shrot term positions while adding to long term positions. If you use options or other forms of leverage, this can work but your timing must be very well, and you must understand how to adapt. Generally, the longer term moves are not about perfect timing, and are more about catching a big move, and a simply more leverage position but not all that leveraged. These are similar to your “core holdings” because of this, I suggest you make deep in the money options your long term plays, and use shorter term playss for out of the money options that are more highly leveraged, and represent a much smaller percentage of your capital. You do not want to use these short term signals though unless they are very accurate and ideal. plus, out of the money options are a low percentage outcome and really require a move. They are more suited for individual stocks that can be more leveraged and make a larger move when the market turns.
Ultimately this strategy is very tricky and probably should not be attempted even by many experts unless it’s done with a ton of caution. The principal is to understand how multiple time frames can occasionally work though even when you are betting opposite directions as core positions. In a short term swing, you might have a 55% chance of a stock going to X and if it does you might make 300% so it’s worth it even if it goes to 0 the 45% of the time you are wrong. However, if you were to bet on a long term move and try to take profits, you would lose your position, and if the market continues to trend without offering an opportunity to buy it back, you can lose out on a monstrous move even though you would have been right all along. Overall, making these little occasional bets on contra trend moves may be a net winner for you but the key is more about limiting the times when your position on the long term is vulnerable to loss. This overall from a risk management perspective allows you to risk beyong the “kelly criterion” safely. This is not our goal, however, it does provide us a better reward on a lower risk. Since we don’t really KNOW the probabilities, and are really just guessing, it is more about protecting yourself from your own ignorance, from the possibility that you are wrong. The long term trend is easy to spot, but hard to stick with. The short term trends are hard to really get but easy to get in and out of and distract you from exiting your long term position before it’s time to do so. This is another benefit. It’s not for everyone and it may not work in all situations, but it’s a possibility to consider.
The reason for caution and not pure bearishness is my next best trend indicator after those 3 (the MACD on a weekly basis) is turning bullish. It looks similar to March 2010 or worse, March 2009 (worse for short sellers because it contradicts previous signals). Additionally, the fuel to the fire then was all the QE and government stmulus and now it appears europe is attempting just that. So it is quite possible we still see the longer term picture change. However, I wouldn’t bet on it yet. Daily indicators don’ provide enough of an edge because the moves are too small, except for one particular indicator that I cannot disclose that gives intraday readings for a move that lasts maybe 5 days or so. However the trick is using the right options on these. I believe I would be better off using longer term options or at least 1-2 month out options rather than weeklys, however the indicator is one that has either overbought or oversold, so buying oversold with a more expensive option is a bit problematic when managing risk since if you set a stop, you likely will have to sell when you are even more oversold and even more prone to an even larger rally. If you add on, you have the odds in your favor, however, the times when you are wrong it will be a money management disaster. Even if you are prudent and rebalance a certain percentage of your capital, if you were to rebalance everyday on the one time that stocks very gradually decline or move sideways you could end up continuing to add to the position and never really getting ahead. Having the longer term bet in the opposite direction makes some sense, but a sideways move will srtill eat up your capital. So it is a bit problematic. An asset allocation model where you shift from 80% bonds 20% stock (of your capital allocated for short term bets) in every “overbought signal” to 80% stock 20% bonds in an “oversold signal” would work okay, but would fail to really maximize gains that are possible due to the possibility of leverage. With ultra long term holds that lasts multiple years, you can have bets that make twice what you put into it without leverage and that do so more than enough to make it work. This is the Buffett/Munger style of patience. But with short term bets you need leverage to do that, and assessing the probability of success is difficult. It’s very unlikely you lose everything in a long term investment, and generally adding to that would get you more of a company at an even better price, but that’s not true with short term bets. So it is a tough problem to solve indeed.
update: although we breached the lows and reversed, we are still setting up for a potential breakdown The market is oscillating to trending downwards which is tough on breakout or breakdown traders for the time being but I really suspect we will soon enter a trending market again.
update: October crash Warning in progress Chart:
(updated 10/3 intraday)
Right now the dip buyers of the last resort will have to step in for us to get the “capitalization” type volume typical of a bottom. If they don’t step in here, or they do and markets continue to fall, the volume doesn’t even begin to pick up until 15% lower. This is the making of a crash that will shock the world amidst an already volatile market scheduled to get even worse. If you are a long term investor, panic should be the exact opposite of what you should be doing. Instead, you should be adding aggressively over the next 3 months because a crash typically results in a low and I am optimistic that a low will be seen within 3 months, I might even say 2 because it would be hard to imagine us not rallying in December pre-christmas / holiday season. It’s hard to determine where the exact low will be, but even if stocks were to return to these levels, if you started buying now and all the way down and then let it run up you would have some pretty significant gains. So it’s not a bad thing to be bullish if your timeframe is longer and you are patient. However, if you are quick, nimble, and not patient on that time frame, you should have been out in July when we issued our first alert, and you had plenty of time. With that being said, you STILL are going to want to look for a clear breakdown of 110 to get out. I don’t mind buying here with puts at this 110 level if you buy the S&P or whatever, but stops are not good in a highly volatile market as you could gap down tomorrow and not have a chance to get out. Around the world short sellers have been targeted, and that is a very BEARISH thing contrary to popular belief. What happens when stocks decline? the bears at some point like to take a profit and they are the only ones with the courage to buy in size of market carnage because they want to withdraw cash like everyone else, but they have to buy to do it. This creates floors or at least slows down the decline. Since markets are interconnected, even though that is mostly in europe where politically the politicians are looking for a scape goat of short sellers, that may happen here, but either way, the markets should go down to match the moves of foreign markets generally. The picture should be clear within days whether or not we are going to see another wave down, or if we bottom here (at least for now) Generally dip buyer get flushed out before the end of a bear market and there’s a final wave down that gets way over extended and then the shorts cover and value investors step in to mark the long term ultimate bottom. I believe that has yet to happen and that 110 isn’t a floor, but it’s hard to tell at this point. If 110 isn’t the floor it could be the halfway point or even further along in this bear market. However, as many of my other posts have shown, there is the potential for one down-wave leading to another breakdown and a continued bear market until 2016, or else we are merely in a sideways 10 year channel that will eventually resultin a parabolic move higher like the one in the 80s and 90s leading up to the 2000 top.
It could potentially be the sign of a bottom that fear is at a max and this is the level dip buyers come in. Technical traders watched 112 and now are in a frenzy but the dip buyers could just be waiting. So today 10/3, watch carefully and have a plan in place.
If you were to pick one market and designate it as a “crash month” it would be October as the crash lows generally hit late October while the volatility peaks as well. If we hadn’t traded down so significantly in August and now recently in September, and had instead traded higher until right around the time of this post (September 24th) I would title this post “crash warning”. In July and August I gave a “crash alert”. September I gave a “crash watch” (July alert continued). I am concerned about the default of Greece which seems to be scheduled in November at the moment I write this intro to information I have already written earlier but have yet to put on the finishing touches. There is soon to be a time when I will be betting heavily on the market if we do in fact hit “crash” sometime in October or November. I also want to bet against volatility around the same time. I am considering betting on Volatility this month but it already is up so high. However, as far as a hedge goes, short treasuries, long volatility would not be a bad play.
We now have the data to prove that in July mutual fund cash levels were dangerously low at 3.3%. This means they were putting cash to work and money was flowing into the market fast and they anticipated it to continue but it did not.
To get an idea of what kind of returns are typical over the next 3 years following such low cash levels consider this…
http://www.efficientfrontier.com/ef/199/fundcash.htm
The thing to be concerned about if you are investing from longer term perspective such as 3 years or 5 or 10 as some do is that it is theoretically possible that due to increase of debt, credit, and cash injections and the resulting “mandrake mechanism” (look it up) that results that stocks could continue to go drastically higher even as cash levels stay the same or decrease for an irrationally long period of time. This could happen in a high inflation period of time in which stocks could go higher along with goods and services, or in rare cases stocks could go lower or stay the same and hard assets like precious metals could continue to go higher. Be aware that although there is a correlations, when the laws of money that govern that correlation change due to such egregiously large stimulus (that’s effects will not be felt until years and years later as business cycle returns), you cannot bet on the correlation remaining the same as a result. However, it is still for the time being a fairly accurate indicator over the long term and certainly tells you when market is more susceptible to changes.
As a result, most likely when the data becomes available we will see that they (mutual funds) were forced to raise significant levels of cash in August. Mutual funds tend to have pressure to outperform on a very short term basis to keep the funds coming in and as a result they tend to get way too aggressive when money is flowing into the market at the top, and tend to be forced to take money out when things get bad to avoid exposure. It is not healthy and over 80% of mutual funds don’t perform better than the S&P. This is why mutual fund cash levels is such a great contrarian indicator. I am unaware if there is a way to get this information in a more timely manner, but you could have been aware for quite sometime that treasuries should have been a high allocation of your funds and you would have been safe mostly while everyone else like lemmings were overly exposed at the worst possible time. I have no idea how much cash the mutual funds have raised at this point and due to the sharp correction I am a bit in the dark. However, for a long term basis, it is very likely that there is still way too much money in stocks and way too little cash on the sidelines at least as far as mutual funds go. On the other hand, for the time being it would not be surprising if money began to slowly enter the market, barring a crash. Unfortunately The volatile month of October could have the opposite effect. People that freak out when they see monthly returns that are bad will fire money managers, they will replace them with others, meanwhile the people being told “don’t worry everything will be fine”, just “buy and wait because things will get better” will probably be too impatient when things start to get bad and they see the problems. There could be a bit of “window dressing” before the end of September as the Quarter closes out to make the losses look less severe, as money managers get overly aggressive hoping to shoe up returns. Markets probably will rally to close out the month of September or at least leading to the near end of September, but you will be walking on egg shells in this market. A few things could happen
1)The returns could still look bad even after window dressing
2)People could pull money out of stocks that fear another 2007-2009.
3)A lot of things can happen before then with the federal reserve always someone to watch and they are always making policy decisions that could shock everyone out of nowhere and I anticipate that may happen soon. If the shock is positive, It is worrisome that people will get overly optimistic and on top of that you could have window dressing and money managers will again get very low levels of cash. The market will be at very high risk of a crash in October if we see a rally that gets overheated, and it could even start a bit earlier such as the last week of September although that would be a bit unusual. If the shock is negative, it could be downplayed, then hedge fund managers would really fear for their job and still get overleveraged in the worst possible time anyways but with worse economic conditions there is still that risk even if the fed starts taking bold decisive action, if politically the future becomes less clouded, and if suddenly there is a major resolution, there still could be some kind of correction in October, or more likely, the crash will only be postponed for maybe another 1-3 months.
4)There will be a lot of political motivation to manipulate the markets on both sides, but being motivated to do so does not mean it will be successful. In fact, it could have the opposite effect as a lot of imes we see government intervention result in the opposite as intended consequence, because they don’t consider the human reaction on all sides or understand the cause and effect relationship of the markets and how they are all interconnected like some sort of machine with gears and outflows and inflows all around the world.
It is not uncommon when trading to be at a crossroads. You often will have bearish scenarios and bullish scenarios converging and only after stocks break above downward channels or below upward channels do you have some kind of resolution. These occur on all sorts of timelines and are only one “technical” side of things. However, the technical side is important. Trendlines occur both as a result of technical and fundamental investor and traders The fundamental traders have an outlook of what they think the stocks earnings will be going forward, and stocks will fluctuate depending upon what multiple they think the stock will be trading at in the future. If they are optomistic about liquidity and the money supply and optomistic about the future outlook of the stock market they will tend to put it in a higher “range” if they are pessimistic they tend to put it in a lower “range”. However, if the company is expected to grow over time and continues to do so, it will trend up on this timeframe and follow the trendline up over time. This also happens for technical trader as those bullish tend to raise targets as stocks go higher and more people may get involved in the trade, but the traders have a pessamistic side and an optomistic side. Additionally you will have traders trade breakouts then sell and value buyers and dip buyers are then going to wait until it comes low enough and then start accumulating. This generally is how channel works. But what happens when someone who has been buying an uptrending stock on every dip every month when someone else with a shorter term timeframe has been shorting it every upswing on a daily basis? One side gives up. It is slightly more likely that the person with the longer time frame will be less likely to panic and drasically alter the outlook while those who are short sighted may be more emotional and impatient and more willing to move elsewhere. But we can’t say for certain. Perhaps the short term trader recognizes that something has changed and it takes the longer term person too long to realize it. Regardless there is generally a change in sentiment among one of those two groups that causes the market to change it’s behavior, and a resolution occurs.
Unlike the owner of this site who has models of gradual rebalancing to take advantage of long term volatility and also long term value opportunities gradually emerging and to keep a balanced portfolio, I have a different time perspective. I do not have the patience to park my money and review only once a month. If I did I would probably have a lot more time on my hands. With that being said I do employ indicators the same way for the same reasons as a GUIDELINE. I tend to be a bit more conservative on my long trades in situations when we have previously been overbought (low cash levels), and more aggressive on the long side, and if cash levels ever return to historically oversold levels (high cash levels o) of 8% or more, I will be more aggressive on the long side. The trade I made in August made my year that normally would have just protected me from the decline if we were in less vulnerable conditions. Because historically cash levels are so low, conceivably we could see a much larger sell off. If mutual funds were to raise cash levels on an average of 10% there would likely be a very large crash and it is more likely to happen then from cash levels go from 10% to 20%. The effects of raising cash likely will result in more cash raising from institutional investors and more hedging and possibly more panicking. It is not just mutual funds that raise cash but people that freak out and sell as stocks decline and move their money out of mutual funds thereby reducing the cash positions and requiring the mutual funds to sell more to raise the same cash levels. Rarely you can see a divergence where the markets do well while mutual funds to terrible like in either the 60s or 70s because people start to lose confidence in mutual funds and it prompts more cash raising even if larger institutions are buying stocks and overall money is not flowing out of the market as fast as it’s flowing out of mutual funds.
so what do we have in the markets here?
It is actually September as I start this October alert, I was tempted to put this as a “warning” because October is the most likely month of all to be a crash month historically. However I have both a bullish and bearish scenario that I want to show you.
Only a few things have changed about the bearish scenario, I see it playing out this way
1) we go to S&P 1100
2) we bounce back to retest the downward channel
3a)We break S&P 1100 forming a year long H+S pattern,
3b)From 1100 we bounce back up and recover to 1250 and trade sideways before it finally goes down and breaks 1100
4)If 3a we trade down to 1025 before recovering as high as 1250 then back down and breaking 1025 to form a multiyear H+S, If 3b we make a shorter lopsided shoulder but still break through this time more quickly with less of a bounce.
5)Sometime in 2013 or maybe sooner, as a result of that breakdown we trade around 600. If we hold there great, but if not we will make a multi-decade head and shoulders and the cascade down will really hit as we hit the end of the 2009 dropoff of this longer term cycle and really breakdown from 2013 to 2016 and finally bottom at 300 or so.
Ultimately the type of decline looks like the Nikkei in the 90s, the inflation adjusted markets in 1964-1984 or stocks during 1929-1933 taking longer to develop but still playing out a similar disastrous way.
The bullish scenario on the other hand looks more like the late 70s and early 80s in nominal terms
We would trade along a upward channel that has only just started. It connects on support the 2009 lows to the August Lows. The resistance starts in 2009 before the final leg down and connects to around the April or so highs of 2010 and extends, The scenario may start in the channel, but as is a possibility with the bearish scenario of trading below the support, so to might we at some point go parabolic and trade above the channel.
1)Gold would look to peak relatively soon in a final parabolic blow off top over the next year or two as it has started it’s parabolic phase.
2)There would have to be some kind of change in the economic laws to bring confidence and stability. tax incentives aren’t enough anymore because people don’t know if in 4 years a change in administration is going to cause them to go up and as it stands the US appears as if it can’t really afford much, we require serious growth to occur.
3)What’s known as the Mandrake mechanism could result in a lot of growth and liquidity very fast as a delayed result of all the stimulous
4)We could start in the upward channel and around 2012 we would break through what likely will become for a very brief time a downtrend line connecting the 07 peak the May 2011 peak, and a rally attempt that retests there, only to see us consolidate and break right through it.
5)We start in the channel, but eventually go parabolic to touch the breakout line and potentially go in a range that is drastically higher such as 36000-50,000. Such an increase requires both a loss in confidence in government, a movement out of bonds as well as the spur of business investment leading to increased liquidity that becomes exponential as businesses continue to seek growth which could happen in spite of unemployment, or because of increased employment.
6)If we peak around 2016 instead, it is there when no one will see what is coming and get over confident and that is when a bear market will likely begin.
As far as the crash alert in October goes, it is one of the most ominous months in existence. Volatility historically skyrockets in October. If you are ever going to buy volatility this is the time and sell it at the end of October. If you ever are going to bet against volatility do so at the very end of October.
Here is why
(seasonalcharts:
http://www.seasonalcharts.com/volatilitaet_aktienindices_sp.html
)
Stocks may not be as bearish in October as the volatility index might suggest, however October is still a bearish month even though May or August is when stocks tend to peak in their cycle.
We did already have comparative moves upward in volatility though so perhaps it will not go much higher.
It however is not a month where you want to be bullish In fact “Sell in may and go away” is to avoid the sideways summer action and the downwards action of August to October and to get in just before holiday season. Bet against this month? The best opportunity is now as I write this 9/15/2011 but I imagine we will try to rally before then and may even trade higher one last time before things start t get ugly. Puts are great insurance to buy on the S&P as the volatility increase will make the cost of time more valuable in options (so plan to sell your options early) but you will also profit from a decline. This is a good way to hedge a longer term portfolio to prevent you from getting out of positions. If you are a value investor, you may want insurance on months like this. Make sure you have plenty of time remaining though so I would buy Jan 2012 puts or later and plan to sell them in October.
Now here’s an illustration of the above
(chart)
here’s the bullish
(chart)
the bearish
(chart) etc
We can see the convergence depending on the timeframe as there are actually two, one should see a resolution before the end of October, the other will not see one until probably sometime in 2012.
9/27 midday:Sorry I don’t have the charts up yet, I will have to redo them when I can.
it is now 9/27 and the last few days the market has rocketed further. This is good if you are bearish as it will give you an opportunity to get short. For the time being I am NOT concerned about a break of resistance to the upside (yet to happen but possible if today continues to the upside), as the markets are volatile and are showing a lot more “noise” lately. Not putting much faith in support zones either. It would be perfectly normal for us to trade to say 120+ even 123 before market finally tops, or we could top right here near the 120 resistance area. Additionally, window dressing should push markets a bit higher until the end of this month. The dumb money then comes in at the first few days of the month as people send in their monthly deposits in the buy+hold+pray(prey) accounts irrespective of price. This could drive prices further as the smart money anticipates this cycle and gets in heavily now and also hedge funds and mutual funds want to boost their performance and say they own all of the hot performing names so they flood into the market generally and sell as more cash comes in. Sometimes they have to put this cash to work and overall they may get long but as far as the percentage of cash they hold it generally will increase. Sometimes stocks continue to increase for the first few days of the first month of a new Q as some money still is getting in, but it never usually continues much beyond that. October however is always a volatile month so don’t be shocked to see the market go higher. Personally I don’t think we will go much higher but would not be surprised to see us push ahead to 123 or so above resistance before we crash lower as people claim “double bottom”. I want to be long volatility either way, and will position myself to be net short in “overbought” situations especially when my weekly and monthly indicators are also trending downwards. So I will add short in daily overbought indicators, as long as the weekly and monthly indicators are net bearish (weighted by my preference and historical accuracy) and look to raise cash and take some profits on daily “oversold” and/ or possibly add hedges to profit from a sharp rip higher. The way to take profits will be to roll the options over to add time and decrease the strike price to more bearish targets while keeping the same number of contracts, and adding the number of contracts in “oversold” conditions. Many of the readers will probably prefer just buying say the VXX or VXX December or Jan calls maybe and holding until somewhere near October’s end. Or perhaps just allocating say 75% cash and only 25% longs for those who always like to be long. You can rebalanced if your positions become cheaper and your net exposure drops. A more aggressive approach would be to shift to shorts, but if you don’t want to be short, you can still shift to 50% long 50% short or so on oversold conditions then back to 75% cash, 25% long. Really it depends on what methods you prefer, and what time frame you prefer and how active you wish to be.
The stronger you believe the next bull market will be, the less willing to try to “time” the market you should be. In bear markets nearly all timers beat the market. The bullish timers even if their signals are inaccurate are out of the market often enough during declines to at least not do as poorly as the market. During sideways or even mild bull markets, there are still a decent amount of timers that beat the market. However, strong bull markets (say 20+%), only a select few “timers beat the market and if there were hyperinflation it would be impossible to beat the market using timing to try to exit the market, as being holding mostly cash during any phase would be a mistake. So keep this in mind. I do not think we bottom until at least sometime in 2012 and I think we are probably going to head lower from here, so I am more aggressively trying to time the market on a daily basis. If you think hyperinflation is right around the corner, you always want to keep at least some stocks and gold at all times because if it hits overnight you may not have a chance to find a good entry point. But there is also your personal flavor for the game. If you are a short term trader but still think hyperinflation is around the corner, allow some cash to be tucked into somewhere where you are not tempted to touch it, and trade with a small amount..
There are too many people that are bullish on gold and predicting hyperinflation for me to worry about it, but I bet after this leg down that many go away and then, I may start to become more concerned. Until then though, the set up here is great. It is not ideal because of the volatility already here so there isn’t a clear entry point where you can also exit if we close the day above that point. But I don’t know if it will get much better than this.
10/3: Watch the 112 mark, it is technical support on short term frame. Also watch the 110 levels which is the level of major volume. If we crash through hard and all of the buyers go away or want out of their position, potentially we could go significantly lower. I would expect in an increasing but already high volatility area, it is very possible for the market to fakeout, but it’s also it will go significantly lower before it finds it’s footing. So the “support” should be pretty tender during the month of October. Long Volatility remains a good play throughout the month and maybe into November. This be a good 3 month range of time for a long term investor to gradually accumulate share on dips due to the tendency for markets to crash and then fully recover in the future around this time period. Christmas is always a time when new products come out and people start shopping so from October, November and maybe early December, you want to be in the market for long term positions. shorter term, you probably want to be long volatility, and consider shorting it in November.
The puts I bought earlier have been sold today. I bought some calls too at the end of the day. I really should not be messing around with this as it is a very dangerous game, but I am betting there is at least one rally attempt (even if it fails and occurs below 110 ultimately I think we should make a move that ends up higher). This is pretty speculative and could be wrong. The downside is pretty heavy from here if we don’t hold, but it is of higher probability that the previous buyers don’t just magically disappear or turn into sellers all at once unless something goes wrong. So the market is certainly vulnerable to some major news one way or another, and I expect volatility to increase and continue to do so which is usually a bearish sign. However, I have been pretty right on, hopefully I don’t get overconfident here… Mostly I am in cash because I am not entirely confident. I am looking for a strong bounce attempt that I think will ultimately fail to break 120 to the upside and probably decline from there. It would be a very bearish sign if the bulls give up without a fight here at S&P 1100 (or SPY 110). If we get a chance to do so at higher levels, I would love to add puts aggressively on the SPY and calls on the VXX which unfortunately I never ended up doing although I talked about it. We are in a downtrend and about to potentially break down a very significant level. Maybe I am wrong and 110 will in fact hold and the call will end up being right, but we will sell off and hold at 110. Either way You have been on the right side of the trade for this long if you followed me. I would not really advize to change much if you are short or hedging against the crash, let the market raly or try to rally first and then come in more aggressively against it. Really the contratrend bet here is more of a “don’t do as I do, but as I say” example. I wouldn’t be comfortable with someone taking on that kind of risk betting on such a short term swing to the upside here. Seriously be very careful. A great play for the aggressive players who perhaps want to be a bit more prudent is a “straddle”. If we in fact rally, you simply take off the call for a profit, ideally for a profit that makes up for the cost of the put position, and then you leave the put position in and even add to it when we are overbought. I would start thinking about betting against the market as early as 114 if you do not have a position yet, but 115 is where I would expect the market to go, maybe 116 not out of the realm of probability, and 120 would just be great and still would be possible. However, a set-up and break above 120 might be a bit concerning as it would tell me that perhaps things are turning and I would have to wait until 125 to think about possibly betting against the market.
10/4 At the very least I feel we get a retest of the 110 low area, probably at least a back-test of 112, and possibly a rally to the 114-116 range which will test the down-trending line. I do think we go lower from there, but I think there is a lot of fear, and quite possibly we remain stuck in a range here. If so, the upside to the range is 1200 in the S&P. However, I am a bit concerned that instead, we will simply fail at some point, retest 1160 and then go lower. The significant thing to watch is whether the Russel breaks the 2010 lows made just after the flash crash. There was a lot of volume there, and it wouldn’t be unusual for the dip buyers to come in, grabbing stock at more of a panic type of price when everyone fears the pocket of low volume below. On the contrary we could trade sideways near these levels (600 in russel) and finally after working off oversold maybe even a slight rally, we could go lower. I’m not thinking that we see a waterfall type event. However, it wouldn’t be unusual, and the thing I do think is fairly reasonable to expect is first a bounce/rip higher and then we sell off lower, maybe bounce one more time, and then drop, but at some point the drop is going to be similar to 2008 if things don’t recover. Yes, the crash alert is a crash warning, but at these levels I find buying the fear to be a good strategy for the very short term.It would not be out of the ordinary for this to be temporary and for a bottom to come soon. I think that if Greece finally defaults, that will probably mark a panic bottom. There is a belief that it will happen in November. So I want to be long volatility through November, and short it if there is a panic type event. Most likely volatility will peak in the end of October, But that is just based on history, and unless there is a major type of panic, I feel it would not be out of the ordinary for volatility to peak a little later. Generally volatility is something that happens during a bear market because people are really trying to hedge themselves if they can’t get out of the market, and soon it is difficult to get in and out of hedges as well without paying a premium for those. I don’t think this decline will be all that rational, but it will probably happen. I think there are several indicators that scare people for the wrong reasons.
1)Bonds are high – I feel this is more due to the fed buying them up and guarenteeing the yields will be lower in the future because of their commitment to buy that makes people want to be in for the trade. This has the opposite effect as suddenly stock traders typically associate rising bond yields with a movement out of stocks. But this may not be the case, but it easily could become a self-fulfilling prophecy)
2)Apple/Netflix and other “leaders” are toast (for now). Amazon’s move should be appluaded, but instead people in Apple and netflix are selling. Leading stocks going down is a bearish sign usually, but this one is also more event related, which happens coincidentally with the bond increase which also becomes self fulfilling. As people see stocks crashing they sell, if they see leading stocks crashing they sell. Now the other leading stocks get hit and more people sell. Netflix sold off because of their choice to not only double prices just about overnight, as well as split the company up and change the DVD side to “quickster or quixter or however you spell it). This is event and stock related, not hedge funds getting out of the market entirely related.
3)The dollar is soaring. – I feel this is a side effect of international traders rushing into bonds because of the fed policy decisions more so than anything. Additionally there are fears of europe problems which adds to strength in the dollar. In the long run, I believe this translates into good things because globally capial is concentrating in the US, and that wealth will be used to produce in the future and that will eventually create growth. However, with goods priced in dollars, the expected relationship is they should drop. This becomes self-fulfilling
4)Copper is getting trounced a typically bearish sign. Why? Well this could be legitimate but if copper is getting trounced why are rail numbers good and dry bulk shipping rates increasing (signalling demand in commodities?). I feel this is partially due to troubles in China which leads to strength in dollars and may become a self fulfilling prophecy. Additionally, a lot of people were either long gold and short copper, or long copper and short gold. This could simply be a rebalancing effect that happens with drastic changes in one of the position. For example if someone was short 1 ounce of gold for $1600 and long $1600 in copper and gold drops to $1400 Now to maintain hat relationship, you would sell $200 of copper. But there already was more of a slow growth than in the past, and expectations were a little high, so add that effect after an already perhaps justified decline in copper prices and you add to it. Now those short gold also are waiting for a drop to add on. There are also those short gold long banks that could for example be rebalancing. But this is more theory and to be honest, I am just guessing about why copper prices have been declining. Either way it doesn’t appear consistent with rail prices and dry bulk prices. However, this could be bearish as it could signal a deflationary or disinflationary cycle as people hold dollars and flock to the dollar and other currencies, and bonds rather than stock and cash rather than currency, which could lead to less money available to pay off the increased amount of debt payments, and more money in the economy will be needed. For the time being the fact that bond prices are able to support stock prices at much higher levels than in 2008 when bond prices (and low yields)were at the same levels and stock prices were much lower tells me there is more money in the system than before, not less, and that is bullish. However, there is no way I want to step in front of a moving train and bet against this momentum which seems to be overdone for what historically seems like legitimate reasons if you look at them in a vacuum. There is a lot of concern in Greece but there isn’t a climax selling type fear that I would have liked to see at the 1100 level.
All of these indicate the troubles are not major… However the hedge funds use indicators that are connected with each other and dependent upon each other much more than people realize, so yes, F.E.A.R (false evidence appearing real) can indeed turn to real FEAR (F&*( Everything And Run!) The strong selling turns into margin calls which forces others to raise cash and soon there’s lots of selling and businesses end up without much cash and they have to raise cash, they have to make layoffs, and they have to make tough decisions that they don’t want to, in order to save the future of the company that still will employ so many and sell and produce the products and services we all depend on regularly. If that happens suddenly businesses find it tougher because with everyone raising cash and money not moving around fast enough those that owe money aren’t going to get enough to be able to pay it off, and banks are suddenly going to be worse off than they thought. This results in foreclosures which also results in lower home prices which results in foreclosures, and only when those saving up cash determine there has been enough panic and prices are low enough, can they start to buy and the people that once could not afford a home now look at home prices and finally get the opportunity to buy houses, and now the money starts flowing again and the loan produces a lot more money in the economy because it not only creates money out of nothing but future debt, but that money ends up in another banks (the seller) and the bank can then use that money as collateral to borrow money from the federal reserve. The federal reserve will loan money to the bank who in turn can loan it to others if the demand is there, and the banks have enough of a balance sheet to take on risks. This will start to happen as banks clear out their balance sheets via dumping enough foreclosures, and will start to happen eventually. However, this is just a continuation of the cycle that had started in 2008 and was only postponed it appears for now. I think this will prvide one of the most fantastic buying opportunities we have seen in a very long time, but it may take quite some time. So far there has been 4 years of stimulous and now there is another cycle of fear that will result in even more stimulous, and ultimately the fundamental problems in housing does have an ending point, provided the soverign wealth defaults don’t start to mount up. If so, I imagine there would be relignment of currency and major injections of capital for a soverign default bailout. This soverign default bailout will eventually clear all of these troubles while I think a lot of the housing problems although behind us are still not off the banks balance sheets and could certainly have another downward spiraal if the economy falters. Keep in mind the market is not as simple as a cause and effect relationship as I have made it, there are multiple combining factors that have consequences that in turn have consequences, and often times the indirect effect is the direct opposite of the direct effect. This is why a lot of decisions have the consequence that is the opposite as intended.
One example is when welfare was created to create fewer poor people. However, it strongly rewarded single mothers, so this removed a lot of the consequences for mothers to have babies out of wedlock. Upon doing this they were given more than enough money to take care of their baby, and the number of single mother births in low income communities skyrocketed. This resulted in over population in poor areas, and created greater dependency upon the government, which resulted in higher taxes, which made it tougher for as many companies to succeed, although you certainly can argue that the government funding can also increase solutions and government grants and such, but what you have to agree with is that a rapidly increasing population is not an ideal environment for employment. Additionally, with it being tough work to find a job compared to filling out a form and getting money from the government, this increased the amount of poor people, not decreased. People want to simplify things so it is easier to understand, but life never is as simple as we want to make it.
Another example might be when government gives a lot of money to businesses for whatever reason and rather than hiring more people, the businesses think “wow, if the government is giving us money, and they want us to spend it, and they are giving us instructions to spend it, things must be worse than we thought, therefore we should raise more money and instead of hiring more people, we should lay off employers. Human emotion and individual thought process is hardly ever in black and white so why should any economic concept be in black and white. “If you give people money they will spend it?” not always. “If you hire more people to work for the government there will be more jobs? Not always, sometimes there will be less because the government jobs may only be needed until a project is complete, and meanwhile the federal (lack of) budget will scare some businesses into fearing higher taxes and to raise more money they may sell assets, move to cash (and sit on it rather than borrow and lend it out and produce), and possibly lay off employees to boost their stock so they have more capital. A lot of things are counter intuitive because the economy is a complex dynamic system. Understand this and you will possibly be ahead of many. Always consider the not so obvious, the unconventional thinking is what will allow you to stay a step ahead, and be bullish when others are bearish and bearish when others are bullish, which allows you to buy low nd sell high. For now I think we are at a crossroads. I certainly see the possibility that value buyers step in and money flows back into the market and everything is fine in addition to the fed using this situation to pump more money into the economy. But there exists the possibility of things selling off and deteriorating as well. I think the prospects of a crash are dangerous here but I don’t anticipate it happening without some kind of fight first, which is why I hold speculative very short term positions and intend to get long term bearish the next time I believe we are overbought and/or near resistance .
Fortunately there are decisions that seem to have negative consequences that have positive ones as well.
10/5 The market closed by rocketing higher and the spy 110 or S&P 11000 area seems to have been defended by the bulls… for now. I anticipate once the bears have momentum back on their side they will push the envelop and the next time bulls may not be so lucky. If they don’t do it on the next attempt, it will be questionable whether the bears can really pull it off. They certainly could miss next time and go one more time, or just grind lower with 4% moves up and down (net result is lower gradually), but at some point, I have to believe the market will flush out the dip buyers by breaking down quickly like it did in August to mark the likely final leg down. If the next leg down is greater than it was in August, then most likely there will still be another leg down according to Elliot Wave theory, which I rarely use as anything other than to determine what “stage” we are likely in of the bear/bull market, and even that is mostly guess work, but it is sometimes a good litmus test. it would not surprise me at all if we peak today and go much lower, but I am not going to get short yet unless we rip considerably higher today.
10/6 All my calls and bullish bets are now off the table. we are around the range I thought we would head to, I am not sure I want to get involved in the market before Friday’s job numbers or over the weekend. However, with that being said I anticipate the contratrend doesn’t have much left in the tank at this point. If it somehow blasts above 118 and closes above that, I would start to be a bit concerned that it maybe is not the time to aggressively bet against the market. Unless you are going to buy a short term call as a hedge against good job numbers or something, I suggest you be patient here. Ideally, we trade up ahead of the job numbers, and continue sideways as they are released and have the opportunity to bet against the market around 116-117.75. I don’t react to news too often, but I do occasionally hedge in anticipation of a major event. For the time being I am in cash, which is a position too.
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