An awful month

Fort the most part this past month has been awful for traders. The market lacks clear direction and the volatility creates an environment where Technical Analysis is almost useless. There - I said it - Technical Analysis is almost useless. Over the past month I have had some terrific gains but have had even more "terrific" losses. Currently I am on the sidelines in observation mode, although I do have a small delta positive investment position. I believe there is some upward movement in our distant future so my bullish position is made up of stalwarts such as AA, CAT, DIA, GE, and XLF. My strategy is to collect their dividends and sell Covered Calls at the height of the bounces. If they get called away, then that will be evidence that the bull is back and I can start counting on some upward direction.

This is a good time to exercise patience and invest in education.

The passing of the Bailout Bill

This has been an unprecedented week in the financial markets. First the House does the right thing by asserting the will of the people and rejecting the Financial Market Bailout Bill. The Dow Jones Industrial Average falls 777 points - the biggest one day point move in history. The House goes on recess. Next the Senate gets a hold of the Bill and adds a ton of "pork" to it in order to purchase "aye" votes for passage. After passing on Wednesday evening in the Senate the index futures sell off and set the market up for another 340 point drop the next day. Back to the House...the "pork" works its magic and the required number of "aye" votes are garnered. The Dow was up 250 points prior to the vote and sold off 400 points closing down 157 on Friday. Glad that's all behind us now.

Now what? Let's step back and look at the big picture ($DJI 10 year monthly):


You can plainly see that just 3 days into the month of October the Dow has penetrated a key (50%) fibo level as well as an uptrending linear regression line. These broken support levels foreshadow a continued bear market that will take the Dow down to the 9900 level in the near term. If that level doesn't hold then we will probably see 9000 and may be looking at a complete retracement of the 2003 - 2008 bull market which would take us to 7250.

How about the S&P 500 ($SPX 10 year monthy)? Take a look:


We blew through the 50% fibo last month and have not looked back in October. The next key level of support is 1075 where the 61.8% fibo and an uptrending linear regression line converge. If that support level fails we could free fall to 925.

Bottom line for me....this is bear market and I will continue to trade it like one. Although the VIX is quite high at 45+, I am not convinced that we have reached capitulation. The ban on short selling will expire next Thursday night and that should bring some sanity back to the market. Ironically, it may be that singleton event that turns this market around. We shall certainly see...

Huh?

This past month has been full of craziness - so much so that I have had nothing constructive to say in my blog. That doesn't mean I haven't been profitable, in fact the past month has been the most consistently profitable trading my account has seen in quite sometime. Many friends have recently asked (somewhat fiendishly) how I'm doing in the market - they are obviously looking (dare I say hoping) for me to say that my ROI has been at least as poor as theirs. When I respond that I have done quite well by taking advantage of the downward move in the overall market I am often met with silence, or a stare that says "Oh, you must be one of those anti-American short sellers that I hear about on CNN." Nothing could be further from the truth and I would like to devote this blog entry to the explanation of how to capitalize on a down trending market.

But first things first...I don't short sell equities. Period. I believe an outright short sale of a company's stock is a bet against the company and the hardworking people that are employed there. It's a personal thing for me - I don't necessarily think short selling is bad, I just don't do it. Short selling plays a vital role in free and open markets by embedding stock buyers at various price levels. If someone borrows a stock from their broker and "shorts" it they have to "cover" at some point by buying the stock back and returning it to the rightful owner. If they buy it back for less than they sold it for they make a profit and if they buy it for more than they sell it for they take a loss. It is this required buying that puts the brakes on a downtrending stock. When you look at an overall downtrending chart and see upward spikes in the price action that last for a couple of days before resuming the downward trend you are witnessing what is known as a "short squeeze". The short positions are buying to cover and driving the stock price up. Not until all (or most) of the shorts have been forced to cover will the price back off and continue downward. If that forced buying wasn't embedded in the markets you would see out of favor stocks (poor earnings, missed FDA approval, false rumors, true rumors, etc.) plummet without pause because there would be no buyers - and that is bad for the company's stock holders, employees, and the market in general.

So....how do I capitalize on a down trending market? I use Options and ETFs (Exchanged Traded Funds) to assert my bias against other market speculators.

If I think the S&P 500 (for example only) is going to tank I step back and watch it...and look for a high probability trading opportunity using equity options to define my projection. When I buy a put (or sell a call) I am taking a bearish position against the speculators that are thinking otherwise. That's what options provide - an alternate market that allows speculators to trade against each other. When I take a bearish option position, I'm taking the other side of another speculator's bullish position - they are typically buying a call (or selling a put). In the end, only one of us is correct and gets paid - the other has to pay up. In this type of market, the speculators are asserting their views against one another and are not directly influencing the price action of the underlying stock. The price of the options are determined by various things - the price of the underlying stock, option supply and demand, time remaining until option expiration, and volatility.

It bears mention at this point that I very rarely trade an individual company equity. Almost all of my trading is done on index and sector ETFs. This limits my risk by reducing my exposure to the unexpected swings of a specific stock in the event of unexpected news or reports. ETFs are often called a "basket" of stocks. One of my favorite trading intruments is the DIA (called the "diamonds"). It is an ETF that tracks (pretty closely) the Dow Jones Industrial Average. When the DOW moves up 100 points, the DIA moves up 1 point (dollar). I typically trade the DIA using complex option strategies that allow me to have defined risk but limited ROI - a trade-off that I am more than happy to make. For example, if I forecast that the DIA (and by extension the DOW) will not fall below $110 in the next 30 days I would sell a DIA OCT08 110 PUT and purchase a DIA OCT08 108 PUT to hedge the position. This is called a credit spread and basically allows me to keep the difference in the 2 prices if I am correct in my forecast. I will dive deeper into credit spreads in my next post...

No time like the present

I have been patiently waiting for the DIA bounce to de-materialize and I think we finally have a break of the flag pattern's lower trend line. Check it out...

I am quite excited about this week and the near term future as the DOW (and subsequently the DIAmonds) sets up for a significant plunge. As of this writing the E-mini DOW futures are showing a morning opening below the trend line. I expect that buyers will step in and force a test of the ascending trend line - if that test fails to break through then the bears will be out in force with a DOW target of 10200 (102 on the DIA).

The SPY has the same basic pattern as the DIA, but has not put in a close below the ascending trend line:


That said, it pierced the 38.2 % fibo with conviction - but the trend line held and the lower tail kissed the 20MA so there is a touch more support to crack. Some bad economic news in the morning should soften these support levels up nicely and bring the bears out looking for 113 on the SPYders.

Bottom? or Bounce?

On July 16 the VIX pierced the 30 level before backing off and closing the day with a long shadowed "doji" - indicating a fear spike during the day followed by some complacency and ultimately indecision by the time the closing bell sounded. Previous spikes above 30 have been the harbingers of significant downtrend reversals and are usually followed by an even more extreme "fear spike" that takes the VIX well into the 30s - thats exactly what happened on the 17th. The VIX move on the 16th and the big volume associated with it convinced me to clear my bearish positions. On the 17th the VIX and broad market price action validated my position change and started moving my hedges (bullish positions) in the proper direction as well.

About my hedges - as the broad market was dropping I made the (well founded) assumption that the market wouldn't fall forever (duh!) and that as we went to lower and lower price ranges my confidence was going to erode. So, as the down move was underway I hedged with some various trades (see My Current Positions). Now granted, I came to the party a bit early so my hedges are well under water at this point - but I have been sleeping like a baby for the past month! Yesterday's big move in the market has put much of my hedge close to break even and is showing potential for some profit in the near term (love the puts I bought on the SKF!!).

Now the big question - bounce or bottom? I think it is too early to call a bottom, but I am convinced that we have the making of a decent bounce underway. Today (the 17th) should confirm or deny my outlook - but since we have option expiration this week (and earnings!) I will try to stay nimble until we print some candles early next week. For now, you can see that I have a bullish bias in my positions - but since they were hedges against my extreme bearish sentiment over the past month I will be happy to bail out of them at break even or small losses. Any profits I pickup from the upside is just icing on an already very tasty cake.

111 on the DIAmonds...

...is the last level of meaningful support (38.2 fibo drawn from the 10/10/02 low to the 10/11/07 high) - after which we have some minor support at 107 and 105 before hitting the 50% retracement level of 102. I'm anticipating some froth at the 111 level but in the end I believe a dead cat bounce will provide just the energy needed to crack this support level.

Also the declining volume on the subsequent big down days tells me that we have not yet reached the bottom. I'm looking for a big volume event on a substantial distribution day to mark the end of the downtrend - capitulation - but we ain't there yet.

I sold my DIA puts for a tidy profit in anticipation of a short bear market rally (or in the event that the 111 support holds), and have lightened up on my other broad market index ETFs. One exception - GLD - I bought puts today as GLD was banging its head on 93. The range between 85 and 93 has been pretty solid and I continue to trade this range with options.

Capitulation? I think not...

As defined by Investopedia, "capitulation" is associated with giving up any previous gains in stock price as investors sell equities in an effort to get out of the market and into less risky investments. It usually involves high volume and sharp declines (also known as "panic selling"). Are we there yet? When I look at the price action of the broad market ETFs (DIA, SPY, QQQQ) and listen closely to what the VIX and VXN are whispering, I'm not convinced. Certainly the sharp decline is evident, however, I'm NOT seeing the volume I would expect from panic selling and short interest continues to climb.

A closer look at the VIX...



...shows a repeating pattern - a pause at the current level before the VIX moves significantly and sharply higher. These past VIX moves correspond to "dead cat bounces" in the DIA, SPY, and QQQQ before heading to much lower levels. 117 looks like a certainty on the DIA, the SPY could go all the way to 125, and the QQQQ will test 46 before moving into the lower 40s.

I continue to hold my PUTs on DIA. SPY, and QQQQ with some calendar spreads to hedge. GLD is very frothy but is trading in a range so I'm moving in and out of the newly available options pretty regularly and clipping a few bucks each time. I'm out of GLD as of today with a nice profit on the gap down. A move to 85 would make me think about getting long for a short term bounce back up to the descending trend line.

The Diamonds

In my previous post I made a clear distinction of the relationship between the VIX and the broad market indexes. I consistently trade the DIA (a.k.a. "the Diamonds"), SPY ("the Spiders"), QQQQ ("the Cubes"), and IWM ("the Rut") - I consider them to be the cornerstone of my trading strategy. I am almost always hedged in these instruments and rely on them for steady growth and income. I am also inclined to speculate on individual stocks (usually using options) and partake of some of the "ultra short" products that are around (SDS and SKF are favorites).

Anyway...back to the VIX. The VIX is an index that measures fear and complacency in the market. Basically it is calculated by measuring options activity and plotting it over time. When the VIX is low then there is lots of complacency and everyone is feeling pretty good - the price of stocks fluctuates in a narrow or "normal" range. When the VIX is high there is a lot of fear and so the price of stocks fluctuates widely.

The VIX is a "contrarian" indicator, meaning that it should be interpreted as being inverse to the market. The old saying goes: "If the VIX is low its time to go and if the VIX is high its time to buy". Bearing that in mind, if you look at my previous post and the associated chart you will see that I pointed out the relative "lowness" of the VIX and correlated it to the SPX and DOW. Clearly on May 19th the VIX was saying "time to go". At that time the DOW, S&P, and NASDAQ indices all rolled over and started heading lower. I was mostly in cash so I quickly bought PUTs on the DIA, SPY, and QQQQ. I also went long the SDS and wrote some CALLs against that position. My hedges have been some short term trades of the indexes on the bounces and a couple of stocks (like AAPL) to catch the upside when it occurred. So....I can say that when the VIX whispered in my ear a couple of weeks ago, I'm awfully glad I listened!

Where to now? Good question! My bet is on a continued downward movement of the broad market, although I've substantially lightened up on unhedged PUTs in favor of some complex option spreads. (My trading mantra is "defined risk, positive time decay".) Today's price action and VIX behavior makes the near future look like party time for the bears...but I'm not immune to fear - as the VIX rises so does my concern. This is not a time to be greedy...this is a time to be smart.

Talk to me VIX

Having survived the dogfight of expiration Friday somewhat intact, I find myself leaving the scene in a kind of bleary-eyed, preoccupied stupor - heading away at Mach 1, yet knowing in the back of my mind that I should re-engage. I reach deep into my soul and call out desperately for my long lost flying partner for help..."Talk to me VIX". In an instant I'm pulled back into the fray - re-energized, refreshed, and ready for battle. My old flying partner has revealed some much needed insight. I have managed to keep enough powder dry to finish what was started - victory will be mine. Now if I can just find that darn aircraft carrier...

The VIX is speaking volumes about the current market conditions - coupled with the DOW and SPX banging their heads on some very formidable overhead resistance, it seems like the end of the bear rally might be upon us. The VIX is showing the same level of complacency we saw back in October just as the market hit its highs and rolled over big time. The SPX has shown some strength in climbing back from the lows of 1275 but it has not been an easy climb. When it broke through 1385, the talking heads were quick to proclaim the bottom had been put in and we were turning to the upside, but follow through has been weak on mediocre volume. The cash is still on the sidelines. The DOW is no different - also banging up against the 200 MA and showing even greater weakness than the SPX. The DOW just can't seem to break through 13,000.

So...what am I doing? I'm mostly in cash but have some speculative PUTs on DIA and am long SDS. Up until today I was holding onto GLD for a hedge but decided to take my profits due to the weakening of the metal commodities. Also long some DUG - a small speculative position that is looking for a decline in Oil prices. I'm excited about the market opportunities that are in front of me. I'm looking for the VIX to start to move up and confirm a rollover in the broad market. Just gotta keep a clear head and listen to my gut.

"Requesting permission to buzz the tower".

The AAPL of my eye

Coming off the recent GOOG debacle in conjunction with yesterday's selling pressure on AAPL I couldn`t help but take a long position before yesterday's close - so I got in at 160.80. My thinking was that everyone will be looking at AAPL today but thinking GOOG and that will give me a nice pop in the morning, but I should be thinking to close out at 10-10:15 - before sanity breaks out. Granted a more gutsy move would have been to stay in it till late in the day (but I have a rule about knowing my exit before I enter), but I closed out a little after 10 at 164.40. Good trade - I'm happy. Now...I'm absorbing the AAPL earnings and guidance and am thinking about that lovely gap down below that was created a couple of days ago. Its 3 points from the 50% fibo at 159.20 to the bottom of the gap at 156. We've got some market movers reporting before the bell - I like my chances of filling that gap and will be looking for a short entry first thing in the morning.

SPY - take 2

The SPY didn't confirm the breakout above the inverted H & S neckline so I left it alone, however, the weakness got me thinking about the SDS (Ultrashort S & P 500 ETF) and SKF (Ultrashort Financials). Neither made very big moves, but they were fairly predictable and provided some nice day trade profits. Tomorrow is another day for the SPY - with AAPL reporting after the close you may have to wait another day for the big SPY bull move but I can be patient. Just keep watching that neckline for a strong break above. The bottoming tails on the last 2 daily candles tells a story of bulls that are chomping at the bit. Lastly, take a look at the AD study on the following chart - the institutions are accumulating.

SPY - what's the story?

I'm looking long and hard at the SPY after it closed today and I'm of the opinion that we are seeing an inverted head and shoulders pattern confirming with a neckline at about 138.50. MACD, STO and RSI show bullish strength - and the OBV is started to climb out of the doldrums. Combined with the general herd mentality that *wants* to take the market higher, I think we have the potential for a pretty significant upside move. We have some formidable overhead resistance - the 78.6 (140.26) & 61.8 (143.61) fibos, a downtrend line, and a 200 MA - so things could go either way, but we are at a short term pivot point (138.55). As of this writing, the futures are down a bit, indicating that we might test the bull's resolve in the morning. Today's light volume only validates the basic indecision of the market but tomorrow's earnings announcements should remedy that (AT&T, Coach, Dupont, McDonalds, etc). If the open is strong and holds until 10:00, I'm buying.

Watchlist weekly wrapup - Mar 28

28-Mar-08
Symbol	Comments (based on 3 Month daily chart)
AAPL	filled gap on daily, encountering overhead resistance at 145
ABX	massive unimpeded selloff as institutions abandon precious metals, encountering overhead resistance at 45
ACH	found support at 35 with renewed institutional interest but on light accumulation volume
AIG	downtrend continues with overhead resistance of the 30MA
AMX	moving sideways with support of 30MA
AMZN	moved up thru 30MA to resistance at 75, pulled back to 30MA
AVB	strong m,ove up thru 30MA making a higher high, pulled back to 30MA
AZO	sideways around 30MA, made a lower high
BEN	moved up thru 30MA to resistance at 105, pulled back to 30MA
BG	big downward move with rest of market and restatemet of Sales, finding support at 90
BIDU	selloff made lower low, moved back up to 30MA
BNI	making higher highs in spite of overall market, pullbaclk to 30MA underway
CAT	making higher highs in spite of overall market
CB	selloff fpund support at 49, consolidation underway below 30MA
CF	lower low, below 30MA
COH	strong move up off of base thru 30MA to overhead resistance of 33, pulled back thru 30MA to support at 29
CROX	downtrend
DE	lost the 30MA on strong volume, support at 80 and overhead resistance at 30MA
DRYS	downtrend seemed to find support at 55, move back up to 30MA stalled
FCX	moved lower thru 30MA to support of 85 with general commodity selloff, bounced back to 30MA making a lower high
FSLR	moving up on renewed institutional interest, encountereing overhead resistance at 230
GLD	hit 100 and then sold off thru 30MA, made a lower high, looking for support
GOOG	downtrend moved up to overhead resistance of 30MA
GRMN	bottoming out at 55 with some institutional accumulation getting started, encountering overhead resistance of 30MA
HOV	moved up thru 30MA to overhead resistance of 13, pulled bacl to 30MA, institutional accum continues
HPQ	sideways movement cut thru 30MA
IBM	established higher high then pulled back to 30MA
JASO	quick move up thru 30MA with renewed institutional interest
LEH	downtrend pausing at support of 37
LVS	downtrend
MA	punched thru 30MA and overhead res of 210, bullish technicals, higher highs
MCD	basing just above a sideways moving 30MA
MMM	basing just below a sideways moving 30MA
MON	strong move up pushed thru 30MA, basing just above a sideways 30MA on light volume, EARNINGS!
MTD	downtrend
NIHD	downtrend
NOK	downtrend
NRG	reversal moved down tru 30MA to support at 37.50
NVDA	downtrend found a bottom at 17.50, encountering overhead resistance of 30MA
PCAR	higher high with pullback to 30MA
POT	enountering overhead res at 165
RIMM	bounced of of 30MA to make a higher high, EARNINGS!
SKX	lost 30MA, at support at 19, lower high
SNDK	downtrend
TSO	downtrend
VIP	downtrend
VSEA	downtrend
WCG	basing
WFR	big move down cracked 30MA, big volume selling
XOM	consolidating around 30MA
DBA	big sell off
DIA	moved up thru 30MA
EFA	moved up thru 30MA
EWH	overhead resistance at 30MA
EWJ	moved up thru 30MA
EWT	big move up on strong volume then sellof to 30MA on volume strength
EWZ	downtrend pushed thru 30MA
IWM	pushed up thru 30MA on light volume, lower low, at support of 30MA
IYR	rapid move up thru 30MA to overhead res at 68, puooing back to 30MA
OIH	consolidating at 30MA
QQQQ	broke thru 30MA, pull back to 30MA
SMH	sideways, congestion at 30MA
SPY	lower lows
USO	sustained upward movement with pullback and bounce off of 30MA
XHB	triple top with pullback to 30MA
XLB	consolidating at 30MA on light vol
XLE	pullback to below 30MA
XLF	lower lows, lost the 30MA
XLI	moved up thru 30MA on light vol, encountering overhead resistance at 38
XLU	congestion below the 30MA, at support of 37.50

IWM finally cracks

A glorious day indeed with the IWM retacing to the 50% fibo! While I probably should have covered my short position going into the weekend, the big body red candle, trendline break, 50MA and 30MA breaks all convinced me that there is more downside room. The technical indicators continue to rollover so I'm still in. A little more volume would be nice on these down days but I like the steady decline of the various A/D indicators, showing that big money is moving out. Nice tight stops will keep my profit locked in, but I'm not in any hurry to get out. A full retracement to 64 would be just fine thank you.

IWM - the ongoing saga...

The IWM continues to be a bit fickle during intraday trading, but it ultimately finished the day by retracing to exactly a point of fibo, trendline, and 20MA support. A welcome move for the bears indeed, however, we now sit at a pretty significant support level. Volume is still quite light with just over 57 million shares trading today. On Balance Volume is about 1 Billion - it was 2.4 Billion on Oct 9 (the last white candle before rolling off of the highs). Offsetting the "support" issue is the fact that several technical indicators are rolling over and Historical Vol is at the highest its been since mid 2002. I'm hanging onto my puts for now and watching to see which way things move when we get some volume strength.

Free money from AAPL!

After the gap fill I like the short side of AAPL. Bought puts when it kissed the intraday downtrend and now looking at the fibo kiss for another set of puts.

IWM Setup for Mar 27

Nothing serious happened above the 70 so I stayed away from the short term long. The low volume kept me from adding to my PUT collection. I'm short LEH, IBM, and XLF as well - all quite profitable today. AAPL is my favorite stock to day trade - I love the big moves it makes and lately it has been quite predictable. I was in and out of Apr08 100c and 170p all day. Great day!

IWM setup for Mar 26

While the IWM fights with resistance at 70, it's clear break through the established trendline could mean a run for 72 is in order. The low volume on this trendline break makes it doubtful so I have opened a short position (long May08 80p). A significant break above the fibo at 70 will make me a short term buyer - out at 72 and then open more shorts.