Chess Moves

As noted in this tab on May 12, I bought $TZA, $SKF and $SDS to play the short side. I only bought each position in 1/3 size of what I would consider to be a full position.  As luck (sort of) would have it, literally since the moment that I bought those inverse ETFs, we have gone straight down 50 $SPX handles. Stairs up, elevator down, to say the least.  At this point, I believe it would be a mistake to add to those positions here.  The closer we get to the 200 day moving average, just above 1100 and rising, the more inclined I am to take any kind of short exposure off of my books.

Thus, I have sold out of those three ETFs.  $TZA at $6.50 (bought at $5.75 as documented in The PPT).  $SKF at $20.51 (bought at $18.32 noted in The PPT), and $SDS at $32.89 (bought $30.38, see The PPT).

I have also fully sold out of longer term trades–long $BZ, $SWHC and $VCI.

I am currently in 100% cash, and remain convinced that is the best course of action for now.

Despite ending the week higher, the bulls continue to lose control of this volatile market.  Earlier in the week, many traders pointed to the exuberant bounce as a good indicator that we would revert to the previous instances since March, 2009, of disappointing the bears just when it looked like we would fall off of the cliff.  However, this time around the rally was sold–and sold hard–on Thursday and Friday to close out the week.

The main reason why I say that the bulls are losing control of the market is because we have lost several key battleground price levels and reference points.  The daily, updated, annotated chart of the $SPX shown below should illustrate these arguments.

Please note that I have included the 150 day moving average in the chart.  The last time that I discussed this moving average was back in February (in the Peanut Gallery), when I saw the bulls begin to take back the initiative in that quick and sharp selloff.  I believe that you should be keying in on that reference point this week.  It is currently at 1124.

Let me be clear that moving averages are not a place where you should have limit orders ready to buy hand over fist. Rather, they should be used to gauge just how powerful, indeed, the underlying bid to the market really is.  Beyond the 150 day m.a., the overall market continues to look weak, as we are breaking down below a bearish wedge.

Because we remain firmly below the 20 and 50 day moving averages, in addition to many charts being broken, I believe that the overwhelming number of longs should not be taken for anything more than daytrade at this point.

I think that a similar type of analysis applies to the Nasdaq daily chart, seen below.

Although the Nasdaq, unlike the S&P, is still (barely) holding the January resistance levels, the semis have been noticeably weak, and in fact they have been one of the leaders to the downside. Their sector ETF daily chart indicates as much.

I would resist the urge to bottom pick the Nasdaq and the semis, for now.

Of course, much of the news driven nature of the current market is due to the weakness in the Euro.  The Euro has long been regarded as a proxy for either risk aversion or strong risk appetite. I would be remiss not to update a chart of the ETF of the currency for you.

Again, this is another chart where you want to resist the urge to call a bottom, until you see an inflection point and a sound base. Obviously, we are not there quite yet.  In fact, there remains a serious downside risk.

The oil space has been getting hit very hard as of late, and the oil service sector ETF chart indicates that the weakness is showing no signs of abating.  In fact, I think this a significant breakdown that will need weeks to heal.

Turning to metals now, if you have missed an entry point in gold and/or silver, their charts remain constructive.  I would use any orderly pullback as a good opportunity to accumulate.

Finally, two key individual stocks that I am keying in on this week are $NFLX and $GS. I have no position yet, but I view $NFLX as an excellent short selling opportunity, as evidenced by the chart and my explanation seen below.

Note that on Friday we began to see confirmation of the bearish shooting star, as the stock was down 8.59% on above average volume.

$GS spiked down and has been in a falling wedge pattern for about a month. Volume is drying up, and so are price swings. Moreover, the stock is at a key support level from the summer of 2009.  Basically, the stock is on the cusp of making its next big move.  Be ready to jump on and ride the move, whether it is up or down.

Above all else, I believe that cash and patience are my best ideas in this current market environment.  It sure would be fun for me if I could give you 10-20 charts of stocks looking ready to break out.  However, we are simply not there yet.  The charts need some time to erase the froth and complacency before resetting.

As frustrating as it is to sit in cash and watch, I think it is important to remember that we are playing a serious game, with high stakes here.  Discretion is the better part of valor.

As I detailed in one of my posts yesterday, the market has a knack for turning the expected into the unexpected.  After several quarters of the market climbing a wall of worry on low volume, technically shaky bounces after sharp corrections, many traders went on tilt and shrugged off the idea of shorting in the face of a bearish setup.  I believe the crucial difference now is that within the past few weeks we have regained many or all of the losses from the 2008 crash.  The wall of worry became awfully slippery the higher up we went.

This time around, bears and heavy cash holders have been rewarded with a market that was set up technically very bearish, and followed through accordingly with price action and volume.  As I am writing this, the $SPX Is off 2.28% at 1131, as we have lost several key levels of support.  Because of the ferocious nature of the selling since 2 p.m. yesterday, I have not had a chance to add to my 1/3 positions in my three inverse ETF holdings–$SKF, $SDS and $TZA.

The 30 Minute chart of the $SPX indicates that we may have more room to fall from here.

Look for possible support at the 150 day moving average at 1124, as well as the 200 day m.a. at 1100.

The Euro also remains under pressure, and if it cannot catch a bid here, it looks as though it will fall back to where it was at its inception.  Here is the monthly chart.

Eventually, we will see actionable swing trading setups on the long side.  For now, however, many charts are either broken or are in the process of breaking down.  Thus, resisting the urge to bottom pick is important.  Likewise, given how much selling we have seen in the past twenty hours, initiating or adding to short positions is probably not a good idea at this point.

Hence, patience and a heavy cash position reign supreme.

After trading in a tight range for most of the day, the $SPX sold off sharply into the bell to close down 1.22% at 1157. Despite making several attempts at recapturing the 50 day moving average, the market rejected that price level today.  However, there are several key support levels below where the bulls will likely try to take a stand. Because we remain in a choppy, uncertain, news driven environment, a large cash position remains preferable.  Aggressive traders can have some short exposure, while any longs should probably not be initiated for anything more than a daytrade at this point, given our position below the 20 and 50 day moving averages.

The key support levels are 1155 and 1150, while the key resistance area to watch is the 50 day m.a. at 1174.

The semis had a notably weak day today, as their sector ETF chart indicates.

I am looking for more short exposure on further weakness here, to compliment my existing short position in the financials.  The financials ETF chart, updated from yesterday, continues to look bearish.

Many traders are keying in on the Euro for a variety of reasons, namely as a gauge of either risk appetite or risk aversion. The ETF shows us that the currency is at a crucial level right now.

Finally, here are updated gold and silver charts. I still like both metals, as they appear to be taking a healthy short term rest.

Ever since March 2009, virtually every time that we have had a market correction it seems as though we have been on the verge of ending the bull run and starting a new phase of the bear market.  Often times, however, just as it seemed as if the bears were about to push the broad indices down through their respective 200 day moving averages, the market would stop on a dime and proceed to sharply turn up on low volume and make new highs.

This phenomenon has been especially frustrating to many traders who were not already fully invested, because they never really got a good chance to reenter.  Many technical traders, in particular, missed out on a lot of those moves higher because they either sat out or decided to go short.  Needless to say, they either missed out on some big profits, or lost a lot of capital trying to go short (or both).  Indeed, the correct play was to simply go along for the ride and chalk the whole thing up to us climbing the “wall of worry” that the early to middle stages of bull markets are so famous for.   It was also correct to dismiss the low volume rallies as being due to the fact that we had a huge gap/vacuum/void to fill from the crash of 2008, which had alleviated a significant amount of selling pressure.

At the beginning of this month, however, several key indices and sectors had recovered many or all of the losses from pre 2008 crash levels.  Because of that fact,  the notion of ignoring the low volume on rallies has become less and less valid. Beyond that, many key leading stocks since 2009 have either become too extended, or have broken down on heavy selling volume.

One trend I am noticing amongst traders is that they have grown so frustrated with trying to short technically weak charts, that they are now using what would normally be their own sound analysis as a contrary indicator.  Instead of going short, they think “I really got squeezed hard the last few times I tried shorting this stock that was up against heavy resistance after a weak volume rally.  So, this time I will go long, even though I know this is a short.”

That kind of thinking can be very dangerous for several reasons.  First off, as I noted before, the market has now effectively filled most or all of the huge gap created by the 2008 crash, so the drift up unsupported by volume argument is weaker than before. Next, to use your own sound technical analysis as a contrary indicator is a mistake because you are allowing the market to throw you off your game–or effectively put you “on tilt.”  The phrase, “on tilt” is a common term used in the poker world, whereby a player loses his cool and changes his playing style for the worse due to a multitude of reasons.

One example of going on tilt would be if you are dealt pocket kings before the flop in a Texas Hold ’em poker game.  You raise, and an opponent goes all-in.  You ponder if your opponent has pocket aces (the only hand that has you beat), but eventually you correctly call, as your opponent turns up pocket queens, meaning you are a huge favorite to win.  When the dealer flips a queen on the board with no king in sight, you lose all of the money you had in front of you.  Despite the painful short term result, you made the correct long term decision. In other words, if you keep making that same decision over the long run, it will be profitable. The odds of another (regular playing) opponent having pocket aces in that situation are not great enough to compel you to fold.

However, you become extremely frustrated from the short term result and think, “Well, if I cannot win playing good cards and making good decisions, then the hell with it.  I am going to gamble it up and play whatever crappy cards I want.”  It is exactly this kind of emotional, knee jerk response that causes otherwise good poker players to go on tilt, and to go broke.

In the stock market, not making those same knee jerk trading decisions based on painful short term results is equally as important, so long as you are making the technically sound decision that is profitable over the long run.

The bulls managed another impressive recovery today, as the $SPX rose 1.37% to close at 1171.  We have now convincingly closed above the 1150 area, which has been a key zone since January.  We also closed pinned against the 50 day moving average, which sets up an interesting scenario going forward.  On the one hand, we have seen a fast and furious V shaped recovery from last week’s high volume selling event. On the other hand, we now find ourselves back to where we were the day before the flash crash.  Beyond that, we are directly below the choppy and ultimate toppy trading range where we spent the entire month of April.  As you can see in the daily updated chart below, you really have to question how much more upside the bulls have left in the coming days.

Moreover, the volume today was far from inspiring.  Thus, despite (or perhaps because of) the exuberant rally that we have seen this week, I initiated several bearish bets today.  I went long three inverse ETF’s, $SKF (double short financials), $SDS (double short S&P) and $TZA (triple short small caps).   I did not buy what I would consider to be full positions in any of them.  I am simply putting my money where my analysis is for now.  If my thesis proves correct, I will likely add more.  If I am proven wrong, I will sell all three within a matter of days.  I still hold a large cash position north of 55% of my portfolio.

One of the main reasons why I have chosen to bet against the financials is because of the unimpressive nature of their sector ETF chart, shown below.

Clearly, the time to initiate a short position here was not in the middle of last week.  However, now that the gap has been filled back up to the trend line, I see an edge as a swing trader here to the short side.

The small caps are also showing a weak daily chart.

Perhaps I am completely wrong and we will blast through what should be strong resistance.  Frankly, if that happens I will be a big boy and take my lumps. I think your job as a swing trader is to conduct rigorous analysis on a daily basis while looking for potential trades that have an edge, where you think you will profit over the long run by using that same analysis, regardless of short term results. Here, we have seen a heavy volume selloff followed by an immediate V shaped low volume bounce right back up to a heavy congestion zone that trapped many bulls before we broke down.

By all means, if you have been sitting in a lot of cash and do not want to go short here, allow me to be the sacrificial lamb. I believe that I have made the proper diagnosis and that I have an edge for this trade, and I am willing to accept the risk that accompanies it.