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September 3, 2008

In Play: Patience

It may be time for a bounce in equities, but I'm not rushing to close my shorts. I expect any bounce from here to be a feeble affair, and if it occurs, I will use it to increase my short positions. The NDX best illustrates what I'm seeing:

index chart

The NDX has embedded itself within the range of a significant congestion zone (potential support area) in conjunction with a short-term oversold reading on RSI. We are due for some kind of bounce, but keep in mind that any reprise could be brief. The accelerating downside volume tells us that any bounce is likely to fail. The reason I refuse to cover my minimal shorts here, even though I expect a bounce, is simply because I believe a new bear leg has begun and hence surprises are likely to be to the downside.

The miners were drubbed today, down 5% as a group, and the bloodletting didn't stop even as oil and precious metals came off their lows. The mining ETF, GDX, set new intraday and closing lows for the cascade out of July. GDX foreshadowed the extent of the first wave of selling in PMs and seems to be doing it again. I expect more pain in the near future for both metals and miners.

Eventually, we will get a violent snapback rally. I was hoping such a rally would materialize in late August and carry the metals back up to major resistance points ($16.50 on silver, for example) so that I could comfortably place shorts, but it was not to be. It is tempting to stalk the PM market for the countertrend bounce since these bounces can be sharp (and hence very profitable). However, it is very difficult to catch countertrend rallies because oversold/bought indicators can get quite stretched in the primary direction.

Unless I see a situation in which the bells are going off in my head so loudly that I cannot possibly ignore them, I will probably just exercise patience and short into overbought levels. My strategy for the next year or so... as commodities work their way through a cyclical bear... is to write OTM calls when prices approach resistance. While this strategy limits gains, it has a built-in fudge factor (time premium) and helps me maintain a cool head with regard to the position. So the potential reward is smaller, but the probability of a profit is higher.

 

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