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November 10, 2008

Play the Gap

Very late post tonight. I wanted to mull things over a bit longer than usual because the market has been quite chaotic, throwing wicked curves in both directions. Also, my instinct is at high odds with what I see on the charts. I'm sure many traders will try to impress upon you the importance of following the charts, but folks, instinct cannot be underweighted, especially when you've been watching the stock market for two decades.

My instinct says the mid-term rally is still on and will, in fact, surprise people with its strength in coming hours. The price pattern on the intraday SPX chart says something entirely different:

spx chart

The nature of the price action since Wednesday is easy to separate into impulsive versus consolidative, and the gap that opened the Monday session appears to have ended the consolidative move at an approximate 50% retracement. This action implies a second impulsive move of 100 points from the peak of the consolidation. Target: SPX 850. Lovely.

So why can't I shake the feeling the market will just run higher from here? One reason is volume. If the consolidation ended with the 15-minute spike that opened the session, the rest of the day must constitute the beginning of the next impulsive leg. If so, we should have seen a notable increase in volume today. Just the opposite happened, and not just on the S&P 500.

ndx chart

index chart

Two more "shoulds" for you: if the next impulsive leg down has begun, the market 1) should continue lower immediately and 2) should take out SPX 900 fairly quickly. These facts gives us a tradable plan: if the market gaps up tomorrow, and takes out SPX 930 (exceeding the mid-point of today's range), follow it long. If the market cracks below SPX 900, follow it short.

Given my earlier confusion, I went completely flat near the close with the exception of my minor long play on oil. I will re-open equity positions based on the plan above. Gotta rest now. See you tomorrow.


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