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August 4, 2006

Risk Control

It scares me when the market is this predictable. It usually means I'm being set up to make an overconfident bet in the wrong direction. As anticipated, index futures leapt after a weak jobs report was published. The biggest gainers, as has been the theme for several days, were financials and home builders. Tech also popped about a percent on the open. However, the gains started to erode quickly, and eventually the session ended with losses. Did traders connect the dots and decide that such poor job creation means the economy is slowing means earnings will fall means sell stocks? I am hesitant to give those eternal optimists such credit. Profit-taking ahead of the weekend is a more likely explanation.

Last night, as I was diving into some charts, I took a guess that the S&P 500 would have about 10 points of upside should the jobs report support the Fed-pause theme. I usually don't spend a lot of time guessing the sizes of moves, but since I am hunting for entry points for shorts ahead of the Fed meeting, I figured the effort may be worthwhile, if not entertaining. Indeed, the index showed a 12 point gain not long after the market opened, and then started to weaken. About an hour into the session, I decided there was a good chance we'd seen the highs for the day, and that the morning pop would prove to be just a reaction and not the beginning of a full-blown party.

So I started shorting.

My first victim was New Century Financial, a mortgage broker which beat its number yesterday, maybe for the last time in many quarters if what I'm reading about delinquencies is true. Though the shares gapped higher today, I thought the price being offered was worth selling. Then I sold some tech. When the market continued to fail to bounce, I sold the S&P itself. I targeted an intraday support line for my S&P trade, but keeping in mind the overconfidence trap mentioned above, I closed the trade before reaching support. That the S&P failed once again to hold 1280 makes me wonder if I should have held the position, but a trader has to do what he or she is comfortable with. Otherwise, one ends up exiting with a weak hand instead of a strong one.

Next week finally brings the much awaited banter from the FOMC. I look forward to it, if for nothing else, so we can just stop talking about it.

Disclosure: Short NEW


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