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December 6, 2008

Speculative Chatter

We bounce chasers finally have some action with which to augment our rationalizations for a larger rally. After a depressing drop on the heels of the ugly (un)employment report, stocks veered higher and posted a 7% rally from the session low. Managing a rally after bad news is a better sign of bullishness than ascending triangles, basing patterns, or just about any other price pattern, in my opinion. Nevertheless, it is always nice to have the patterns in one's favor:

index chart

If the last five days constitute the trend line crawl characteristic of a scenario "A" outcome, Monday's nasty drop certainly made it one of the ugliest (and costliest) crawls in my memory. To keep this scenario alive, we need to see a continuation of strength during the next 2-3 sessions. An immediate failure to hold above that trend line would not bode well. Also, keep that other eye on the dollar. Friday's rally came in the face of a stronger dollar... also an encouraging sign... but at some point either the dollar or stocks will give.

Scenario "A" setups typically undergo a back-test of the trendline several sessions after the breakout. Given this likely behavior, it is important to realize that we may see lower prices a week or so from now without killing the setup for a mid-term rally, and I'll bet any back-test will materialize in a way that scares weak hands out of their longs just in time to make them miss the spectacular part of the move. Imagine the back-test occurring on one of those 7-8% down days while the dollar lurches to a new high. Think you could hold through that?

Okay, back to the rationalizations. Take a look at the attempts thus far to set a bottom for the crash:

index chart

Not only are the gains of the most recent bounce being held better, but the price pattern after the initial rally looks downright constructive. I'm thinking we make a run at SPX 1000 before getting our trendline back-test. Now, given the slope of the trend line, a back-test could see SPX 850. How many people will be able to hold through another 15% drop, especially if they find themselves chasing the initial breakout up in the SPX 950-1000 zone? Hmmmm.

These musings are, of course, just speculative chatter, but having a framework of expectations helps one understand the action better because the trader is forced to reconcile any divergences from expectations. As for trading strategy, I am sitting on a modest amount of longs which I consider my base positions for a mid-term rally. I will push those bets... or even short against them... as action dictates.


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