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October 21, 2009

Sucker Punch

Last night's blog post was about two paragraphs long before I realized the banality of the effort. There was simply nothing new to be gleaned from the Tuesday session, despite the fact that it unfolded exactly as anticipated. The pump and dump constructed around Apple's earnings report rewarded traders... who read it properly... as if picking up a pile of cash off the sidewalk. However, it seems the big guns didn't capture as big a take as they would have liked. Another pump was staged in the opening hours Wednesday, and the trap sprung late in the day as the S&P 500 tanked 2% in the last hour.

s&p 500 daily chart

I must say it was a beautifully-set trap. During the length of the rally out of March, a session sporting a falling dollar along with strong outperformance by the NDX over the SPX clued traders into easy money to be had on the long side. Today, the recipe was used to bake up some sucker food. We can now take the opposite clue... given failure under such positive conditions, the odds that we have embarked on a more serious correction have increased substantially. After trapping longs at today's higher prices, stocks will likely not allow for an easy escape. I expect the SPX to quickly move to the 65DMA, meaning we'll likely see 40-50 handles of downside in coming days. As usual, we will observe price behavior around the 65DMA to form expectations over the larger nature of the correction.

Our present anticipation for a countertrend rally in the dollar suggests the timing of this turn is reasonable. It also suggests the correction in equities could run deeper than the typical corrective fare since March. If the 65DMA proves to be weak support, we could see price move to a lower pivot, perhaps SPX 950 or even 875. If the dollar indeed turns higher, it will also produce a substantial headwind for precious metals and miners. My plan for such an environment is to reduce exposure. However, I have no intention of selling any of my precious metals holdings! One has to remember that these are not bets on precious metals per se but rather bets on a falling dollar. Therefore, I will reduce my exposure to a falling dollar. My preferred method of doing so is to short a stock index. Two reasons... First, it is a hedge that should work quite well as the DX labors higher. Second, it would not be out of the question for stocks to tank while PMs hold firm or even rise as the dollar rallies. That is a hedge I can live with!

I will be building a short position against the NDX because I expect tech to outperform to the downside as it has to the upside. However, the timing of my trades will be based on analysis of the SPX, with which I am much more intimate. We're going to need downside confirmation tomorrow, but indications continue to mount that exhaustion of the grand rally is upon us. Bank stocks are weakening. Small caps failed to better the September highs. Treasury bond charts are sporting bearish patterns. The list goes on. Let's see if Thursday can augment the list.


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