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November 1, 2009

Trap Sprung

The bull trap discussed in the last post sprung with force on Friday, surprising even the author who believed further upside would unfold and then be rejected. I was wondering how to reconcile the potential for higher prices with holding the 76 pivot on the DX. Now we know. There would be no further upside.

s&p 500 daily chart

This latter development... the loss of the 65DMA... is of higher importance than the reversal of the swing low, especially since most of the other major indexes did not form swing lows (thanks to Gary for pointing that out in his weekend letter). While the moving average break does not necessarily mean we'll go spiraling into the abyss, the next few days of trading should distance price enough below the 65DMA to set up a back-test. Typically, a break of the 65DMA will result in a continuation of the move to test a major pivot. There are several minor pivots just below the current price, but the nearest major pivot is SPX 950. Given my expectation that this correction will be scary enough to convince traders that the market has rolled over, I would actually be surprised if the SPX didn't find its way down to 950 before the end of the dollar's countertrend rally, and SPX 875 is certainly not out of the question.

Speaking of the buck, it appears the countertrend rally is now in full force. I will remain tentative about buying anything until the DX retraces to its 200DMA. I expect the ride to be choppy, so apart from equity index shorts, I probably won't be doing much trading over the next several weeks unless the outlook changes.

Gold has held up amazingly well considering the dollar strength and the 15% liquidation in mining shares. Our little yellow friend is off a mere $25... barely 2%. This strength is a testament to the fundamentals and gives us a hint as to how potent a move could be in store for gold once the dollar cracks again. I remain heavily long precious metals and mining shares simply because one never knows when the dollar event will occur. It would be convenient if the DX retraces to its 200DMA as I currently expect, thereby providing a low-risk entry for leverage, but there is certainly no guarantee events will unfold that way.

Now for a little reflection. A couple months ago I suggested waiting for a break of the 65DMA to initiate equity short positions. Those with such patience (I wasn't one of them) would have dodged the rise from SPX 900 up to today's break at SPX 1040, as well as a lot of the pain from the May and June chop shop. If SPX 1100 turns out to be a significant top, traders would have also missed the top by 60 handles... seems like a small sacrifice at this point, doesn't it?


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