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February 1, 2009

When Not to Trade

As you all know, my short-term view of the equity market has been quite muddled recently. I'm sure I'm not alone in this ambiguity. The action has been making minced meat out of traders looking for the typical post-crash bounce and likewise, those hunting a second crash. Granted, we saw a 27% pop off the November low, but given the size of the 2008 crash, many were looking for 40-50%, yours truly included. However, considering the level of the frustration expressed on various blogs, I feel fortunate to have realized my confusion for what it was and pretty much stayed clear of any big commitments in January. In the earlier days of my trading career, I was always eager to pick a side and do something, but I quickly learned that if I traded every time I had an opinion, I'd go broke. There will always be opportunity. The key is to relax and wait for a competitive advantage.

stock index chart

The trade I missed in January was to short the recent approach of the 65DMA on the SPX. It was a low-risk entry and, in fact, may have marked the beginning of a new leg to the downside. The key to direction, in my opinion, will be either a close above the 65DMA or below SPX 800. Here is the reason the 800 level is so important:

stock index chart

Yes, my bias is still leaning toward a near term bounce, but frankly, I don't care if I'm wrong. First, when SPX 800 is eventually lost on a monthly basis, I would expect a back-test before we hit the road to 500, so there will be plenty of opportunity to play the short side. Second, the key here is simply not to be committed long. The risks are just too high, and I'd rather preserve capital for juicier game.

Gold. Gold, gold, gold. (I'm not stuttering... just trying to plant a keyword for search engines). Well, that sure was a nice run from $800 to $925. We now have a breakout on the upper trend line, which of course compels us to hunt for long-side trades at this juncture.

gold chart

I'm still not terribly excited about buying the metal here. Commodity markets have been chock full of false breakouts in recent weeks and besides, I'm simply terrible at chasing moves. I get shaken out too easily in situations like the present. The only change this breakout brings is one of perspective. As long as price stays above that trend line, I will be seeking long-side opportunities. Could gold shoot straight to $1000? Sure, but that's what core positions are for.

So how about commodities in general?

commodity index chart

Perhaps gold will be a leader and continue its breakout, but until the CRB pops higher, I'm keeping a foot planted in the "one more sell-off" camp.

If bonds are ever going to reverse to new highs, now would be the time:

treasury bond chart

If bonds were to shift back into rally mode, I'd expect a giant sucking sound of funds out of the equity market. Should we call it the Perot Effect?

I suppose a clue will soon be provided by trading in the buck:

dollar index chart

If Treasuries head higher, there will be a demand for dollars to buy them, so action in the dollar could help support one case or another. Six days ago, the dollar index hammered a nice reversal off 87, and that reversal is now being tested. A close above 87 likely means we're back to buy bonds / sell stocks, but if the dollar rally fails, the main trade I will want to pursue is long precious metals.

 

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