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September 4, 2008


Despite today's multi-percent rise in my trading account equity, I am pacing around my trading desk, disgruntled. A high level of confidence has accompanied my view that the rally out of July was nothing more than corrective affair, mostly instigated by the collapse of oil's parabolic run, and that sooner than later this rally would fail in epic fashion. Therefore, I have been stalking signs of a turning point in order to push my shorts. Watching the S&P 500 slip 3% while holding only a base short position activated the area of my brain that controls grumbling, pacing, and other functions of discontent.

To be fair (to myself, that is), I did not play this setup inappropriately. I did see signs that the rally was failing and so did not get caught flat-footed. Given the circumstances, it was quite prudent to maintain a base short position. The nice thing about being prudent is that you can still make money (or avoid losing it) even when you're wrong. The disgruntlement stems solely from my hope to have found a comfortable entry point for a significantly larger short position.

All is not lost, however. If we have, indeed, begun the third wave of the decline off the May high, then we still have a long way to go. For the third wave to match the first in size, we should still see 180 points of downside on the S&P 500. That's right: one hundred eighty. As in another 15%. And today's action greatly increased the odds that the third wave has begun. Let's see why.

index chart

It is rare for price to slice its way straight through a heavy congestion zone. It is even rarer to see it do so in conjunction with RSI already in oversold territory. The market is much weaker than even bears anticipated (ahem. that means yours truly). Volume is also accelerating on both the NDX and SPX and the banks joined the fray today, so this late-summer price reduction appears to be the real deal.

Now a quick note on why I am still not pushing my shorts. I simply never chase a move that has already seen 4 straight days in the same direction. It's too easy to get whipsawed like that because snapbacks can be violent. To chase the move now would simply be betting on an outright crash, and while I believe a crash is a higher probability now than during any time in my trading career, it is still simply gambling. No, thank you. I will bulk up on the short side if we get a labored consolidation move that brings us off oversold levels on lower volume. If the market does crash, I'm sure my limbic system will kick into disgruntled overdrive, but at least I'll still be wealthier and disgruntled.

As a side note, the hypothetical straddle described early last week... and tracked on the home page... finally had a significant move as the S&P 500 broke out of its 3-week trading range. A break to the downside was preferred because volatility premiums tend to increase during sell-offs, giving the trade a bit of a kicker. The option pair is now valued at $32.50, up 24% from the purchase price. The current oversold conditions could be used as an excuse to close the position (and if it were a real trade, I would close it), but I'm going to track it to options expiration.


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