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Seven More Reasons Not To Be Long
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Seven More Reasons Not To Be Long

Seven More Reasons Not To Be Long

by The MoleAugust 12, 2012

Let me precede this post with a warning: I am not saying that it’s impossible for equities to push any higher. Quite on the contrary – there are signs that indicate that we soon may run into a little short squeeze. If that outlook sounds contradictory to you then you may want to go back and read Volar’s excellent excerpt on platykurtotic vs. leptokurtotic markets which he posted almost a year ago. Simply put – it all depends – August is a good month for trend traders and if you are betting on mean reversion you may get burned.

Now as stainless steel rats we are sworn to trade by our rules (whatever they are) and to only take setups which strongly suggest that the odds are in our favor. And it’s that last little detail that is the problem right now – momo and sentiment is all over the place.  Meaning if you look hard enough you will find plenty of reasons to be short and plenty of reasons to be long. Unfortunately as human beings we all have a tendency to discard information that contradicts our current point of view and at the same time embrace information that supports it. Which easily translates into trading losses.

The purpose of today’s post is to show you the upside risk that is present right now. If you are a trend trader then you don’t care as you have been long for a while and your rules tell you to stay in until your stops take you out. Your system thrives on leptokurtotic markets and the few times you get away with it you win big. For the rest of you guys I have collected seven charts that demonstrate why holding long here represents significant risk. Over the next few days these charts may be meaningless but medium to long term I believe that their combined message advocates caution.

Exhibit 1 – the Dow vs. the TRAN: According to Dow theory those two should on average be moving in the same direction. When the performance of the average diverges it is a warning that change is in the air. Again, bear in mind that this is a long term chart – nevertheless it started to detach in July and the present divergence resembles a mirror image.

Exhibit 2: Similar situation on the Russell 2000 which obviously represents quite a bit more risk than the trannies. That little trend line I painted has been breached but I’m still labeling this as divergent.

A lot more where this came from – I will also show you two charts that suggest that we may head into a short squeeze before gravity sets in. As the old saying goes – the bus moves fastest once everyone got off. Please step into my lair:
[amprotect=nonmember] More charts and cynical commentary below for anyone donning a secret decoder ring. If you are interested in becoming a Gold member then don’t waste time and sign up here. And if you are a Zero or Geronimo subscriber it includes access to all Gold posts, so you actually get double the bang for your buck.
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Exhibit 3: NYSE up vs. down volume – it’s been somewhat supportive thus far but there was a steep drop on Friday which I deemed worthwhile pointing out. This chart can be worthless during short squeezes (see Jan/Feb of this year) but that steep drop in one session may be a tell.

Exhibit 4: NYSE Advancing vs. Declining issues – rather surprised to see that divergence holding thus far. Judging by the recent past, this can go on for quite a while but once we drop into 1.5 territory we are usually close to rolling over, even it’s just for a quick wipeout.

Exhibit 5: NYA50:NYA200 ratio – measures quality of the current rally. And it’s starting to lag – I will keep an eye on this as it may just be summer tape. Admittedly it’s rather early and we may push higher here soon. Also, the Fed’s recent machinations have seemingly prolonged the lifetime of bearish divergences.

Exhibit 6 – copper. Which is not supporting this rally at all. Neither is gold or silver for that matter – almost everything else has been stuck in sideways purgatory.

Exhibit 7: My JNK:TLT ratio. Yes, you could call it supportive but I call this a lot less confident than what we see on the equities front.

Exhibit 8: I didn’t count this one as I posted it last Friday. But it’s a pretty strong argument and bodes repeating: With a VIX below 15 (as of the Friday close) I simply cannot be long here for more than a day or two.

Now as I want to be fair and balanced I found it to be my duty to also present two charts that point in the exact opposite direction:

VIX:VXO – this one measures the delta between front month strikes risk vs. front month ATM strikes risk. I use it to determine whether or not market makers are pricing in the possibility of a short term correction – which would obviously affect ATM options more than OTM options. I sometimes call it the MM lie detector. And it’s looking supportive to me – no doubt. Which suggests that market makers are pricing for a leptokurtotic market (i.e. trending market).

And even on the more long term VXV:VIX ratio I see nothing bearish. Even measuring three months out it seems that market makers are in general positive. Which is a bit confusing as August/September and sometimes October are not exactly seasonally bullish periods.

Bottom Line: Frankly I do not want to be long here and I cannot really be short just yet. Based on where we are right now I need to either see a short squeeze or a wipeout before I want to think directional again. HOWEVER, it is the long term VIX chart I presented on Friday that has me looking at a few lottery short tickets. In combination with the charts presented here I think the risk to benefit ratio is reasonable to devote a tiny amount of my assets to this setup. But that’s pretty much it – until I see some serious movement in either direction I would strongly discourage you from making any directional bets. Not sure when that wil happen thus I advocate patience. Don’t try to make wild guesses here – it’s a waste of time and most likely you will get taken to the cleaners.

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Cheers,

About The Author
The Mole
Mole created Evil Speculator amidst the chaos of the financial crisis in early August of 2008. His vision for Evil Speculator is a refuge of reason, hands-on trading knowledge, and inspiration for traders of all ages and stripes. You can follow him and his nefarious schemes at the usual social media waterholes.
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