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by The MoleFebruary 16, 2009

It’s good to be back in business – as the sun was setting in Los Angeles I was getting worried about not being able to trade at all tomorrow. Anyway, I have lost most of my day, so let’s get cracking.

Being cut off from civilization however gave me a lot of time to reflect on last week and thus draw various conclusions which I would like to share with you rats before we get to our charts. What’s become abundantly clear is that Thursday and Friday was nothing but one big shake out designed to clear out the hobby bears.

Keirsten was so kind to send me some screen grabs of her Level II historical time/sales history over the weekend. I have not even bothered to highlight particular sections as the massive block orders posted just before 4:15pm EST are quite salient. Remember futures and and big ETFs like SPY keep trading for another 15 minutes past the NYSE closing bell. That is usually right when market makers and primary dealers show their cards – once it’s too late for the average small spec to jump onto the bandwagon. Let’s also not forget that probably 80% (educated guess) of all small specs out there are unaware that SPY, IWM, QQQQ, and DIA continue to trade for a 15 more minutes. Even if you do know you probably get a horrible fill and it’s probably too late to get in as in most cases a large chunk of the move has already completed.

We both basically came to the following conclusion: The big boys were probably quietly buying up puts throughout the Friday peaks – then a few minutes before the closing bell they initiated a massive block sell assault, which triggered panic market orders by the bullish L2 crowd who suddenly faced being hit by margin calls. They usually panic and place market order in a desperate attempt to get out. Once they got the pendulum swinging towards the bearish end the rest was pretty much procedural. The nasty slew of economic news reports spread all across a three day weekend only helped to expedite bearish sentiment. It’s been downhill since and ES futures are trading around 808.75 as I’m typing this.

In one of my comments this morning I mentioned that we have been stuck in this 800 region for over a month now and that it might take a significant trigger event to get us out of this channel. We finally did breach 8000 on the DJI last week (i.e. 2 consecutive closes below) but the SPX has thus far been stubbornly clinging to the bull’s line in the sand at 800. Maybe this weekend’s flood of bad news represents an inflection point that will able to get us out of this horrible whipsaw zone we have had to put with for much too long now. But I still believe that the permabulls will not admit defeat so easily and put up a massive fight to hold the fort. For they know that a breach of 800 will most likely lead to a breach of the November 21 low of 741.02 – and beyond that lies the darkness of the abyss.

Which brings me to the theme of tonight’s post: Bushido.

Bushido comes out of Buddhism, Zen, Confucianism, and Shintoism. The combination of these schools of thought and religions formed the code of warrior values known as Bushido.

From Buddhism, Bushido gets its relationship to danger and death. The samurai did not fear death and had no fear of danger. Through Zen, a school of Buddhism one Samurai engaged in mental disciplines with the goal of reaching the ultimate Absolute. Zen meditation teaches one to focus and reach a level of thought words cannot describe. Zen teaches one to know thyself and how not to limit yourself. Samurai used this as a tool to drive out fear, unsteadiness and ultimately mistakes. These things could get them killed.

So, what does all that have to do with trading?

Everything! Especially in this upcoming week.

If the past few weeks have taught us anything it’s that technical analysis has slowly degraded to point where it utility has almost broken down. Various inter market correlations have been out of sync,Β  daily moves have bordered the random, and trading during NYSE hours has turned into a virtual war of wits. The stakes are high on both ends – and in this case the two warrior factions are the bulls and the bears. The bulls are represented best by the PPT, the primary dealers, and the millions of mouth breathers sliding the slope of hope (i.e. the Cramer crowd). The market makers are neutral and synonymous with arms dealers – no matter where the tape goes they make money as long as they keep the conflict going. The bears are the few remaining hedge funds, institutional speculators, Tim Knight and his intrepid disciples, and finally us rats.

The past two trading days were brilliantly executed strategies that turned out to be an extremely profitable endeavor by institutionals. Sun Tzu would have been proud – with the exception of maybe Eric and a few hardcore bears most of the small specs buckled and got shaken out. Anyone who was expecting another rip leading to an opportunity to reload on puts is probably kicking him/herself right now – myself included.

Now where am I going with this? I had plenty of time to think long and hard about what I needed to convey this week as we might be on the brink of a significant move to the downside. What differentiates this blog from many others is that it seeks to avoid academic technical analysis which might be useless to hands-on traders. My core mission is to offer insights that will lead to real trades capable of producing maximum profits at the least amount of risk exposure.

What is clear to me right now is that whatever happens tomorrow morning, unless you are already positioned, active participation in wave {3} of 3 of intermediate (5) will require the following:

  • Commitment to participate
  • A lack of fear
  • Focus
  • Time
  • Capacity to embrace death (i.e. total loss of invested capital):

A commitment to participate: You have to make a decision on whether or not you want to trade this wave down. I know this may sound silly because chances are you have been waiting for this for weeks now and might even have incurred losses in all the whipsaws. But I want to make it clear that, just like 3 of intermediate wave (3) this one won’t be easy and in the best case scenario we probably will have to endure losses before we arrive at a final release to the downside. It is crucial that you sell the rips and are not lured into chasing the market. Even if you are able to time your trades well, there is not guarantee that a PPT assault of the likes we witnessed on Wednesday and Thursday won’t repeat itself. They will do whatever it takes to keep this market from crashing. So, before you position yourself you must commit yourself to sitting through any counter moves.

A lack of fear: This plays into the commitment part – I am sure we will see nasty whipsaws this week. Use them. This is the only way to position yourself. Follow your charts, the RLs, the fibs, and whatever else you think you can rely on. But be ready to pull the trigger – if you snooze you will lose. Now, that does not mean that you should be reckless – follow your system to the letter, whatever that may be.

Focus: Again, leads into the prior point. We cannot be driven by fear. This has been my mantra here for months now but we have to constantly remind ourselves that it is human emotion that keeps us from placing winning trades.

Time: I made a big mistake two 1/2 weeks ago in buying February puts. The one weakness of Elliott Wave Theory is that does not offer us a clear time dimension. It is up to us as traders to look at various complementing indicators that may give us a reasonable estimate as to how far we are along in a particular count. That doesn’t mean you buy puts six months out, but it’s obvious that option buyers should err on the cautious side, especially at critical defensible lines.

Capacity to embrace death: I know that sounds a bit over the top – just stay with me here πŸ™‚ Whatever capital you devote to riding this one down should be money you can afford to lose. We are not gamblers, and as traders we do our best to position ourselves ahead of moves that afford the highest probability of success. However, I personally always approach a trade with an expectation that I will lose. I know where my line in the sand is and that is where I exit, no questions asked and no re-evaluation. Never enter a trade unless you know what your exit is. However, we have recently reached a point at which risk management is almost impossible. Therefore, this plays into point number one: If you decide to play this week you might not be able to employ your usual stop loss provisions. Or at least you might have to be extremely generous in how much losses you will be able to tolerate. For me personally, this means playing it relatively small – I initially thought that I would be vested 50% or more at this very stage. However, even if I decide to take entries in the coming days – assuming we don’t just plunge to the bottom tomorrow morning of course – then I will most likely limit myself to less than 20% of my trading capital. Remember rats – the key to surviving in the long term as a trader is not getting taken out by your own greed.

Sorry this took so long – now that I have painted the picture from a psychological perspective let’s look at some charts:

You might remember that SPY chart I posted on Friday in which I proposed that we might complete an a-b-c which would have gotten us to around 854 (equality). Frankly, at this stage this train seems to have left the station as the ES futures were trading around 808.75 as I started typing this. In the chart above I am calculating the SPX equivalent by deducting the PREM from the ES. That gets us to around an equivalent of about 810.75 – barely above the bottom of minute wave (i) of minor 2 of intermediate (5). There is a very good chance we’ll blast through that tomorrow at some point (probably after an obligatory post-gap counter rally) and then proceed to challenge 786, which is a long retracement level plus it happens to be close to the 78.6% fib line relative to the November 21 bottom.

I do believe that the bulls will make a stand right around that level, and whether or not they succeed will determine if we push up into wave E of a triangle which would complete intermediate wave (4), or if this is already intermediate (5) and we finally breach the November lows and proceed our plunge into the abyss. Frankly, I give both scenarios equal weight at this point as various of my trend/sentiment indicators are almost in equilibrium right now:

Medium term we are far from oversold levels by any standard.

More long term we are traditionally in neutral territory, but when compared with recent readings we are slightly overbought.

This one gives me hope – the moving averages on the NYSE new highs/lows chart have not budged and there is plenty of room below. Again, we have not seen such levels since last August at the peak of intermediate wave (2) of primary wave {1} of cycle wave c.

The CPC chart shows that the we have retraced from those extremely bullish levels but then started to drop again on Thursday and Friday. No matter which way you read this chart, there is plenty of room above and I do believe that we will see a ratio of 1.3 and above before this wave is complete.

Oh, I must say I like this chart very very much πŸ™‚ There has been a lot of pressure on the Yen all last week plus over the weekend. I wish I had the time and space here tonight to explain some of the underlying dynamics. However, this post is way too long already and this is the gist: It might be possible that we see the Yen drop a bit further but it can’t last forever and eventually it will snap back inside the the BB, even if it’s only for a day or two. If and when that happens – and that might be tomorrow or it might be a week from now – it will put immense pressure on equities. I was spot on with that last time I posted this chart and I am confident that we will see a repeat.

In that context the following news tidbit is extremely interesting:

Japanese Finance Minister Nakagawa Resigns After Furor Over G-7 Briefing

The proverbial excrement is about to hit the fan down in Japan and it might just be the trigger event we have been waiting for.

UPDATE: Karl Denninger points out that there might be an FX dislocation in progress. Again, I didn’t have access to the markets all day and am just now catching up on news.

This chart is my fly in the proverbial ointment. As I’ve made it already abundantly clear – as long as this one keeps pointing up I am extremely hesitant to expose myself to the downside. I will of course need to see those readings after the open, as a gap to the downside might be able to swing them southward.

Last but not least my favorite chart for tonight. What seems to be developing on the weekly stochastic may be a repeat of what we saw prior to wave 5 of (3). Remember that back then I was a bit nervous about my stochastics pointing up, after which we however got one last drop before we consolidated into intermediate (4). The pattern looks familiar but I don’t want to jump to conclusions. Nevertheless, it’s a possibility – and based on prior precedence a door to the downside appears to be open.

I think Gold might actually have overstayed its welcome and I might try my luck with a very small position in GLD in a few days (yes, I swore I would never touch the stuff again, but I can’t help myself). The stochs/MACD on GLD look like they are close to rolling over – but emphasis is on ‘close to’ – don’t jump on this tomorrow morning. I will let you guys know when I think this one is ready for the plucking. Hey, 6th time is a charm, right? πŸ˜‰

Alright, that’s all I got for tonight – my apologies if this one feels a bit rushed but as you know I didn’t have much time this weekend due to my 10 hour power outage. Based on the flood of comments you guys have been on fire this weekend – I’m truly impressed by the quality of the discussions I see here lately. Good stuff – keep it up and we might just make it through this wave with some profits.

Also a big up to Eric – mate, you stuck with your guns last Friday and are now reaping the benefits.




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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