Market Madness

Financial markets are known to push people just past the breaking point before reversing strongly back to the larger trend.  This is perfectly normal for wave 2 behavior, which I believe is over at this point.  While our line in the sand laid forth on Wednesday was pierced to the upside, the utter lack of strength in our once leading indexes, the $NDX and $COMPQ, certainly beared watching.  As I write, the $NDX is down a little over 2%, while the larger $COMPQ is down just under 2%.  Yes, I know that DELL had bad earnings, that accounts for one stock.  Something else had to give to get the reversal in breadth, and price, that we have this morning.  For those of you who use pivots also, you might note that /NQ (Nasdaq futures) opened below the S1 pivot this morning, rallied up, and turned down from a little beneath it, a strong bearish sign.

This image represents a complete reversal in breadth from the past 2 days.  The chart below indicates that the price is confirming this reversal by breaking through the lows of 8/26, a previous 1st wave low.  As Elliott allows it at this point, the probablities of a corrective pattern taking us to a lower low is almost solely contained to an expanded flat.  As it stands now, that is still a possibility, as the market has only had 3 waves down thus far.  If this is the case we should be looking for around yesterday’s high for a target, as illustrated by the other chart below.

And the best working alternate…

On Tuesday I mentioned that everyone was watching FRE and FNM.  I told Mole yesterday that their momentum and/or rate of change was falling off a cliff, and that that was a strong bearish indication. Today, they have both finally decided to turn down.  While this is just one day, it ends the four day uptrend in which these stocks have almost doubled.  We need moves like that in a bear market, otherwise we would have nothing left to short.  While I wasn’t happy to see it, I am happy to see it coming to an end.  Here is a quick chart of FRE, 20day 10minute.  I used the most recent move down and up as a reference.  There are other highs that I could base this off of, but the implications remain the same no matter which high you use.  Notice the break of the trendline, the A=C equality, the retracement to the 23.6% fib, and the beauftiful gap rejection.

This is another chart I posted on Tuesday night.  While the major two that we have been watching (FRE and FNM) are breaking down, we need some confirmation by the rest of the sector.  As soon as the $BKX breaks that lower support level, we would have great confirmation in that the financials are moving lower collectively.

Lastly, I will toss out an interesting trade that I took yesterday.  This is not a recomendation to follow me into danger, but I think there are some interesting elements that combined to make this a high probability trade IMO.  I grabbed a small put position on MBI.  Let me throw up a chart, and I will walk you through my reasoning.

After rallying nearly 500% since it’s June lows, MBI gapped up and ran an astounding 30%+ yesterday.  It made a higher high on a slight divergence in the RSI.  It pushed outside the 20Day 2.0 Bollinger bands, as well as outside the 2.5 Bollinger band on a 100Day setting (not shown).  A move back inside either of these would be a fantastic reversal signal, as we are outside of the range of 95% of the past 20 days, and 97% of the action in the past 100 days.  That is a pretty good indicator that this rubber band is stretched to the breaking point.  I think this stock can easily head back to the $5 range in a short matter of months, as soon as it closes inside these levels.  As I said, I only picked up a small position yesterday, but here is why I did it…

Notice the IV in the back months.  100% for OCT and 133% for NOV.  These may seem very high, but looking at the average implied volatility, we would see that these levels are relatively low.  I also notice that by the end of the day, the volume on the OCT 14 Puts had pushed about 15K contracts changing hands on ZERO open interest.  This is a tell tale sign, while not always correct, it is a great indication of an explosive move. I ran through some quick calculations, and found that certain options could potentially double on volatility alone.  Then when you throw in a 60% loss or so in stock price, these things have fantastic potential.  Here is how they are trading today, with MBI down between 5% and 8%.  Notice the IV’s today…

With a vega of .02, a 50% gain in IV should translate to a $1 increase in option price.  That alone is a 30% to 50% move in option price depending on your strike.  I got a chance to get these options at a low IV yesterday, and it is much higher today.  Ideally, you would look to enter positions with a low IV, especially if in the past the IV has exploded above 200.  Typically, I do not trade options with IV over 100% because I trade OTM options, and that IV greatly affects the time value in my options.  I decided to go ahead and take this because I liked the set-up so well, and liked the “multiple streams of income.” (delta and vega)

That said, the market is treating the bearish case very well today.  In fact, given the action of $NDX and $COMPQ, the indexes I follow closest, I am forced to return the near term trend to down.  Almost everyone that I have heard expects the “big boys” to come back and squeeze the shorts out of the market.    Since that is what everyone expects, I am not surprised to see the market selling off hard today.  It should be an interesting day on Tuesday.

Hopefully this can spark some interesting discussion.  I would love to hear thoughts or questions.

Skål!