Reset!

I enjoyed a mental reset on Saturday – instead of looking at charts I went to the gym and completely ripped the place up for some much needed stress relief. In the evening I took a hot date to see the new Start Trek movie, which IMNSHO totally kicked ass – and that’s coming from an old Treki.

Today I feel completely refreshed and energized and am really looking forward to Monday. Something many of you might be surprised to hear after last week’s drama and internal tensions. What you should know about me is that I had a fairly tough upbringing as a kid and thus I had the luxury of developing a certain mental fortitude. Having studied martial arts in my life for two decades I’m also more than used to getting knocked on my ass with blood in my mouth. These are the type of moments that define you as a trader – what you do when you just took a big loss despite your best analysis and stringent adherence to managing your capital.

Just like in boxing or martial arts, getting hit is part of the game and you can’t enter the ring expecting to land a knock out punch in the first round and walk away with your nose clean. Just doesn’t work that way. You’ll have to roll with the punches and as the old saying goes in boxing: Everyone has a plan until they get hit 🙂

Last Friday was simply the ‘market doing its thing’ – it’s a complete waste of time to ponder about market manipulations and the whys and what. That won’t get you your money back – as I said a few months ago – this market is heavily manipulated and thus if we decide to play we have to abide by rules that guarantee us the best possible odds. In retrospect I violated this mandate by adding on short positions in an obvious bullish Primary consolidation wave anywhere else but at the very peak of the tape. I had dipped into put options at the May 22nd peak and thus suffered all last week getting mentally and financially whipsawed. This is not something you want to be doing in a bear market rally and I only have myself to blame for being led to the wood chipper.

Now – mind you – loading up on lower degree peaks is perfectly fine during confirmed Primary waves to the downside. But trading ‘against the grain’ so to say always has its risks and and to quote myself on several occasions ‘nasty surprises usually happen in the direction of the trend’ – and that dear ladies and leeches right now remains to the upside.

As per this blog, I also decided that it’s time to change the game a little bit. First up, moving forward there will be a zero tolerance policy for haters, spammers, trolls, idiots, drama queens, as well as vapid chitchat. Offending comments will be deleted and repeat offenders will be blocked. This is my house and if you walk in with muddy shoes and throw your weight around you will be dealt with appropriately. Frankly, I simply don’t have the time to engage in some silly Kindergarten feud and my primary concern remains to be my mission to bank coin – for myself of course and for anyone who follows this blog. Anyone who attempts to distract me or any of the long time contributors will be dealt with quickly and mercilessly. Which means I will shoot first and ask questions later. If you don’t like those rules and feel that you are entitled to this or that then please move on and find another place to stink up – we really don’t want you here. I’m not hosting a popularity contest and I am perfectly happy catering to half the audience I’ve been getting if that means I can focus on my trading and maximize everyone’s returns.

In short – there will be a lot less noise in here going forward.

Let’s start with the short term chart first. After Friday’s debable we are now facing two main scenarios:

Soylent Blue: The Friday peak marked the top of Minor X of Intermediate (B) of Primary {2} and we either gap down Monday morning or push a few points higher on Monday which will be followed by a drop to the downside. A breach of 930 will disqualify this scenario and a drop through 880 will confirm it.

Soylent Green: The Friday rally was a break out of a pretty ugly triangle which will be followed by a continued run higher over the next few weeks. The implication here is that we completed a ‘sideways consolidation’ through May and completed Intermediate (X) of Primary {2} on May 28th. A breach of 880 will disqualify this scenario and a push through 930 will confirm it.

As is apparent from both scenario – we are still inside that dreaded 880 – 930 sideways range we’ve been trapped in since late April. Until we do get to those inflection points – are we to take trades in equities at all and if so, when are the best moments to strike?

Let’s assume you buy into Soylent Green and are looking for the best time to load up. The orange box on the chart above around the 907 – 910 range marks a spot where I believe a brief retest of the upper triangle boundary could occur. The beauty of this entry is that a failure would be fairly clear once we break through the 905 – 02 range. So, there’s relatively little risk to be endured (short of holding overnight and being gapped to hell of course).

If we push through 930 and rally higher it’s also possible that there would be a quick retest – again your risk is easily managed around that mark.

However, if you are in the bear camp I would have very little compunction about shorting the market on a continued push to the upside Monday morning – as long as we remain below 924 (the May 20 high) – after that I would be very cautious to play the short side.

Similarly, if we finally breach through 880 then I would not add short positions unless I see a retest of that line. And if that gets breached by more than a few points I would head for the exit quickly. This is probably the only exception to the ‘trade only against the trend at the peak’ rule I mentioned above as my stop would be only a few points away.

For the record – even if I decide to go short again I will be only playing with a few OTM lottery tickets. My rationalization is as follows – if we go down from here it’ll be a substantial move and it’ll probably happen quickly and push Mr. VIX up by quite a bit. If things start running against me this will also prevent me from taking too much of a hit.

I have talked about the ISEE index in the past and the Friday readings are frankly in the stratosphere. Now we all know that the bulltarts require a lot less oxygen to maintain their tiny brain functions and anything is possible these days. But a close above 225 in the ISEE has in the past been a precursor of at least a short term top and was followed by a retracement a few days later. So, it’s very much possible we creep a bit higher Monday or Tuesday and then drop like a rock. So, call me stubborn or stupid but at this point I still give Soylent Blue about roughly 65% of a probability. However, my lines in the sand above stand – should we breach 925 my puts will drop faster than a dress during prom night.

This chart also points towards at least an interim top – we now completed three months to the upside and that has not happened since the end of Cycle wave b completed in October 2007. In terms of percentage gains we have also made a huge amount of progress and rallied 38% since the 667 low. Mmmh – 38% – where have I heard that number before? 😉

Here’s something fascinating I discovered when I looked at my trusted weekly stochastic chart. First up – the stochs are still pointing down, so we got ourselves a bit of a bearish divergence here. But there’s something else, which I named the ‘200 MA Rope-A-Dope’. Again, to lend from traditional boxing terms – this one was coined by the legendary Muhammed Ali – here’s the Wikipedia entry:

The rope-a-dope is performed by a boxer assuming a protected stance, in Ali’s classic pose, lying against the ropes, and allowing his opponent to hit him, in the hope that the opponent will become tired and make mistakes which the boxer can exploit in a counter attack.

In competitive situations other than boxing, rope-a-dope is used to describe strategies in which one party purposely puts itself in what appears to be a losing position, attempting thereby to become the eventual victor.

Now look what happened last time we approached the 200-day MA – we actually dropped short of a touch, thus luring in the bears, and then rallied up again to actually complete the touch. Of course it was all downhill from there and left a lot of hobby bears confused and aggravated (and a few Dollars poorer).

Well, maybe I’m wrong but it seems to me the same game is being played this time around. Sorry for all the allegories but here it goes: ‘Fool me once shame on you – fool me twice shame on me’.

This is what I roughly see in store for us in the longer term. As is apparent from the chart – we remain at an inflection point that will determine the direction of the Intermediate degree trend occupying the next three weeks or so. I know some of you criticize my ‘either we go up or down charts’ – but what you fail to see is that there are trigger points which invalidate one scenario or the other. And getting positioned accordingly right after or ahead of a decision point has resulted in large profits in the past few months.

I have taken the liberties to suggest potential buying/selling opportunities for us in the coming weeks/months. The chart only depicts the direction and approximate pattern of both scenarios as I’m expecting a peak of Primary {2} sometime in August or September. But beyond the direction of the longer term trend it’s also important to know how trade them.

In that context I would like you to read one of my old posts from last year. In essence: Back in June 2008 I speculated that the Dow would drop below $10k and probably further – a lot of people laughed at me back then. This was around the time when I was posting my notorious ‘drop into the abyss charts’ – and they were the reason I got booted off of a certain blog which shall remain unnamed (no, not the Slope), which in turn was the genesis of Evil Speculator. Anyway, as explained in the post – simply buying $4000 worth of Dec08 SPY puts several weeks *before* the peak of Minor 2 of Intermediate (4) of {1} would have banked a trader over $60,000 in profits by November 20th. Had you nailed the top by a few days or so the profits would have been over $100k. The trick would have been to hold all through the noise, the rumors, the short sell ban, the bailouts, etc. – just get those puts and hold them all the way.

This time the stakes are even bigger as this would be a Primary degree wave trade. What I’m looking for is a long term option spread strategy that would beat a vanilla put option purchase *but still benefit from an increase in vega*. Let’s assume we paint a top around August – by my estimation it’ll probably take around 6-7 months to reach the bottom of Intermediate (3) of {3} – which is where I would want to cash out. By then we are also getting dangerously close to hyperinflation and we have to be worried about holding capital in Dollar denominated cash.

Thus, I have sent a ‘code red activation’ to Fujisan who will address the matter in the coming weeks in her ongoing series. I wanted to give her plenty of time to think about this and to plan our strategy. As the old saying goes: Luck favors the prepared mind 🙂

Once we get closer to a turning point it will be time to start loading up on long term positions with the expectation to make a killing by early 2010. Let me be very clear about this: Nothing else matters to me at this point and the name of the game on my end is capital preservation. The type of slip up we had to deal with on Friday is unacceptable and will hurt our chances to make a veritable fortune later this year. If I see a high probability trade during the remainder of Primary {2} I will of course take it as described above, but frankly – if it wasn’t for this blog I would probably just take a few weeks off and return late July.

Curly averted a disaster in the mortgage market by going on a spending binge a in the credit markets on Friday as bond yields collapsed – for now. According to Jeff over at the Housing Time Bomb there was massive buying in the MBS and the treasury market. Of course he accomplished that via ‘quantitative easing’ – thus further robbing us of purchasing power in the Dollar (which also dropped below 80 and continues to head lower). Of course Curly is fighting a war he can’t win and as soon as we are touching that diagonal trend line I will be there with ZN puts to play those yields to the upside.

Okay, let’s talk cable. For the noobs – back in the 1800s, Pound Sterling and US Dollars was traded via telegraph cable, so its called cable. Since Fujisan brought up the GBP/JPY I took a look at it and found it even more interesting for the reasons highlighted on the chart. I do like Bollingers when looking at currencies and it seems that the GBP/JPY and the 2.0 BB have a developed a rubberball/wall relationship – every time it breaches the upper band it bounces back almost immediately.

Also, the Dollar has now reached oversold conditions which I do not believe will remain for much longer. Even if this was a third wave to the downside we should expect a fourth wave up fairly soon. If this is the late stage of a C wave then you know what comes next. Thus, I will follow Fujisan into the gates of hell on this one and either play the currency pair down or perhaps go long the FXY.

BTW, in that context check out the symbol M6BM9 – it’s the current front month of the GBP/USD micro futures contract. It was launched on March 23, and complements the design of the current suite of Treasury futures contracts at the exchange. The notional contract size is $200,000, the minimum tick is one-quarter of one thirty-second ($15.625), and it trades on the March quarterly cycle. These contracts trade both open outcry and on the CME Globex electronic platform. TOS offers them btw – here is a list of all new ‘micros’:

Euro/U.S. dollar EUR/USD M6E
British pound/U.S. dollar GBP/USD M6B
Australian/U.S. dollar AUD/USD M6A
U.S. dollar/Japanese yen USD/JPY M6J
U.S. dollar/Swiss franc USD/CHF M6F
U.S./Canadian dollar USD/CAD M6C

ES futures opened a while a go and are now at 918ish – but they haven’t really dropped massively since Friday just yet. I actually would prefer a push higher as opposed to a large drop for obvious reasons.

See you on the other side.

Cheers,

Mole