Two Lines in the Sand

I’m going to make things extremely short and sweet tonight as our comments counter indicates that the majority of our audience is either enjoying a week in the Hamptons or has simply walked away in disgust until after Labor Day.

I’m not going to sugarcoat it – today was not a fun day for the bears. I expected a little rally today, but low volume or not, the breadth was very strong and the bulls were in complete control. Even though we had a bit of a pullback late in the day, we closed not too far from today’s highs. So, the one question in your mind is probably where do we go from here. The answer is in the only chart I’m going to post tonight, which pretty much tells the story:

SPX in limbo land.

Tomorrow should be extremely interesting, as we are at a fork in the road on a short term basis. You know as Yogi Bera once said: ‘If you come to a fork in the road – take it!’ 🙂  In all seriousness: If we wind up breaching the Friday highs we will need to completely revise our wave count, and in that case our upwards target on the SPX would be the area around 1350. Now, that is the scary scenario for us bears, but the highest probability remains a drop towards challenging the July 15 lows and that very soon. In order to put the bullish scenario to the sidelines we would need to breach the 23.6% line which marks the 1257 zone. Once we get there things should speed up quite nicely.

The one thorn in my eye is something that became more apparent when I was drawing the ‘fancy’ chart above. As you can see we have been spent a LOT of time inside 23.6% – 38.2% zone. It’s about time that we push outside of this ‘limbo area’ with some confidence otherwise this implicitly would defeat the wave 3 of 3 scenario. For the EWT challenged, let me explain: According to EWT this third wave down is supposed to be extremely violent and put the fear of God into those pesky permabulls. However, if we forget the wave count for a moment things are still looking pretty sideways as of now. Berk and I have been arguing about that point today and I concede that the wave count can be interpreted that we are moving down fast enough. But I personally need to see a bit more conviction – pre Labor Day week or not. At some point we are running out of excuses and need to see a monster drop that whipsaws the bulls for a change. That’s my personal opinion and I have tried to visualize my prospective in the chart above.

As a final point: The treasury yields ($TNX) actually finished down today after rallying up in the morning. We had the same situation happening yesterday, when I was looking at the treasuries after the market closed and liked what I saw as a bear (e.g. dropping yields = bad for market). However, in early morning trading they pushed up strongly and that in combination with futures in the plus (@ESU8, @YMU8, @NQU8) gave me a strong indication that the market was going to rally today.

So, my plan is to go to bed early tonight and get up 1/2 hour before the market opens (hey, I live in CA – I need my beauty sleep) to make sure that those yields don’t paint a rally again while I’m not looking. If you are short the market right now (and Berk and I are) and you see a situation forming where the futures and yields are pushing up ahead of the opening bell, then you might want to get ready to grab a hedge position to soften the blow (e.g. IWM, SPY, QQQQ calls). This will give you some profits to enjoy while you start closing out the short positions you don’t want to hang on to. In the case of Berk and I that’s a lot of negative delta to close out, so we plan to sacrifice a few chicken tonight to sway the market Gods to our favor. Be aware that we might see a fake-out as well – the market might push up, we back up the truck on some index calls, and then we bounce off the 38.2% line and trace back down to new lows. Hey, who said options trading is easy? Unfortunately there is not perfect answer right now and if we see a meek pre-market action to the up side tomorrow you might want to hold off with loading up on those calls until we do breach that line with confidence. After all, we are not that far away.

But enough with the doom & gloom – chances are we drop like a rock tomorrow and party like that until the weekend. But now you’re armed with a baseline of what to do when, so adjust your trading according to your personal risk/capital/exposure levels.

Cheers!