When the market subsequently began reversing higher, the bears were promptly forced to cover their positions, adding to the bullish momentum and attracting even more bulls.
When the major indices fell to new lows yesterday, we bought the inversely correlated UltraShort Oil & Gas ProShares (DUG) and UltraShort Emerging Markets (EEV), both of which broke out above resistance levels on their daily charts. Initially, both positioned rocketed higher as the stock market fell apart. However, because we were quite aware of the possibility of a "bear trap," we took a very pro-active stance to managing those positions. After the stock market recovered most of its steep losses in less than hour, we sent an Intraday Trade Alert to subscribers, informing them of our decision to scratch the trades (sell at breakeven). This was a good thing, as both DUG and EEV collapsed in the hours that followed. Even though we knew the odds of a "bear trap" sell-off were high, we took a shot with short selling because there was still the possibility of an all-out breakdown. Ultimately, there was no harm done, and no capital lost, because we micro-managed the positions at a time when it was necessary to do so.
After recent losses in the market, it may be easy to get excited about yesterday's bullish reversal and strong gains. But be aware that, including yesterday, there have been three such days of massive gains within the past month. Recall the S&P 500 rallied 11.6% on October 13, and 10.7% on October 28. What was the outcome of those days? Both times, the S&P 500 fell back to its prior lows just two weeks later. IF the same thing happens again, the major indices should follow-through with a confirmed move to new multi-year lows. Nevertheless, the scenario may play out differently this time. Yesterday's "undercut" below the October 2008 lows was bullish because it caused the remaining bulls to "throw in the towel." It's at such pivotal moments in the market, when even the die-hard bulls finally give up hope, that significant bottoms of bear markets are often formed. The daily chart of the S&P 500 below illustrates the "undercut:"
In addition to the "undercut," notice there is also a "triple bottom" formation in place, which could help stocks to build a more sustainable base of support. Still, neither the "undercut" nor "triple bottom" in the market indicates stocks have bottomed for the long-term. What is likely, however, is that we'll see a tradeable counter-trend bounce in the short to intermediate-term. Time will tell whether it becomes more sustainable than the stock market's other reversal attempts of the past month.
In the short-term, our plan is to wait for the major indices to approach support of their 20-period exponential moving averages on the hourly chart (20-EMA/60 min). During trend reversals, waiting for the major indices to touch their 20-EMA/60 min., rather than chasing a parabolic rally, is an ideal way to participate in the bullishness with a controlled level of risk. The touch of the 20-EMA/60 min. could come from a short period of sideways consolidation or a pullback in price. Either way is preferable to seeing another day of large gains without giving the market a chance to catch its breath. Next week, we'll take a look at trade setups in the industry sectors and international ETFs that may provide the best chance for outperformance if the market's rally gets some legs. For now, all bets are off on the short side
unless yesterday's intraday lows are broken -- yikes!
Open ETF positions:
Long - DGP
Short - (none)
