Securities Research Services

Monday, March 12, 2007

Timing is Everything

On Friday the market gapped up on the jobs report, but the reaction to the report tells us more about the market than the report itself. Traders immediately sold the gap, which shows that the rebound rally continues to lose momentum.

The market tends to cause the most pain for the greatest number of people.

At the same time, there continues to be too many traders betting on more downside for this market to actually make a significant move lower from here. When everyone is leaning the same way, the market rarely accommodates them.

Even so, we understand why everyone is expecting more downside. The charts project it. Scans over the weekend showed a very large number of stocks that have been moving up to test their broken 50-day averages on declining volume. The 50-day average is a classic entry point for institutional traders and since volume has been in retreat the entire move back up the expectation for a failure at this level is perfectly reasonable.

Timing is everything.

The big question then is one of timing. Shorting tends to be a more difficult endeavor than going long because it requires very good timing. Over anticipating when a move will occur can put shorts off balance and they often times get squeezed right before the decline they had been looking for actually occurs.

Since options expire on Friday, timing is of particular importance to options traders who have to worry about both time and price. For put buyers who purchased this month's contracts (which were the cheapest and therefore most tempting), if the market fails to decline before Friday, their options will expire worthless – that is of course unless they were genius or lucky enough to have shorted the market before the first major drop occurred two weeks ago.

Now then, what we have here is a market likely to see further price erosion, but one that is also likely to burn the greatest number of traders. What better way to burn the most traders than to refuse to head much lower before Friday's expiration?

Timing this market is not a precise science, but the MACD histogram indicator can give us some clues on what to expect over the next few days. Without going into the boring details about how a histogram measures the market, let's just focus on what the histogram tells us here instead. The histogram is a great at measuring overbought and oversold levels. When the histogram is very deep in the red, then the stock or the index it is measuring can be said to be very oversold.

Looking at the histogram of the Dow below, we can see that a few days ago it was indeed very, very oversold. On Friday the Dow remained oversold, but had worked off a great deal of its oversold condition.

It is reasonable then to expect that the market will not move straight back down off of Friday's weak day, but that we will instead see another few days of either small moves higher or sideways consolidation, which would keep recently purchased put contracts from earning their buyers any money.

Patience is needed as the oversold condition works itself off.

Friday's gap higher was probably an ideal place to short this market. Now shorts need to be patient because the market still needs to work off its oversold condition and cause as much pain for the largest number of people that it can.

1 comment:

Anonymous said...

just like srs's posting today, the market is going to fly. though i cannot say how far, dow should be higher than 12300 for the most of this trading session or even close there at 4pm. regard,wei.