Securities Research Services

Thursday, June 26, 2008

The Real Danger Traders Face

Yesterday the Fed did nothing and as such, so did the market.

Over the past week what have appeared to be good trade set ups have crumbled as the market has moved from a trending environment (bull trend in commodities and bear trend in the broader market) to an environment where random moves reign supreme.

Bull markets offer definable risk and careful planning allows good traders to eke out a tradable advantage; likewise, bear markets. Random markets, however, are very tough to trade and depend more on luck and risk can not be quantifiable. That doesn't mean that traders don't try though.

This is the danger that traders face. They do well for a period of time when markets are trending, but when the character of the market changes, and it usually does so almost imperceptivity, trades start getting chewed up.

It's difficult to know when this phenomenon will occur. It happened to us this week. And herein lay the crux of what separates successful traders from unsuccessful traders.

When trades that were working stop working, successful traders take the hint and move to cash until a true tradable advantage reemerges. Everyone else continues to fight with the market, good trade set ups keep getting chewed up by random one day up, one day down swings, and along with them, so does their profits earned when the market actually was offering valid trade set ups.

This bears repeating:


We have entered that period where true tradable advantages are few and far between. Today few trade good set ups are presenting themselves and those few set ups are highly questionable. Some may work, but getting into the one that will work while avoiding those that won't is purely a gamble.


This situation might last a day or two while the market feels its way through the meaning of yesterday's Fed release. Or, this situation could last a bit longer. Until the market finds its direction again, however, cash is king.

Is a Short Squeeze Setting Up?

The financials, which generally dictate the direction of the market may be heading lower here, but we offer that there is no tradable advantage in opening short positions and of course opening a countertrend long position is akin to playing Russian roulette.

Take a look at the huge short squeezes that have occurred since the XLF turned sharply lower a year ago:

There is a bit of downside potential here but at any moment the XLF could turn sharply higher squeezing short positions. Institutions with deep pockets are likely buying weakness here for a potential squeeze. We do not recommend joining them as the potential to get caught in a sharp swing lower before the probable upside move occurs is a real danger.

Potential Trade

If the market does indeed panic like it did in December and again in March buying into that weakness might offer a tremendous opportunity. If the SPY were to wash out to $125 in a sharp bold move, we would be buying in hand over fist for what has a lot of promise for a great bounce. Just don't try to buy if and until that washout move occurs.

No comments: