Time to Look For Buying Opportunities

Today we would like to once again reiterate the concept of price regression. What we have seen thus far this week is classic bear market activity. Despite what may appear to be so, the sky is not falling here, the market is just making some much needed adjustments to the fact that banks were over leveraged. This has been in the works for a long time and we are now seeing the market correct the situation that regulators refused to do themselves.

So, let’s get back to price regression. Monday’s sell off was likely a capitulation-type event. We hesitate to call it “the capitulation” that ends the bear market because there is just not evidence for that at this time. Nevertheless, the washout on Monday took prices down to extreme levels in relation to the 50-week average and the lower weekly B-Band on the SPY. We saw a lot of these types of wash out events during the last bear market and each and every one of them led to a regression back to the mean (50-week average) which shortly followed. We seriously doubt that this time will be different.

What does this mean for traders? For starters it means that it’s too late to short anything on longer than a day trading basis; at least for the near term. It also means that over the next few weeks we are likely to see prices regress back toward the 50-week average, which as you can see from the table below gives us a lot of near term upside potential.

With that in mind we would offer a warning. This does not mean that it’s safe to go out and start buying beat down stocks. Remember, we are still in a bear market and as such surprises can and probably will occur in the direction of the longer term trend, which is down.

Rather, in our opinion, it is better to focus on those stocks that both held up well during the latest slide and that are showing buying interest at these levels. This rules out buying stocks at 52-week lows for example; they may bounce hard, but then again, they might surprise lower as well.

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To get a list of stocks that both held up well during the slide and that are showing institutional buying interest, just provide your name and email in the form above.

Moreover, don’t look for an easy ride back up. There is still a lot of confusion out there. The market takes time to put in a bottom, even a near term bottom. It would not be out of the question that prices retest recent lows and it wouldn’t be impossible that they might even take out those lows before a real rally gets under way.

This is certainly no time to just throw caution to the wind and buy a falling knife. Be very choosy and trade only those stocks that offer the least amount of risk in this environment. High risk might offer high reward but it also offers the chance to lose big. Set your sites on consistent gains over time by always staying focused on risk management and reap the rewards. Anything less is gambling and we all know the long term results of that.

Was this Capitulation?

Last week we moved to a 100% cash position. Betting on a bailout was just too risky. It would have been nice had we bet against a bailout, but as we noted any bet made last week was a crap shoot pure and simple.

Our primary goal is to protect the assets of our subscribers. We are not gamblers. By moving to cash we have given ourselves a huge advantage in this market. Today we experienced a Black Monday event as the market took one of the biggest losses in recent history. Our subscribers experienced no loss on this event.

Let’s take a step back now and evaluate this situation from a trader’s perspective. We protected our assets against a risk situation that was impossible to manage. Blood flowed heavily in the streets today as Congress voted down the bail out. We now have our trading accounts fully in tact to take advantage of the fallout.

It seems likely to us that a bailout package of some sort will get passed this week. Like it or hate it Congress can’t just throw up their hands in defeat over this and the public who takes a look at the damage to their retirement accounts are now likely to second guess their position on this situation.

It would then appear that this sell off creates a huge buying opportunity rather than a reason to sell more. The bulk of the selling is likely now behind us. We certainly won’t now step in and try and catch a falling knife, but we are well positioned now to go long as soon as we see some evidence that the selling has played itself out. We were not willing to bet on this bail out vote but we are willing to bet that we will get that evidence that buyers are stepping back in this week; likely as early as tomorrow.

Bottom Line: Today’s sell off was not a reason to buy. We don’t have that yet. But, it was a reason to start watching for reasons to buy and those reasons might be just around the corner.

This is NOT Business As Usual

Under normal market circumstances it is possible to come to a relatively reasonable conclusion about the market’s potential just by paying close attention to price and volume. For example, when the Fed is getting ready to act institutional money usually has a pretty good clue about how that action will affect the future outcome of the market and they tend to build positions accordingly. When they are building those positions they tend to leave footprints, sometimes subtle, that betray what they are doing.

What is different about the situation this time is the fact that the major game changer that the market is waiting on is in the hands of Congress. Congress isn’t nearly as predictable as the Fed.

It seems likely that the market will rally, at least initially, if a government bailout plan is passed. But what happens if that bailout plan is delayed? It’s altogether possible that positions taken here in anticipation of a bailout rally could easily get stopped out as the market drifts in wait for Congress to vote on this bill.

So which side do you put your money on here? Do you bet that Congress will drag its heels and short the market? What happens if Congress surprises and the market gaps up 400 points?

We really hate the odds on this. Moreover, it appears that institutional money doesn’t like the odds either as market volume and volatility have both been way down over the past couple of days.

If the bailout is announced wouldn’t you rather have a large cash position that you could then put to work after the market shows its hand in response to the package? Wouldn’t it be much worse to bet on a bailout, get stopped out as the bailout is delayed only to see the market gap up a few days later?

This is the hand that the government is dealing us here since they determined they would get involved in business that is probably not theirs to get involved in in the first place.

Recommended Position: Cash

Trading Positions

We took profit on BKE late last week at $65 and remain primarily in cash this week with only one small short position. With market surprise risk as high as it is here we will let others take on the risk exposure while we remain primarily in cash.

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10-Year Trend

The SPY is resting right near its 10-year trendline. Technically it's not in good shape and a trendline isn't necessarily a reason to buy. Nevertheless, it's important not to have too much short exposure here. With a government bailout looming and with the trendline still in tact there is potential for an upside surprise.

Keeping a mostly cash position is recommended until we get through this difficult week.

Sellers Taking Back Control

Early last week we recommended closing short positions due to the fact that the SPY had extended too far away from its 50-week average and was trading near weekly B-Band support. This recommendation kept a lot of traders out of trouble as the SPY gapped up an astounding 6% on Friday following a big up day on Thursday.

Unfortunately for longs buyers failed to follow through on Monday and we are now seeing continued price erosion.

Two weeks ago we noted that the market was not showing signs of stabilization given the fact that both the 50-week average and lower weekly B-Band were both continuing to make new lows. Based on this steady indicator erosion we recommended getting more short at that time. That recommendation also proved to be profitable for those who closed those short positions early last week as we recommended.

Now that shorts have been squeezed, as risk indicators indicated they might, we once again find ourselves back in the same boat we were in a couple of weeks back. The 50-week average and the lower B-Band continue to erode. And with the short squeeze out of the way, there now seems to be a lot of traders who bought into the excitement late last week who are now stuck on the wrong side of the trade.

Short risk remains high just due to the fact that the market is still technically oversold. Near term, however, a lot of pressure was released and sellers appear to once again be in control.

We recommend a light short position at current levels as long as tight stops are used. Shorting bans on the financials are not going to keep prices from going down if sellers continue to unload their positions, which they were certainly doing today.

Tale of Two Trades

After assessing the risk we offered clients two long side trades earlier this week. We reasoned that the market was very likely to be defended in the current area and as such dips would be buying opportunities, not reasons to panic.

As always, this did not mean throwing caution to the wind, but rather carefully choosing entry points and establishing stops to get us out in case something went wrong.

One trade worked and the other one failed.

This brings us to an important reality of the market. No one is ever right 100% of the time. In fact, no one is ever right even 80% of the time.

The good news is that with careful and thoughtful risk management procedures in place it is possible to be right only 50% of the time and still enjoy huge profits.

Let's take a look at this week's trades and see why:

OCR



OCR failed at its trend and we quickly stopped out.

BKE

BKE rallied sharply higher and remains open. Profits on the BKE trade have erased the loss on the OCR trade and then some giving us a net gain on the week and the trade is not even over yet.

Our primary concern is risk management. We have found that over time focus on limiting risk allows profits to take care of themselves.

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Tradable Bottom Likely in Place

As we have been discussing over the past few trading days there was a strong likelihood that it was late in the game for the short trade. The SPY tested the downside in the morning almost reaching $113, the price we predicted it could stretch to mid week. On Monday we wrote:

As we mentioned a couple of weeks ago, the $117 level is likely going to act as a magnet. In fact, with the ferocity of the decline today there is some potential that we will see the SPY make an intraweek low as far down as $113.

After the scary shakeout dip in the morning session where the VIX spiked as high as $42, buyers stepped up to the plate and defended the $117 20-year trend as we predicted they would. The VIX sharply plummeted back to $33 and the SPY rallied to close back above $120.

It’s doubtful the bear has had its last growl, but it is certainly very likely that an important multi week bottom is now in place that will offer some great long side opportunities.

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VIX

The VIX is now back at the area where the market has put in significant lows over the past year. Volume continues to spike as well. Either we are putting in a significant tradable bottom or something is different this time. We suspect that despite the gloom and doom in the news that a bounce is in the offering from current levels. Time will tell.

Regression Theory and Key Reversal Days

If you return to our May, 2008 archives you will note that we indicated during that month that short risk was low. Our reasoning was based on the fact that the SPY had rallied up to its 200-day average, an area which coincided with the bear market downtrend. We advised shorting strength in this area.

Indeed, the market declined more than 15% from the May top and shorting strength in the early May rally proved to be the most profitable position to take.

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It's time for traders to start looking at the long side once again. Enter your name and email address above to receive stocks that offer the best upside potential for this new market development.

Now that the market has experienced a multi month decline from its May top the risk situation has reversed. Note that over the past month we have indicated that risk on the short side has increased even as short positions have been paying off well. The increase in risk can be measured objectively based on the relation to the weekly B-Band and the 50-week average.

Today the SPY tagged the lower weekly B-Band.

Also recall an interesting characteristic of bear markets wherein prices tend to regress to their mean, which we outlined in February. The mean that bear markets tend to regress to is their 50-week averages. As of today’s close the 50-week average is at $133.60, or more than 8% above today’s closing price.

Moreover, note that $117 represents support at the SPY’s 20-year trendline.

The market’s downtrend is still in tact and the road is bound to remain bumpy for some weeks to come. But, what has changed since May highs is the fact that the SPY is oversold, it is at an area where support is very likely to be found, and volume at today’s $117 test was the type of volume that can be expected at key reversal points.

In other words, shorting at these levels offers too much risk to manage and traders should begin looking for buying opportunities into dips.

Recent Trade Performance

The market has been extremely volatile of late so we thought we would take a look at some of our recent trades to give an idea of what has been working and to show why this environment has been so difficult to trade.

Before we get started we would like to point out an important truism about all markets. If you manage risk properly, profits will take care of themselves.

One of the number one factors in risk management is the idea that you carefully avoid trading against the trend. Bear markets tend to experience strong bounces and they tend to be more volatile than bull markets.

Bounces that occur during market downswings can oftentimes lead to bullish chart set ups. And this is where traders get into a great deal of trouble. Bullish chart set ups that were working during stronger markets tend to be traps during bear markets. Surprises most often occur in the direction of the trend and those who bought into some of the many bullish set ups that emerged after last week's market rally paid dearly today as the market took one of the biggest hits since 911.

We advised readers and clients alike to hold short positions and keep a heavy supply of cash handy last week and so we ended up having a good day today while a lot of others who exposed themselves to too much risk did not.

On to the charts:

EEV

EEV is an ETF that trades contra to the Emerging Markets ETF (EEM). We probably exited a bit early but considering the volatility in this market we were happy to lock in our profits when available.

EWW

EWW offered clients excellent risk:reward after breaking through support to new lows. We plan to take profit on this short position tomorrow.

ADM

ADM offered quick profits and excellent risk:reward.

Now lets take a look at a couple of positions that didn't work out for us and see what lessons we can learn from them:

HBC

HBC initially worked for us. After we had a decent profit we lowered our stop loss so that if it did move against us we would lose no money. This is a perfect example of the frustrating behavior that stocks in this current market have offered traders. It offered great risk reward, it quickly moved in our direction, but then it whipsawed and quickly gave back profits.

Lessons learned here are twofold: First, it is important to adjust stops when profits are on the table, and Second, stocks can and do whipsaw in this market so it's important to not get greedy. If you look at EEV you might wonder why we didn't hold this position longer. The reason we locked in profits when we had them is because it's nearly impossible to know which stocks will keep on going and which ones will whipsaw back.

CNI

CNI is another perfect example of a stock that started out strong and then turned around in this volatile environment.

So remember, risk management is Job Number One. Trade only in the direction of the trend. Adjust stops after profit is on the table. And lock in profit when it's there because it might not be there very long.

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If you would like to receive free stock trades like the ones presented above, simply provide your name and email address in the form above.

Let the Indicators be Your Guide

Pilots understand that when flying through a storm they can’t rely on their feelings and they can’t rely on what they see through the cockpit window. In order to fly safely through the storm they must depend on their instrument gages to tell them where they are at in relation to the horizon.

Last week, the SPY moved down to its lows and then bounced weakly later in the week. This caused a lot of traders to buy in thinking that the market was ready to carve out a double bottom.

We warned, however, that the B-Band support and the 50-week average were continuing to decline to lower prices and we argued that this meant that the market was not stabilizing as it might have appeared late in the week. Likewise, the sentiment readings remained stuck in neutral.

The Risk Assessment Meter is our gage that helps us navigate the storm. Appearances can be deceiving but indicators that continue to decline showed us that the upside move was not to be trusted and that only the short side offered good risk management potential.

Indeed, today the market responded to the LEH implosion and a potential destruction in AIG.

As we mentioned a couple of weeks ago, the $117 level is likely going to act as a magnet. In fact, with the ferocity of the decline today there is some potential that we will see the SPY make an intraweek low as far down as $113.

Tomorrow the Fed meets and there is some talk of a .50 basis point rate cut to stem the tide of selling. How the market responds to this is just about anyone’s guess. If the Fed does make a big cut and the market responds favorably, it will no doubt just offer up another shorting opportunity at higher prices. This will continue to be true until the indicators start to stabilize and they certainly aren’t there yet.

It's a Craps Shoot

Over the past two trading days the market has shown moderately bullish resillience. Near term trends have turned slightly bullish in most major indices but intermediate and long term trends remain decisively down, which does not offer us a good risk:reward ratio.

Over the weekend it is possible that LEH and AIG may get government financing, which could give the market a boost on Monday. On the other hand, the oil rigs in the gulf are in the path of another hurricane, which could spike oil prices.

The market has been in a tug-o-war between bulls and the bears so it's really hard to know what to expect on Monday. At best trying to predict Monday's action is a craps shoot.

We really don't like the odds on either side right now.

When risk:reward improves, we will put our sidelined cash back to work.

No Stabilization In Sight

The market continues to show no signs of stabilization. If you check back through past reports here you will note that the 50-week average and the lower weekly Bollinger Band continue to steadily drift lower. When the market starts to put in a real bottom these two indicators should flatten out, which is just not happening right now.

In fact, the only thing the bulls have in their favor right now is the fact that near term sentiment readings are starting to move into the excessively pessimistic range. In an established downtrend pessimism does not make for a good reason to step in and start buying stocks.

Moreover, the fact that the market couldn’t put together more than a one day rally following the FAN/FRED bailout just adds emphasis to the precarious position that stocks are in here.

Keep Your Powder Dry

Socialization of the mortgage guarantors caught short traders off balance today as the market gapped up big. The SPY gapped back inside the trading range that it broke down from last week putting into question the hypothesis that a fresh leg lower was the destiny of this fall’s trading.

Benefiting most from this government takeover were the homebuilders, REITs and other property holding companies. The tech sector continued to lag.

The market is not out of the woods yet, however. It still faces formidable overhead resistance. Unless and until the SPY can close back over $130.75 it will be a good idea to not invest too heavily on the long side.

Today was a one day event. It needs follow through and a close over important resistance levels before it can be trusted. There will be plenty of time to get long when and if that should occur. Until then, keep your powder dry and tighten up stops on short positions.

Don't Say We Didn't Warn You

Sentiment readings remain surprisingly stuck at neutral and the VIX still has plenty of room to move before reaching fear levels struck during March and July lows.

The SPY has support at a multi decade trend line in the $117-$120 area, so this is likely going to act like a price magnet as we move into the fall trading session.

Don’t expect the market to head straight down, but certainly use any strength to go short again until the SPY reaches its trend line.

Big Boys Come Back In Selling Mood

The VIX broke out to the upside today and near term sentiment measures remain close to neutral. With the heavy volume today it looks like institutional money will remain in a selling mood for the next few weeks.