In poker terms a straight flush is one of the better hands one can get. For most investors it’s a nightmare and for traders it can be either wonderful or a disaster as well. It really depends on how you play the hand. The hand we got dealt here was a surprise. While new lows were part of my expectations yesterday the ferocity of the sell-off at this time of year was unexpected. In fact it was the worst start to markets in February in 32 years. Nothing pretty or predictable about it.
Here’s where we are: As you can see from the $SPX chart on the right we flushed right through to a key trend line going back to June. We also are very close to the 150MA. The fact that we went almost in a straight line, without re-test, from the 50MA to the 150MA is astonishing. For months the few remaining bears like myself have been pointing out the false premise of this rally only to be mocked and told that margin debt, low volumes, and low $VIX and other indicators were so bullish. Now that earnings, growth and of course tapering are removing the curtain what’s left is not all that pretty. That said, I maintain that bull markets don’t die on a dime and this monster is not necessarily dead. However, we have to recognize that this is now the severest corrective move in almost 2 years. In fact, the last time the $SPX got anywhere near the 150MA was in December of 2012 only to commence the rally that culminated in the high of December 2013. Technical damage is being done and the next 48 hours are kind of critical to see how the market reacts.
As I came in mostly cash yesterday I started scaling in long and as the action turned into carnage I widened my scales, looked for strength and started shorting volatility aggressively as the day progressed, with some calls and scales added into a close that smelled of liquidation. Bottom line, I either made some great buys yesterday or I’ll be under pressure for a bit. Obviously I would have preferred to be short yesterday, but part of my acquired trading psychology is to never dwell on woulda, coulda, shoulda. It serves no purpose other than to cloud your train of thought. I can’t re-trade yesterday I have to focus on the trades today and tomorrow.
One of the principle reasons I kept expanding my positions is the weekly $VIX chart. We had been elevated for several days now, but for months frankly I have been waiting to short one of the big volatility spikes. They are historically simply one of the best money making opportunities out there. As this weekly $VIX chart shows the market, for now, is repeating the same pattern it has over the past few corrections. One key thing to understand about shorting volatility: While indices can go lower, $VIX does not necessarily need to go higher. We saw this a few times yesterday where $SPX made new lows, but $VIX and $VXX barely managed to inch higher. We don’t even need to see indexes go higher much for these to turn lower, all we need is some stability. A simple range day or two and volatility would decrease. Hence you can see these very large reversals. Now of course any sizable reversal bounce and they just collapse. Hence, while I kept scaling into longs, I shorted volatility. Now the risk for me is that something really bad is happening from a systemic perspective and $VIX goes straight to 30 or 40. I haven’t seen any evidence of this, but my risk is puts mostly, although I do have some $VIX futures and they would hurt if such a case were to unfold. But, so far, all I see is an aggressive flush to get rid of some of the excess.
The impact of margin debt does concern me as I do not know how systemic the issue is at the moment. Clearly some people got blown out last night. Fear, dislocation, and huge volume all were indicators that there were liquidations at the end of the trading day.
My trade plan: We have some very key support near the September gap and highs. This is my next scale zone should we get there today. If we do not move into that zone I presume we will bounce with the $SPY $177 area being the key initial resistance. Bulls want a convincing show of force today or tomorrow at the latest. So a bounce could be violent. If so my aim is to significantly scale out of positions on the way up and take profits where I have them. Many, MANY traders are caught above $177 and will want to unload if they get back to break-even. Therefore any move into that zone would likely cap any advance this week unless this entire move down was a bear trap and a flush of weak hands.
Ultimately we will test the 50MA and take a stab at the top gaps, but I have to assume this will now take a lot longer.
A few charts of interest:
$AAPL: I got some calls yesterday as $AAPL became a safety stock yesterday. Already oversold and destroyed $APPL was actually up on the day. Great place to get some calls as it may rip on a market bounce.
$GS: Complete carnage and also shockingly went through the 200MA like butter. The key reason: Rates have been falling like hail from the sky raising concerns about the validity of this entire recovery and raising deflation fears again. $GS is now down 5 weeks in a row in a decline that qualifies as stunning. I’ve been trying to catch a bounce to no avail, but gave calls another shot yesterday, including into the close as $GS showed some relative strength. When it does bounce calls will rip.
$DJIA: Index of shame. Multiple months of rallying taken away in mere days. As I kept saying this bull market is based on a house of sand that can just disappear. Ironic I didn’t take full advantage of this first decline, but be sure I’ll be there for the real decline 😉
$NYMO and $CPC: These are charts of caution actually as they show that the markets is, so far, taking this decline in stride. Frankly not what I want to see and this tells me more downside may still be in order. For example a bounce to $177 $SPY may get sold for a visit to the 200MA. That’s speculative at the moment and we will cross that bridge when we come to it, but it is something I’m keeping an eye on.