REVERSAL POINT?

Despite the rally over the last few days, we could soon start another move down...and it could happen as early as tomorrow. Last week I mentioned that we could be in a wave "C" of a bearish ABC pattern...and that we could possibly rally up towards the 1227 area on the S&P 500. Although 1227 is still a possibility, the stronger area of resistance seems to be right here...near 1210. There is resistance here from the 8/15, 8/16, and 8/17 highs as well as the 4/23/10 and 4/26/10 highs. The Dow has resistance here at 11550 (3/16/11 low as well as the 8/15, 8/16, and 8/17 highs). The very strong Nasdaq resistance is at 2600 which is very close. Despite the large move higher today, the volume was half of what it was on Friday. Although we could still move a little bit higher (1227 is only 17 points away), we will likely start another move down very soon. I don't know yet if that next move down will carry the market to that 1040 target area, but we should at least get back down to the 1120 area which would still be a nice trade. I love the reward to risk right here. I bought puts at the close on SPY, DIA, and QQQ. I also bought calls on the FAZ. The FAZ is a leveraged inverse ETF for the financial sector. I am still very bearish on the financial stocks...despite Warren Buffet's purchase of Bank of America stock. The financial stocks may start to stabilize (I said may) in the near future, but I don't think it will happen until at least another move down. The chart on the FAZ shows a great possible bullish ABC pattern with a clear stop loss area below its 50 day MA (and the early June resistance area around $52). If I'm wrong and I stop out about two dollars lower (around $50), I'll lose a little bit of money. If I'm right and the financial stocks make another move down, the FAZ could end up testing it's previous high...AROUND $80!!! You could wait for some confirmation on all of these trades...which I will normally do. I didn't wait for confirmation this time because the resistance areas (and support area on the FAZ) is so strong. The volume today backs up my prediction of a possible reversal right here. There is also Fibonacci confluence. Although technically we would turn more bullish if the S&P can close above 1258, I'd likely stop myself out if the S&P closes above 1227. If you don't want to trade the FAZ, you could look to buy puts on some of the individual financial stocks. JPM, WFC, and MS all have very bearish patterns. NFLX also looks like it is ready to make another move down.

Many of you have heard arguments on CNBC about a great buying opportunity right here. They use 2008-2009 and last year's sell off as examples. Don't forget that these rallies were due to QE1 and QE2 (the Fed's quantitative easing policy). We currently don't have these safety nets below the market right now. The problems in Europe have not gone away and will likely keep dragging the world markets down. We'll see what happens over the next few days. If I'm wrong, I won't lose that much. If I'm right, I'm going to hit the jackpot. That is the beauty of a great reward to risk position. If we start breaking above these key resistance levels, I won't have a problem turning more bullish.

SNAP BACK RALLY

When the market is this oversold, you can often get a snap back rally like we saw today. These rallies can look tempting, but they are often followed by another move down. In the short term, we might rally up a bit further. The S&P 500 closed at the highs of the day and the volume was a bit higher than normal. If we do move higher, the areas to watch would be 1172...followed by 1205....then 1227. These are all key resistance areas. This latest rally could be a C wave of a bearish ABC pattern. If so, we could move up to that 1227 area. Eventually the market should resume its move down to 1040...and that could happen sooner rather than later. The markets have been selling off on bad news lately and there's more news coming out over the next few days. Many are waiting for the Fed to step in and save the day, but that doesn't look likely at this point. There is a saying on Wall Street that says "Don't fight the Fed". If the Fed does step in with something to rally the market, I might have to ride that wave up...at least part of the way up.

The scary scenario is that gold could start to crash a bit. If gold starts to drop and the market continues to drop, you will see fear build as investors scramble to find a new safe place to hide. They could go to Treasuries, but that trade has also gone parabolic...despite the downgrade. The move down in silver today also worries me a bit. I don't think the sell off on August 4th took the market down far enough. I still think silver could rally much higher by the end of the year, but there could still be a sharp 5 to 7 day sell off before that climb takes place. Friday it looked like silver was starting to break out, but today's sharp selling has brought the SLV back below the breakout point. If it doesn't get back above that August 4th high within the next day or two, the SLV might start a bigger sell off. You could also look at a close below the 10 day MA on the SLV as a bearish sign.

The highest probability trades would be to either wait for the market to rally up a bit more (around 1205 or 1227) and buy some puts, or to wait for a break below 1120 to buy puts. The financial stocks still look very weak.

1120

We are back to watching the 1120 area on the S&P 500. If we break below this level, we will likely continue the move down towards 1040. The S&P 500 has either opened trading near 1120 or closed trading near 1120 for 6 of the last 11 trading days. This makes that area pretty significant. With the market down pretty big over the last week, we could get a short term bounce in the near term. I bought some puts at the close today in case we break below 1120 tomorrow. If we do end up rallying up a bit, I will look to add more contracts. Although I am expecting the market to move down a lot further in the longer term, we could start to get some choppy trading ranges in the intermediate term that could decrease some of the volatility. I don't expect to see much sideways price action until we get down close to that 1040 area, but be aware that it could happen. You need to use good money management in these types of markets. You can make money very quickly when the volatility is high, but you can also lose it very quickly. The Dow Transportation Index has already broken below its August 9th low. The Dow Transportation Index is often considered a leading indicator of the market. Since it has already broken below this low, it makes it more probable that the major indexes will follow soon and break below their August 9th lows. If you do end up buying some put options in the next day or so, make sure you buy out to October. You want to make sure you give yourself enough time in case there is a short 3-5 day rally. Like I said last week...the shorter term movement of the market is very difficult to predict, but the longer term expectation is that the markets will continue to move lower. The financial stocks all look like they will continue to move lower. There were many bearish engulfing candlestick patterns on the financial stocks....look at GS, MS, JPM, C, BAC, WFC, etc.

IS THE NEXT DECLINE ON HOLD?

I will be leaving on vacation tomorrow so this will be my last post this week. The market did break above that .382 retracement today. It also closed above its 10 day MA. These are not the strongest resistance areas, but we can't ignore those bullish clues. One of the mistakes I made after last year's market sell off is that I ignored some of those early bullish clues. I was so convinced that we were moving lower that I ignored those closes above the resistance levels. I mentioned last night that we could move up to the 1225 to 1250 area if we closed above that .382 retracement. That could happen in the short term. The volume has been declining on each of these up days. This is usually a bearish signal and a signal of a correction. However...if we move much higher, the short sellers will start to get squeezed. You can't let a short position move against you very much before you need to step in and cover it. For those familiar with shorting stocks, this means that you would "buy to cover" the position. This additional buying to close those short positions can cause the market to shoot up very quickly. That type of move would likely cause the volume to spike up...and it could lead to a continuation of the rally. I still feel that we are going lower in the intermediate term, but it is really hard to tell where we are going in the short term. Since I am leaving on vacation, I exited some of my bearish trades at the market close today. We not only broke above that resistance area, but we closed at the highs of the day. I was waiting to see if the rally would fade into the close, but it didn't. There is another resistance area to watch...about 1219 on the S&P 500. This was the April 26th high in 2010. If we break above this level, we might start to see that short squeeze. The market has been up for three days in a row. It could pull back a little before going higher. If we sell off big in the next few days, then the counter trend rally would likely be over and the next move down should be underway. That next downside target would be 1040. If we just pull back a bit (a hundred or so Dow points), we would likely move a bit higher. If you want to look at some potential short term bullish trades, AAPL fits our trend analysis criteria. GOOG is close, but still needs some confirmation (a move above its 10 day MA). That's about it from the bullish side. This is why I'm not likely to play any bullish trade. That...and the fact that I'm going on vacation. See you next week.

PATIENCE

The market is near a critical area. Although the longer term forecast is for another move down, the shorter term expectation is less clear. A lot will depend on tomorrow's movement. The latest rally has brought the markets up near their .382 Fibonacci retracement levels. This level could act as a resistance level. The .382 level on the S&P 500 is around 1195. On the Dow it is around 11424...on the Nasdaq it is around 2534. These levels would allow for a small move up tomorrow. If this level holds as resistance, the S&P should move down to the next support area (around 1040). If we have a strong day tomorrow...which would be characterized by a big move up that closes well above that .382 Fibonacci level...we could see a short term run up to the 1225 to 1250 area on the S&P 500. This could allow you to set up some short term call option trades that would help to offset the paper losses on your current put option trades. If it does make it up to that 1225 to 1250 area, you could then get out of any call option trades and possibly even look to add to your longer term put option positions. The market is still very oversold, so a rally up to that area wouldn't be surprising. The next move would then likely be a drop to that 1040 area...that would be a big move down. I'll repeat what I have said earlier...if you are new to trading, you might want to sit out of the market for a couple of weeks. Based on the system that I will teach you, there aren't a lot of high probability trades right now. The market is far below its 50 day MA. This means that we could either move lower, or rally up a bit. How's that for certainty. The volatility of the markets does create a lot of day trading opportunities, but day trading is not a great way to start your trading career. There are too many ups and downs to day trading. You have to have a very high risk tolerance and you really need to know how to read your charts. Patience is the key. If you miss one or two opportunities, you will get others...so don't force a bad trade. One last note...keep an eye on gold. The margin requirements were recently raised on gold (last week). When these requirements were raised on silver back in late April, the SLV dropped dramatically. I'm not brave enough yet to buy puts on the GLD, but I will watch it.

VOLATILITY

There have been some wild swings over the last few days. I was watching the market earlier today and thought to myself, "The Dow is only down 200 points". Only 200 points? Normally that would be a huge down day, but in this environment it's been average. Expect more volatility over the next few days...and maybe weeks.

We got the snap back rally on Tuesday. That was a great opportunity to enter into some new put trades...or to to the Straddle trade (buy an ATM call and put). The market is likely heading lower, but it's impossible to predict exactly when it will make the next move down. There could be other snap back rallies (perhaps one to correct today's move down), so you might have additional opportunities to set up new trades. For others, this can be a very scary time in the market. If you are new to trading, I would recommend that you sit on the sidelines for a little while. These markets are moving very fast and swinging wildly. There can be a lot of money to be made on these swings, but there is also a lot that can be lost.

If you do enter new trades, use limit orders. DO NOT USE MARKET ORDERS!!! I also wouldn't use stop orders. When the market starts to swing back and forth like this, it often triggers all your stops. You might find yourself getting stopped out of every trade...even though many of your expected trade directions end up working out. I didn't say that you won't still stop yourself out of a trade...just that you shouldn't set up the open stop orders. If you are unable to check in on your trades during the day, you could use a contingent stop order. This will only trigger if the stock hits a certain price. The best trade is to just risk the amount that you are spending on the option and not use a stop. Normally this isn't the recommended way to trade the option because you often need a big move on the stock in order to get a 2:1 reward to risk on the option trade. Well guess what?...we are getting big moves. You must be willing to lose the amount you spend on the option. If you put $5,000 in a put trade and you don't use a stop, you better be willing to lose the $5,000 if the trade doesn't work out.

Remember that we trade probabilities. I don't know what the markets will ultimately do in the future. Based on my experience with a number of these volatile market conditions, I would suggest that the higher probability is for another big move down. If we do get another snap back rally, you would want to consider buying some puts out about 60 to 90 days...not the shorter term options. I know that the options are expensive right now...almost double what they were a month ago, but you still need to give yourself some time for the market to make its move. There is a chance that the market will try to retrace this recent decline...possible 38.2% or maybe even 50%. A move back up to that 1227 support/resistance area would represent a 50% retracement. I don't think it will retrace that far, but you never know. THIS IS FOR COURSE 2 STUDENTS: If you know how to use Debit Spreads, you can significantly reduce the cost of these expensive option trades. You can also offset the inflated option risk. I'm trying to move my Debit Spreads a bit more out of the money in order to have the opportunity for 150% to 200% possible returns. You can also try to set up some Credit Spreads when the market makes a rally. Try setting those up further out-of-the-money if you can. It might lower the percentage gain a bit, but It will create a high probability return. Try using the weekly options if you can. There won't be any new weekly options tomorrow because next Friday is August expiration.

One of the reasons why I think we are moving lower is because there are so many people out there saying that the bottom is in and that this is a great buying opportunity. Major bottoms are usually formed when the bulls are beaten up and nobody wants to buy because they feel the market will continue to go lower. This was the sentiment at the March 2009 bottom. I don't think we are close to that level of pessimism...not yet anyway. I think that the banks will continue to suffer. Puts on the XLF or calls on the FAZ (this is a leveraged inverse ETF on the financial sector) would be the best trade there.

SEA OF RED

Today we saw some of the heaviest selling since the 2008 financial collapse. The market was extremely oversold last Thursday/Friday. Now it is beyond extremely oversold. We are due for a bounce. If it doesn't come by tomorrow or Wednesday, this market could really collapse. Don't try to time the bounce. If you have been buying calls over the last week (trying to pick the bottom), you have probably gotten hammered. The trade is not to try to catch the little bounce. That is a low probability trade because you would have to time it perfectly. The trade is to wait for the bounce and set yourself up for the next move down. If we have a snap back rally, look to buy puts on the SPY, DIA, or QQQ (or all three). Buy them out about 90 days to give yourself plenty of time to capture another move down. The safer trade would be to buy a call and a put (Straddle trade) using the same strike price. You could probably use the September options on that trade...although the Octobers would be a bit safer. Either way, you would still need to wait for the rally. The rally should be sudden and big...about 300 to 400 points. It will look like the market bottomed and is starting another rally, but it will likely just be a small retracement that is setting up for the next move down. If you are unsure about either possible move, try buying the call and the put. If the market continues to sell off tomorrow, you could look to buy some puts to try to take advantage of it, but don't buy too many. The put options are very inflated right now. You would need a big move down in order to make money on them. A smaller move down or a rally would cause the options to deflate. I've been trading for over 13 years and I don't think I've ever seen the NYSE advanced/decline ratio this high. There were 3033 stocks on the NYSE that were down today, just 44 that were up. Even though we are oversold, I still don't see any buyers. 1129 was the last support area on the S&P 500 and we just blew through that level. The next support is at 1040. If we get there without a market bounce, it would create a historic move that will be talked about for years. The SLV should continue to pull back. The fact that it barely moved up on such a big down day in the market tells you that it probably has further to drop. Gold looks like it is making the parabolic move that silver made a few months ago. You can buy calls on the GLD, but make sure you look for warning signs that may signal the end of the run. I think that any snap back rally in the market would also lead to some profit taking in the GLD. I'd also look to short the financials if we get a snap back rally. As with 2008, this is the most vulnerable sector to a global market sell off. You can trade the whole sector by buying puts on the XLF. If you want some additional leverage, try puts on the FAS or calls on the FAZ. All of these trades should be done on the snap back rally.

PANIC

There was definitely panic on the Street today. There seemed to be no safe place to go. Money was coming out of everything. We hit a lot of extreme levels today. Usually when we hit these levels the market snaps back a bit. Normally I would expect the snap back rally soon (and we may just get that), but tomorrow is Friday. I don't know if there are a lot of traders that will want to be long this market going into the weekend. For that reason, it could be another decent down day. Many have commented that these last few days have been bad. I don't necessarily agree...unless you have a lot of money tied up in mutual funds or other long term stock holdings. Remember that the market is never good or bad...it's just the market. We put these labels on the market. The market was very good for those that were short...or had large put option positions. It was bad for those that had long positions or call options. I'm suggesting that the move down over the last few days has been great for us traders. It has broken us out of the range that we had been in for the last 7 months. Now the market can start trending again. Remember what I had said in earlier postings...I said that I didn't really care which way we broke as long as we broke out of the range. We can still make money in a sideways range, but you often end up working twice as hard for half the profits. There are a few opportunities right now, but we might need to be patient. There are two main reasons why I don't recommend buying puts right here. First...the market is extremely oversold and due for a bounce. I don't know when the bounce will occur, but it is due. Second...the put options right now are inflated. Any rally or even small down day will deflate them. This means that you could have a small move down in the market and see your put options actually drop in value...possibly a significant drop. It also means that the only way you could make money with a new put option trade is if the market drops a lot...again. This would be a lower probability due to the already extreme oversold condition. The trade?...wait for the rally. Once the market snaps back a bit...even if it only a small amount, the puts will start to deflate. A significant snap back (300 or 400 points on the Dow) would relieve the extremely oversold condition and set up perfectly for another move down. Be careful not to get suckered into buying tons of calls on a big snap back rally. At the start of the financial collapse in 2008, the Dow dropped 774 points in one day...still the largest point drop ever (the "flash crash" saw the Dow down 1000 points, but it rallied back before the close to only finish down 342). The next day the Dow rallied 479 points...one of the top 10 biggest one day gains ever. That rally then led to a 3000 point drop in the Dow over the next 8 days! The "flash crash" in 2010 was followed by a 400 point rally two day's later. That rally led to a 1100 point drop in the Dow over the next 10 days. With the technical levels that we have broken, it is definitely possible that the market could test the lows of 2009. Yep, that would be the "double dip". Just a reminder....that was Dow 6469. Just to put things in perspective...the drop in 2008 was due to the financial collapse of banks and businesses. This drop could be due to the financial collapse of countries! In 2008, it was billions of dollars. In 2011, it could be trillions of dollars. As always, we will continue to trade the trends. If this is just an ordinary correction and the market moves back up, we will change from bearish to bullish and ride that trend. As of right now, the trend is down...so we will look to trade bearish. For those that are beat up a bit, I suggest that you stay out of the market for a week or so and allow yourself to get mentally prepared to work on the draw down. For those that are looking for a lower risk trade, you could try this one. Wait for the snap back rally....then buy a call and a put (same strike price) on the SPY, DIA, or QQQ (or try all three). This trade is called a Straddle trade. I cover the details of this trade in Course 2. It seems simple, but it is not a simple trade. I don't recommend that you go out and trade this strategy on a regular basis without learning the proper conditions. For this trade to work, you need the stock to make a big move up or a big move down. I think we have those conditions. Since you are buying both a call and a put, it is critical that the options are not inflated. This is why you must wait for a rally in the market to deflate the options. You must not get greedy on this trade. Normally this trade will give you a 10% to 20% return. With more volatile markets, the returns can get as high as 80% to 90%. During the financial collapse of 2008, I traded this strategy on almost every snap back rally. Although I wasn't making 300% returns with the trade, it was still "easy money" at the time. These conditions could end up being similar to 2008. This trade can work well in these conditions because if the market continues to drop hard, your puts will make money...if the market starts to rally and the shorts get squeezed, your calls will make money. If the market starts to move sideways again, you will lose money. I think the probability is low for an extended sideways trend...at least for now. Give yourself some time for this trade....about 45 to 60 days at least. SLV and GLD look like they are going to start their drops. I don't know that I'd trade them down unless I was using a Bear Put Spread or a Bear Call Spread (Course 2)...due to the put options being inflated. You can trade some spreads when the options are inflated. I'm expecting a correction in both the SLV and GLD, but then I'm expecting another huge move up. Instead of trying to capture the smaller move down (although it could end up being a decent move down), you might want to use the sell off to start buying January options...especially on the SLV. I think the SLV could pull back to within the $32 to $35 range. The GLD could pull back to around $154 to $156.

UPDATE

We broke below 1258 today. That signals that the bears are definitely in control of this market. With the market extremely oversold, I would still expect some sort of rally within the next few days. The break of the 1258 support means that this sell off could get ugly. There is still some support at 1250...but if it breaks through that, we are looking at a possible "double dip". If you traded calls on the SPY and puts on the VIX, your goal now would be to try to get out at breakeven...or at a small loss. A rally in the market would likely be a retracement that leads to another move down. I don't recommend any new trades here. The safest place is in cash right now. Once I see a clearer signal or a good pattern, I'll let you know.

WILD DAY

There was a lot of volatility in the market today. There was the big gap up at the open which was expected...then the big sell off during the day which was not expected. There was a point early this morning when it looked like there would be bearish engulfing patterns all over the place. The bulls managed to pull the market off its lows going into the close, but the day was still very bearish overall. Most of the selling was due to a very weak ISM number and the uncertainty that the debt ceiling legislation might not get passed. We need to put today's volatile price action into perspective. I read that today was only the tenth time over the past 26 years that the S&P 500 has been up 1% or more in the first half hour of trading only to give it all back (and more) by 10:30am. In other words...it was a rare event. With the Dow having been down for the last six days, it was highly probable that a 1% move up in the morning would lead to a bigger rally today...and perhaps over the next few days. As you will learn in trading, a probable move doesn't mean an absolute move. This is why you never bet your entire account on a single event...no matter how high the probability. That said, the Dow has now been down for 7 days in a row. We haven't seen that many down days in a row since 2008 after the collapse of the financials. The market is oversold and due for a rally. The final votes on the debt ceiling should take place tomorrow. Barring any additional bad news, the market should at least stage a decent rally...despite the bearish price action today. Any rally would likely cause the volatility index (VIX) to drop significantly. I still think the "calls on the SPY, puts on the VIX" trade will work. I still don't recommend any new trades right here. Today's movement in the market reminded us that there is still a lot of uncertainty out there. It is dangerous to buy the market right now and even more dangerous to sell it...given the 7 down days in a row on the Dow. The safest place is in cash. I've talked about 1265 as a key support area, but the specific level is closer to 1258 based on Elliott Wave analysis. A break below this area would signal the possible start of a huge move down. A strong "up" day with a close near the highs of the day would likely signal the start of a bigger move up...at least back up to the 1344 area. With the increased volatility in the market, look to take profits off the table with any "big" move in the market. Don't get greedy. The market has been swinging back and forth...not trending very much.