Anatomy of a Crazy Market Day

With the Dow selling off over 300 points from the high to the low Wednesday, and then bouncing back to close only 113 points off the high, it was a crazy day. Our trading model covered shorts, holding the SPY puts bought earlier today in their place. Even with the market recovery, the puts bought earlier are still up over 17%, and will act as downside protection when we go long, likely on either another pullback or a breakout of today's highs.

Here's a 1-minute chart of Wednesday's action, showing why the lower high just after noon was a great short entry and then why the 3:00 panic selling was time to cover shorts:


At the top of the chart in green and red are the up volume vs down volume and down volume vs. up volume graphs. Below that is the TRIN chart, which shows the volume going to advancing issues vs. declining issues. The TRIN moves inversely to the market. Below that is TICK, which shows issues upticking vs. downticking. Finally, below the TICK are charts of the S&P 500 ETF (SPY) and the triple long financials ETF (FAS).

Just after noon, the market retested the day's high but couldn't make a new high. Up volume, shown at the top, had dropped dramatically vs. down volume. TRIN had moved up dramatically from under 0.5 to 2.00, a strong negative divergence. TICK was downtrending despite the rally. Our trading model signaled it was time to add to shorts.

Over the next 3 hours, the market sold off dramatically. Just before 3:00, TICK hit an extreme level of -1450, signaling panic selling. Just after 3:00, TRIN peaked at an extreme level well over 3.0. TICK began to turn positive. The market was clearly turning around again.

The S&P 500 bounced off its 50-day moving average and rebounded to close almost 1% higher after dropping to almost 2% lower. It was an impressive rebound from a sharp pullback.

The strength of the bounce off the lows, particularly in the last few minutes, indicated significant short covering. As we mentioned yesterday, there have been "clear bouts of frenzied short covering after recent pullbacks," and today's late action proved that to be true yet again.

While Tuesdays and Wednesday's pullbacks have relieved much of the short-term overbought conditions, the market is still likely to have a more significant pullback at some point fairly soon. However, that pullback could come from a significantly higher level now. If it comes immediately, we still have our puts to profit from it.

Given our bullish intermediate-term outlook, month end coming up (where portfolio managers will want to show long exposure during this rally), and the high amount of short buying power in the market, we're more comfortable for now holding our puts and going long with put protection on a pullback or a breakout.

Open Positions: 1% long SPY April 77 puts, speculative traders long an additional 1% SPY April 77 puts.

Comments

[Paul_L]

Keep up the good work!

2009 Mar 27 12:26 AM