Thoughts on Options Expiration, Vertical Charts and Market Crashes

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Since my timing signal turned bullish, noted by the green dot, the market action has been absolutely perfect if you are a bull. Dips have been bought, support levels have held, and the RSI action has stayed between the 40-80 level. Aside from the normal “we haven’t corrected properly” argument, it’s really difficult to forecast what could bring this market down, but there is an extremely noticeable bearish wedge forming that is making me a little uncomfortable.

I started to trim down some of my positions and even exit a few throughout the day yesterday as this week has been good and I wanted to raise some cash as Friday could be an interesting day. It’s options expiration Friday and a full moon. Click on this chart to see how the markets trade around the full moon (indicated by grey arrows) and it’s had an extremely bullish bias since Aug ’10, and it’s only a matter of time before this lopsided move oscillates back in the other direction, at least for one moon cycle. I’m not that into Gann, but his concepts are mildly interesting and like Mulder… “I want to believe”.

OE and moon cycles aside, that chart of the Dow Jones is practically vertical and I can’t deny that little voice on my right shoulder reminding me that this is going to end badly. I’m currently reading Why Stock Markets Crash and the following on risk-driven markets seems strangely familiar as I read this last night. I’m not even at that point where I think a crash is even possible, but I know that many out there in the blogosphere are.

As the risk of a crash looms stronger, rational traders are enticed to stay invested only because of the higher accelerated returns, which provide an adequate compensation for the increasing risk. The fundamental point in this model is that a crash is not certain and there is a finite chance that the bubble ends and lands smoothly, thus making it rational for traders to stay invested in the market and to profit from (risky) gains.

It’s obvious Bernanke is banking on that smooth landing…while most of us “rational traders” are just along for the ride. Click to enlarge: