Playing for a Bounce?

Some of the best trades come when everyone gets very panicky.  The crowd can often act very stupidly in the markets.  You can picture price fluctuations around an equilibrium level as a rubber band being stretched - if it gets pulled too far, eventually it will snap back.  As a short term trader, I try to wait until the rubber band is strecthed to its extreme point.

- Linda Bradford Raschke, quoted in The New Market Wizards (1992) by Jack Schwager, pg. 300 

I think that’s enough for now.  I bought SPY at the very end of the day yesterday at $116.40, and I added to my Goldman (GS) position at $100 midday.  I think a bounce is coming and here are some reasons why:

• The Dow has dropped 812 points (-7.11%) and the S&P 95 points (-7.59%) so far this week. 
• Volume has been really high on the NYSE and in major ETFs like the S&P 500 SPDRs (SPY) and Financial Select Sector SPDR (XLF).  In fact, I believe the SPY set an all-time record yesterday with 624 million shares trading hands. 
• Both Monday and Wednesday were 90% down days where more than 90% of the volume traded on the NYSE was on a downtick.  These types of days, on the up or downside, are thought to be climactic.  Two this week suggests to me the selling has reached a climax.
• The Fear Index [VIX] spiked to 36 Wednesday and closed there - the highest closing level since 2002.
• The selling in Goldman (GS) and Morgan (MS) has just been insane.  In spite of releasing a pretty solid earnings report before the open on Tuesday, Goldman is down 26% on the week.  It was down 14% yesterday on volume of 112 million shares - out of 394 million outstanding.  BY FAR, yesterday was the biggest volume day in Goldman’s entire history as a public company dating back to 1999.  It’s the same story at Morgan Stanley, which is down 42% on the week and 24% on Wednesday with 330 million shares trading hands - out of 1,109 million outstanding.  Again, that’s BY FAR the highest volume day for Morgan Stanley in the last 10 years.
• In another sign of complete panic, according to the WSJ Markets Data Center, yesterday the 3-month T-Bill closed yielding 0.036%, which is down from 1.475% at last Friday's close.  That compares with a low of 0.518% on March 20 in the wake of the Bear Stearns (BSC) bail out.  To be clear this means that investors are willing to lend money to the Treasury for three months without being paid ANY interest just for the security of knowing that their principal is safe.  It’s a sign of capitulation because it shows that everything else is being sold, and nothing is trusted.
• Yesterday, the SEC came out  and outlawed “naked short-selling” on ALL public companies.  If you recall, they did the same thing back on July 15 except that it only applied to the largest financial stocks - and it worked as that day marked the bottom for financials.  In other words, the government is sort of making it illegal for stocks to go down.  Socialism anybody?

For all these reasons, I think stocks might have bottomed yesterday, or at least they’re real close, and a bounce should be coming.  I don’t think the bear market is over by any means, but for the short term, it might take a little break.

Disclosure: Top Gun is long the S&P 500 ETF and Goldman Sachs.

Comments

[User 226857:]

Greg,
UYG getting creamed !!! Can't believe people don't trust in GS

2008 Sep 18 12:42 PM

[MarvinMBA:]

Bounce or no bounce, get out while you can is my sage advice. Beyond a bounce (if any) were heading into third world territory and Deep Depression is my take on what is going on...manipulation of financial failed intitutions and ongoing mark to market is going to cause a hyper inflation. Where and what actions would make some sort of turn around and will it come to late? Job Growth and Fiscal Policy might do it...Get money into the hands of the public by job and Tax policy. But its way too late at this stage. Getting M1 and the housing market going again is impossible. Cheap energy is now impossible but nessasary for cheap commodities for disposable income but its not coming. Our Govenment got us into this mess and no matter what it does, the underlying problems will remain notwithstanding the mark to market failures that the Fed is trying to hold at bay by bailing out the losers. WE NEED A NEW PARADYNE AND ITS NOT NOT THERE.
Its going to be tough for the average guy to keep a job, and provide food for the faimily going forward from here. Marvin the Maven

2008 Sep 18 12:43 PM

[Umm, yeah:]

@Marvin - psst, it's paradigm, not paradyne. But seriously I hear ya and am also feeling the pain.

In regards to the article - I thought naked short selling has always been illegal, but only now are they finally going after the perpetrators. And I fail to see how this prevents *all* shorting, nor how it is making it illegal for stocks from going down?

2008 Sep 18 12:54 PM

[Nikola:]

Wishful thinking. There is going to be a technical bounce, sure, but that's got nothing to do with reasons stated above.

Yesterday there was a good article here.... in terms of what sort of thing needs to happen for things to settle down. No major bad news for 60 days. And that's not likely to happen for a few more months = end of the year.

2008 Sep 18 12:55 PM

[Matt Blackman:]

Greg;
Interesting article but it is clear from your last comment on the SEC's recent action "banning" naked short selling that you do not understand what naked short selling is. It is ludicrous to make the statement that by banning the practice which was "banned" in January 2005 with the Regulation Short Sales rules (RegSHO) that the government is "making it illegal for stocks to go down."

However, for some reason, the SEC decided not to enforce the RegSHO rules until recently.

Naked short selling is the destructive practice of selling a stock short without having to first borrow it like everyone with the odd exception of market makers, brokers and hedge funds have to do.

This action by the SEC does not "make it illegal for stocks to go down" as you state, it makes it illegal for those who short stocks to do so without having to first borrow the stock. This practice by the way, effectively allowed those few players the ability to counterfeit the stock which hurts everyone. I explained naked short selling in my March 23, 2007 newsletter at tradesystemguru.com/co.../

There was an excellent 25 min documentary done by Bloomberg in March 2007 entitled Phantom Shares that everyone should watch (which hopefully still works). The link can be viewed at the bottom of the page at tradesystemguru.com/co.../

I don't dispute the fact that with its recent action the government has crossed a dangerous moral hazard threshold in socializing markets but let's not start making charges that simply aren't true.

2008 Sep 18 01:24 PM

[Winston Smi...:]

Some times the rubber band breaks. Government is trying desperately to tie it back together but it will break again soon. Buying GS and MS at this is a little premature.

2008 Sep 18 01:27 PM

[Matt Blackman:]

Found another good article that explains the naked short selling problem..
www.sec.gov/comments/s...

2008 Sep 18 01:48 PM

[Matt Blackman:]

Sorry, here is the correct link to the naked short selling article entitled The 'Phantom Shares' Menace by John Welborn
www.cato.org/pubs/regu...

2008 Sep 18 01:50 PM

[Umm, yeah:]

Wow - I just read an AP article where Britain is completely banning (temporarily) shorting all together.

See:
ap.google.com/article/...

2008 Sep 18 02:13 PM

[Troutbum:]

I'm on board; good to see all the naysayers here another sign of irrational panic and capitulation. Anyone who thinks 30% moves in Goldamn or Morgan are justified do not have a clue.

Just how far do you think governments (all governments) will let this panic go?

Re: the short selling- layoff the guy. Naked Short selling has not been illegal- coupled with the no uptick rule has lead to the markets moving too fast...well beyond fundamentals and the abiliyt of institutions to react.

So bottom line; once governments step in, slow down the action, bring a little rationality and stability back...money will flow back in and there will be an updraft...significant updraft as we are way oversold.

I'm not talking raging bull only more than a dead cat bounce...and I am in for the ride baby.

2008 Sep 18 09:19 PM

[williambanzai7:]

Sympathy for the Shorts
(Lyrics by WilliamBanzai7)

Please allow me to introduce myself
Im a man of wealth and taste
Ive been around for a long, long year
Stole many a mans nest egg and faith
And I was round when Livermore
Had his moment of doubt and pain
Made damn sure that Milken
Washed his hands and sealed his fate
Pleased to meet you
Hope you guess my name
But whats puzzling you
Is the nature of my game
I stuck around AIG
When I saw it was a time for a change
Fired the CEO and his SVPs
While Bernanke screamed in vain
I killed a bank
Was best friends with Hank
When the markets raged
And the cold Pizzas stank
Pleased to meet you
Hope you guess my name, oh yeah
Ah, whats puzzling you
Is the nature of my game, oh yeah
I watched with glee
While your investment banks bleed
Fought for ten decades
To kill paper they made
I shouted out,
Who killed the GSEs?
When after all
It was you and me
Let me please introduce myself
Im a man of wealth and taste
And I laid traps for bankers
Who get fired before they reach Mumbai
Pleased to meet you
Hope you guessed my name, oh yeah
But whats puzzling you
Is the nature of my game, oh yeah, get down, baby
Pleased to meet you
Hope you guessed my name, oh yeah
But whats confusing you
Is just the nature of my game
Just as every banker is a criminal
And all the investors saints
As heads is tails
Just call me hedge fund joe
cause Im in need of some restraint
So if you meet me
Have some courtesy
Have some sympathy, and some taste
Use all your well-learned risk controls
Or Ill lay your trading book to waste, um yeah
Pleased to meet you
Hope you guessed my name, um yeah
But whats puzzling you
Is the nature of my game, um mean it, get down
Woo, who
Oh yeah, get on down
Oh yeah
Oh yeah!
Tell me baby, whats my name

2008 Sep 18 09:27 PM

[Brian in Mo...:]

williambanzai7 - Nice Tune ! So familiar these days isn't it ...

2008 Sep 18 11:41 PM

[Greg Feirman1:]

I said the government is "sort of" making it illegal for stocks to go down. I was being somewhat literary rather than literal here.

The whole idea is that they're going after short sellers right now because they want to stop the market from going down. Anybody disagree that that's why they made this announcement when they did? The point was to intimidate and help the market out.

All the details about naked short selling don't concern me. It makes sense that you should have to line up the shares first. But the SEC's intention was to stop stocks from going down and use the force of their government power to that end. Hence they are "sort of" making it illegal for stocks go down.

When the people with the guns (i.e. power) start to flex their muscles to some end, in this case stopping stocks from going down, it's worth paying attention to and it will probably be, ceteris paribus, effective to some extent.

2008 Sep 30 12:41 AM

[Greg Feirman1:]

And I dig the lyrics WilliamBanzai7!

2008 Sep 30 12:44 AM