Right Back Where We Began

Sep 20, 2008: 7:21 PM CST

In an amazing turn of events, the Dow Jones and the S&P 500 stock market indexes ended one of the most turbulent weeks in their history virtually unchanged in percentage terms, while the NASDAQ and Russell 2000 closed higher on the week, with the Russell increasing almost 5.00%

Let’s take a quick look at the week that will live in history.  I mentioned on Monday’s post “Use Extreme Caution in the Week Ahead” that the trading ‘environment could swing violently up and down due to market events scheduled to happen this week’ but I should have included the word “unscheduled events” as well!  It was a tumultous week, and it seems virtually all strategies were tested to their breaking points in the week.  But when the dust settled on Friday’s close, it was a very tame if not negligible percentage change for the week, despite multiple back-to-back 5% moves in the major US Equity Indexes.

First, let’s look at the Dow Jones 30-minute bars to capture the intraday wonders that shaped last week:

The Dow began the week gapping down from 11,450 to plunge 1,000 points in a few days to a low near 10,450 before skyrocketing 1,000 points in less than 24 hours.  It will distinctly go down in history.

What we had was a relatively orderly decline with the 20 period EMA serving as major resistance on the way down (minus a few blips above the average).  A lengthy positive momentum divergence took hold prior to the price rally.

Let’s not kid ourselves with the technicals, however.  Technical analysis is used to forecast probabilities and assess price structure;  it assumes that “all that can be known is filtered into the price” and it cannot tell the future and certainly major economic announcements cannot be anticipated or ‘discounted.’  Friday’s major accelerated advance was exascerbated (created?) by the SEC regulation banning short-selling in Financial stocks and word of an economic bailout which could total over $1,000,000,000,000 (that’s a trillion).

Also, I’m using the Dow because it paints price without overnight gaps for a cleaner picture – for a total intraday representation of the wild week, view the DIA or other major market ETF – Every single day last week gapped – some of the gaps were in excess of 3.00%.  We’ll have yet another ‘high percentage gap’ month, though it will be interesting to see the gap-fill rate (only 2 of the 5 gap days in the DIA filled).

Next, let’s look at the S&P 500’s daily chart to see where we are in the structure.

Price actually did meet a bearish technical price projection and was on its way to complete an orderly down-swing (primary or impulse swing) which terminated at 1,140 prior to the Government Rescue Plan eroded the technical price structure.

How do you manufacture a price rally in the markets?  Force a short-squeeze; force people out of their positions.  Folks, there must be some dramatic reasons the Fed/SEC chose to institute this rule and price manipulation – the consequences of not doing so must have been unimaginable or devastating.  I will continue to reassure myself of this and think beyond the ‘trading world.’

Nevertheless – if technicals still apply – (spoken tongue in cheek), price is testing resistance at the declining 50 period EMA with the moving averages in the most bearish orientation possible in a primary downtrend.  We would invalidate this structure with a clean break and close above 1,300 – the May price high (and above both EMAs).

Instead of discussing the structure of the weekly chart, I wanted to introduce you to the “Doji of Doom” (so I call it) which will forever now be a part of our weekly charts (and memories of those of us who survived through it)

I’ll let you bask in the beauty (horror?) of this long-legged dragonfly doji.

TraderMike captured the sentiment of the risks of Short-Selling in his recent post “Picking Your Spots when Selling Short” which I now deem required reading. Shorting is not the mirror image of ‘going long’ even if the execution (button clicking) is identical.  You really have to be more accurate and aware of the trade management tactics that are different from long (buy) trades.  In regards to Friday’s short-covering rally and subsequent losses, Mike deals out an appropriate yet hard to digest statement:

“My contention is that if you were caught short Friday morning you should consider your losses as tuition paid to the school of hard knocks.”

He then discusses a variety of sources that could have warned you against aggressive shorting in the week (including my “Use Extreme Caution” post warning of massive swings in both directions – much appreciation for the link), prior intervention by the Fed at “magical” times during prior sell-offs (causing ‘rip your lip off’ rallies), bullish technical divergences (via Dr. Brett Steenbarger), and a few others you should read on his post.

Mike has it exactly right:  “I think it makes much more sense to short bounces back to a trendline or moving average.”

If you are new to shorting, please start small – while it’s still legal!  The dynamics really are different in professional trading.

Continue reading and studying in an effort to put last week’s activities into perspective, and realize that the activities last week were clearly the exception in trading – not the rule.

1 Comment

One Response to “Right Back Where We Began”

  1. complacent panda Says:

    There were articles talking about a naked short ban going into place on Thursday morning. Although no one would have known that shorting altogether would be banned (I’m still surprised), being short after the news sounded like a bad deal to me when considering what happened last time naked short selling was banned. So, there were news signals as well.