Wednesday, May 6, 2009

The Market Will Reverse When...

Everyone wants to know the answer. Wouldn't it be great to have a crystal ball just for a day and know exactly what the market is going to do. Easy money right? But, short of that, you are stuck using scientific wild-ass guesses based on what you read, hear and feel.

No one knows for sure where the market is going tomorrow, a month from now or a year from now. There are a lot of predictions and one person may get it right once in awhile but never consistently.

An excellent analyst will get it right 60% of the time. That's right. 60%. A good analyst may get it right 52% of the time. It may not seem like much but the difference between getting it right 60% and 52% of the time is huge. A normal person who is going alone and basing everything on their own beliefs may get it right 30% of the time. If you are reading this, you are likely in that category.

What's my point? My point is, the odds of you predicting where the market is going tomorrow or especially, hour to hour is very poor. And what the average person will do is play one side and put too much money on that side. No hedges, no protection. And since they get it wrong more than get it right, they slowly lose their money.

I don't advocate paying a professional to manage your money, although doing so may relieve a lot of stress and they are likely to get you better long term returns than you can do on your own. What I am suggesting is, you always always always have to be prepared to get it wrong. First, don't get over extended. Second, know what your short term and long term goals are. If you are buying AAPL, you are not buying it to sell it tomorrow on a 2 point gain. You have a long term plan. So don't buy it and sell it 3 days later because it is down 5 points.

If you are playing 2x and 3x ETFs, your goals should be much shorter and you have to be prepared to move quick and you HAVE TO, HAVE TO, HAVE TO, have a hedge unless you just like to gamble.

Third, always hedge your risky plays or set stops about 6% less than what you bought at if you are not comfortable. Speculative plays are small investments in risky plays so no need for a hedge. But if you are putting 20% of your money into a single 2x ETF, you better be playing some puts or covered calls. So many people loose so much money playing these etf's without a hedge. I have been guilty with SRS at times and most times I go without a hedge, I get burned.

OK, that was a bit of a rant, but something that was on my mind. Back to the title. When do we know the market will reverse. As I mentioned, no one really knows. Well, almost no one does. There are some people that know where it is going in the next hour or the next day. These people are the market makers. They decide what trades get executed, what bids and asks go by the board, and even will hold stock themselves and sell later in order to manipulate price movements.

You can't beat these guys day trading. You can have victories, but sooner or later, you will get beat. They know where the market is going. But, they will tell us some things based on market moves.

The market will reverse when there is enough volume on dips that will buy into any weakness causing the market to bounce off of any dips. When that happens and the market rewards these buyers consistently, it is time to destroy these buyers. Why do they do this? Simple.

The market maker, as mentioned before, may hold stock themselves and sell later. Or it may sell stock on loan and buy back later. So as markets pull back and buyers get in, they can sell stock to these buyers that are not actually there right now, but later in the day, buy that stock at a lower price as they drive down the price by manipulating bids and what orders get processed.

The market maker wants your money. They will get most peoples money because they will fall into the trap. I am guilty of falling into the trap in April of insisting the market must go down. I was shorting on moves up and the stocks just kept moving up so I then got stooped out. The market maker bought my short stock at $10 and sold it back to me at $12. There were so many shorts doing this it was easy money. Thus, a short squeeze.

The reason this happened was there were not enough buyers in the market to make the market move on its own. So they fed off of the shorts. When buyers hit the market in stride, then you will start to initially see dips being bought in earnest. I think we are starting to see that. And then shortly after, the MM's will make these buyers pay buy letting the market slide as they keep buying, stopping out, buying again, etc.

The VIX is down today and is a signal that the market is not ready to reverse. No need to stick your neck out. I have a play I put together that I am liking very much. I own a block of SKF but had covered calls on it for protection. As SKF went down, I bought the covered calls back for a 60% gain on the calls. I lost on the stock, but as soon as I buy the covered calls, I buy out of the money puts for a small amount. If SKF goes up, I sell more covered calls and sell the puts at a 50% loss at the most.

I know this is not going to make me rich but it is basically using SKF as a vehicle to scalp via the options market. I am not making or losing anything on the stock but using it as a tool to trade and profit on options. So the SKF shares are actually a hedge against my options even though the investment is much higher.

OK, enough typing for one night. Watch out for a 890 head fake this week. If it breaks 890, I will be more bearish. Until then, I will actually buy on gaps down. With stops, of course.


  1. Non farm payrolls could beat this Friday.

  2. And it will. And market has and will take that as great data. But look at the chart of unemployment below. Try it at 6 months, 1 year, 3 years. Notice the trend?

    So you are hanging your hat on unemployment being around 500K vs. 600K as a good thing. Sure it may be a good thing I guess if you are one of the 100K not laid off this month. But I guarantee you those 100K and more are laid off next month.

    And don't forget the impact Chrysler and GM will have on unemployment in May. It is a huge ripple effect. The good thing about unemployment being lower this month is the stock market will rally because of it. But if unemployment goes from 500K in april to 570K in May, this entire rally will be wiped out in a matter of days.