Home > Commodities and Rates, Short-Term Trader > How One Trader Plans To Approach The Week Ahead

How One Trader Plans To Approach The Week Ahead

I posted last weekend that probability was skewed in favor of a market sell-off with 1150 in the SPX as my target for short positions. Thursday afternoon I covered my short positions as we touched off near 1150 and nibbled from the long side only to be stopped out as the major averages clearly broke through critical support. I was anticipating at the least a short-term bounce before looking into the likely-hood of a more serious decline. I was wrong.

While events like Thursday's crash are anomalous, it did act as a cold reminder that as traders we must always be prepared for even the most unlikely of events.

Heading into last week I was confident the market was clearly on the brink of a correction. This week, the only thing I am fully confident on is that we will continue to see wild swings as the VIX traded 40.95 into Friday's close. There is evidence however, to suggest we could be in for a rally to the tune of 40-60 S&P points. Why? For a few simple reasons.

1. We traded down below the 200 day moving averages (ema & sma) on the 'hiccup' and made another retest of these ma's on Friday. That was the first time in a while we have traded near the 200 day ma's.  The last time the SPX traded down to the 200 day EMA (Exponential Moving Average) was back on February 5th, which incidentally turned out to be the dead lows. For the 200 day SMA (Simple Moving Average) it hasn't been since July 13, 2009. As a rule of thumb, the market is a buy on this "first attempt", as historically the market finds some support in this area even if it only last for a short while.

2. The VIX traded up above its 10 day moving average by 2.42 Standard Deviations. Any time the VIX exceeds the 2 Std Dev threshold you get a strong buy signal.  I have found this to be a very reliable tool over the years for market timing. Despite not having a hard sell-off Friday afternoon the VIX climbed higher on options hedging ahead of the EU meeting this weekend.

3. Equity markets have recently traded closely with the Euro for obvious reasons, thus making it every bit as important to watch as it does the major Indices. Last week, the EURUSD  traded down near the 1.25 level which is support created in 2008-2009 and a longer-term trend-line.

Eurusd

Furthermore, C.O.T. (Commitment of Traders) reports show record position sizes across the board in all three categories -Commercial (Hedgers), Large Specs (Hedge Funds), and Small Specs (Lil' Guys). The extreme positioning coupled with major support should at the least lead to a near term rally.

How substantial? Hard to say. If we rewind back to 2008 we will remember a couple of instances where our own monetary policy makers went to work over a weekend and the ensuing bounces turned out to be nothing more than one-day-wonders.

4. Various oscillators, such as the McClellan Oscillator, were pushed down into 2008 levels. It doesn't get much more oversold than that!

The game-plan I assembled for this coming week consist of two scenarios:

Scenario A – Involves an equity market rally to begin early in the week taking price back towards the broken long-term
trend-line and critical resistance area of 1150-1165 in the S&P 500 Cash. Once a bounce is completed I will
be looking for signs of reversing lower and at the least a retest of the panic low.  A retest doesn't necessarily require an actual
touch of the low but an attempt at moving lower towards the old low at
which point selling pressure will dry up. It is also possible that the selling won't dry up and we will make fresh lows…..we will need to first get to that point before making any further assessments.

Scenario B – Involves making a quick retest of the crash low early in the week
followed by a recovery back towards the above mentioned resistance area. After that, again I would be looking some type of move lower similar to scenario A.

The difference between the two scenarios is how things initially unfold and the similarity is that downside risk appears to be muted in the very near term and that we will likely have a rally before rolling over and at least retesting the Thursday low and possibly breaking it.

Click on chart of the S&P 500 to view both scenarios:

SPX CHART

As I am finishing up this article I started yesterday, currently Sunday 9:45 P.M. EST, the S&P
futures are trading significantly higher by about 25 handles while the Euro is up slightly over 1% on the heels of news that the EU has put together a backstop. If tomorrow morning the world markets, Euro, and our own Index futures can maintain these gains then I would be looking to lean towards Scenario A.

As the week progresses I will be posting comments regarding these outlined possibilities and on any other trade set-ups I am seeing. In any event, be sure to buckle up as another wild week of trading lies just ahead.

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