In Bear Market Rallies: Caveat Emptor
In an effort to stave off financial Armageddon, the Federal Reserve pulled out all the stops this week. In their first move, they set out to provide liquidity to the banking system in ways that are too complex to go into here. They also lowered both the discount rate on Sunday and the Fed Funds rate on Tuesday. Additionally, the venerable investment bank Bear Stearns was snatched from the jaws of insolvency by one of its rivals JPMorgan Chase (with the help of a $30 billion credit line from the Fed) for a humiliating $2.00 a share. Bear's stock price had closed at $30 on the day before the acquisition was announced - Ouch!
The Feds "panic like" machinations over the weekend were initially perceived -and rightly so- as though the financial crisis was at a breaking point. The S&P's sold off about 30 points in the Globex, however, by the opening bell on Monday, cooler heads prevailed. The next morning Goldman Sachs'- not so terrible-earnings served to quell some of those fears and stocks rocketed ahead of the FOMC. The largely-anticipated interest rate easing only served to propel stocks even higher. The Nasdaq and S&P ended the day with impressive gains.
Do these explosive upside moves point to the end of the decline or are they more typical of rallies in a Bear market? Statistics corroborate the latter. Case in point: On January 3, 2001, in the midst of one of the worst bear markets in history, the Nasdaq had an astonishing 14.2% melt-up. Moreover, in the period between March of 2000 and May of 2001 there were eight instances were the markets had one- day up moves of more than 7%. Might the latest move be just another in the series of head-fakes to lure buyers into thinking the worst is over? Nobody knows for sure, but the probabilities are that this is a correction in a downtrend. Since this is probably the case, caveat emptor (let the buyer beware) would be a good practice. When trading countertrend you must be nimble, as the path of least resistance thus far has been lower.
The lesson of treating countertrends trades differently than trades done in harmony with the dominant trend - also holds true for day traders. Last week, while teaching the E-mini course in L.A., I challenged the students to buy only the pullbacks in an uptrend and sell only the rallies in a downtrend. This of course was not easy at first because it required PATIENCE to wait for the price to come to them. After a few days of practicing, most of the students were finally catching on and by Friday, the results they were achieving were very good. There are times when it makes sense –from a risk reward perspective- to trade countertrend and I'll touch on this in my future newsletters. For neophytes though, I think it's best if their sole focus is on indentifying trends, support, and resistance levels.
As usual, let's look at the technical picture of the Russell 2000 E-mini (ER2). We'll begin be perusing the daily chart. What's worth mentioning here are the three successful attempts at an important support level (645-643)-which I've highlighted in yellow. The Fed-day upturn vaulted the ER2 to an important resistance Level (685). Above this area, there is a massive layer of resistance stretching all the way up to 725. I suspect that it will take some work for the market to get through such an abundance of sellers.
In the shorter-term, the hourly chart paints a slightly different picture in that it seems like the market is still locked in a range between 645 and 685 for the week or so. Keep in mind the ER2 has moved almost 40 points in 2 trading days. A pause or some corrective action in the short-term here would not be surprising.
In summary: We've experienced tremendous volatility in the last few days. It's been indeed a trader's dream. On Monday, The Vix (volatility index) spiked to 35. Also, on Friday, the volume on the QID (the leveraged short QQQ proshares) traded over 60 million shares and the ISEE index closed at 75 -indicating massive put buying. This has happened twice in the past 9 months (August 16 and January 22), and after each of these occurrences, a sizable rally has ensued. I believe this time is no different; we now have all the makings for a reprise. My sense is that a rally lasting several weeks is probable. This move will likely culminate at a major resistance area- where the major downtrend should resume.
Until next time, I hope everyone has a profitable week.
If you have questions, comments or you'd like a specific topic covered, please email me at gvelazquez@tradingacademy.com |
Gabe Velazquez is a professional
trader with 14 years of experience. His focus is intra-day and swing trading the
ER2 (Russell 2000 e-mini) using technical analysis as his primary tool. Gabe has
managed both stocks and futures accounts as well as conducted educational seminars
on technical analysis for the past ten years. He is a frequent guest on Biz radio,
where he shares his market knowledge and utilization of technical indicators.
Gabe also teaches the
