Snapshot Notes - October 11, 2007

As of:

SPX 1523

During the past few days, we've gone over several studies related to the recent price patterns and readings from some of our indicators. Those studies suggested that we should be seeing a change to a much choppier environment from what we've been experiencing.

That kind of culminated today with the gap up opening. This morning I went over some figures related to the gap, suggesting that the Nasdaq 100 shouldn't gain more than 0.5% from the open, and should ultimately lose around 2% before the close. It's generally not a good idea to place all of our eggs in the historical basket, and surely there was a good dose of serendipity involved, but today's action conformed very closely to what we went over this morning.

The interesting thing is that the aftermath of reversals like this weren't too bad, particularly in the very short-term. Like I noted this afternoon, any time the NDX hit a new yearly high on an intraday basis, then reversed to close below the low of the prior three days, then there was a strong tendency to see a rebound the following day. However, the rebounds were best for quick-fingered traders only, as the following few days showed a negative return.

If we see some additional downside follow-through tomorrow morning, then I'll look to trade that potential rebound idea, particularly since our short-term guides for the NDX are at or close to oversold levels. I'd be keeping things pretty light, however, as rebounds from reversals like today tend to be short-lived.

As of:

SPX 1523

HELP ARCHIVE

This morning I went over a set of stats regarding the gap up open in the Nasdaq 100 exchange-traded fund, QQQQ. If today followed the precedents we went over, then we should have expected QQQQ to top out prior to hitting 54 today and lose about 2.1% sometime before the close.

Amazingly enough, it has followed the script perfectly. The morning high was 53.94 and so far the fund has lost 2.1% from the opening price. While it's nice when things follow their precedents closely, we can't forget that there was more than a little luck involved.

So what now? Well, if we somehow keep to this script, then the following day QQQQ rebounded and closed in positive territory 4 of the 5 times, though the average return was a very modest +0.4%. The four winning trades suffered a maximum drawdown the next day that averaged -0.4% before rebounding to gain more than twice that amount before the close. After three trading days, we still had 4 of 5 positive, and the average return crept up to +1.0%.

I don't want to get too wrapped up in following those prior examples just because today happened to conform closely, but we should at least note that in all cases but one there was only modest additional follow-through to the downside.

The stats are pretty similar when we look at this from a different angle. I checked for what has happened in the history of the Nasdaq 100 when it sets a new yearly high intraday, then reverses to close below the low of the prior two days, like it's on track to do today. Surprisingly, the next day closed in positive territory 8 out of 11 times and the overall average return was +0.9%. The three losers were very modest losses of -0.6%, +0.7% and -0.1%. Even by five days later, there were still 7 of 11 in positive territory.

If the NDX loses a bit more and closes below Monday's low of 2144, then there would have been five historical precedents. The next-day rebound bias was still in effect, as 4 of the 5 occurrences led to gains the following day, averaging a whopping +1.8%. After that, though, things got more dicey...buying the next day's close and holding for three days resulted in no winning trades out of the five, and your average return was a dismal -2.2%. The rebound effect was very short-term only.

Traders have a tendency to think that these kinds of reversals are bad for the market going forward, since they look so intimidating on a chart. Over the past few years, we've gone over the actual history of these things many times, and more often than not history wins out over the ugly looking charts, so I think it's premature to get overly negative here just because of a reversal like this.

That said, I'm still not seeing the kinds of readings I want to see before thinking we're at a good risk/reward position on the long side. If we close weakly and see some additional downside follow-through tomorrow morning, then that should change and I'd be looking to take at least a small long position in the NDX, with the understanding that it may be for just a short-term try at a quick oversold rebound.

As of:

SPX 1523

HELP ARCHIVE

Good Thursday morning...we begin the day with what has become a common sight, as the indices gap to new highs and the majority of sectors are in the green.

In just a hot momentum market, I'm not sure something like this even matters, but I checked for what's happened the other times the Nasdaq 100 Trust (QQQQ) has gapped up more than 0.5% above the prior day's high, when the prior day was at least a 52-week high.

There have been five other occurrences, and buying the open and holding 'til the close resulted in zero winning trades, with an overall average return of -1.7%. The most that QQQQ was able to gain during the day (on average) was +0.4% (only one of the five gained any more than 0.5% during the day), while the average drawdown (i.e. maximum loss) was -2.1%. That suggests that we shouldn't see QQQQ reach more than about 54.00 during today's trading, and the morning gap should be closed by the end of trading today.

That's assuming we're going to hold to historical precedents, and this market has kind of been throwing some of those by the wayside. We've experienced momentum-driven tapes a few times in the past several years, and those are usually difficult to navigate except for breakout traders and buy-and-hold investors. Someone like me, who wants some kind of two-sided volatility to establish probable risk/reward characteristics for trades, has a hard time keeping up with the Joneses in an environment like this.

Over the past several days, I've touched on a few of our indicators that have given signs of excessive optimism. In the past when we've seen those types of readings while in a strong uptrend in stocks, the major indices have had a consistent tendency to stall out and either enter a moderate decline or lurch forward in a very choppy manner, with those gains ultimately being given back sometime during the next few weeks or months.

I'm looking for us to enter that kind of environment very soon, but so far there are no signs of letup in the buying pressure. Very little of what I've looked at suggests that shorting is anything other than very high-risk at this point, but entering new longs seems just as risky, especially for trading positions. I've been unable to find many low-risk long entries the past few weeks that weren't preceding a major market-moving event, so this has been an exceptionally challenging time to be patient in trading accounts. That's what I'm still doing, though - being patient - and I'll continue to do so until I can identify a setup that seems to have acceptable risk compared to the probable reward. I don't see that here.

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