Snapshot Notes - October 25, 2007

As of:

SPX 1511

Coming into this week, we had a number of different indicators and studies suggesting that the most likely course of action would be a two or three day rally to begin the week. When we rallied into Tuesday afternoon, our measures began to switch and it became difficult to find anything suggesting a solid edge going forward.

Since then, we've seen a lot of chop, with heavy morning selling pressure transitioning to sizable afternoon rallies. Net net, though, we haven't moved much of anywhere.

After tomorrow, we'll be heading into a period of notable seasonality, which is remarkably positive. Holding the S&P 500 during the last three days of October through the first three days of November has given a positive return during every one of the past 12 years in the S&P 500 tracking fund, SPY. The 100% winning trades returned an average of +3.3%, with an average drawdown (i.e. maximum loss) of only -0.7% compared to an average maximum gain of +3.6%.

Adding to the potential positives was the revelation this morning that the AAII sentiment survey had reached another extreme. Unlike the Investor's Intelligence survey, which focuses on newsletter writers and barely budged last week, the AAII poll is strictly for individual investors and is much more "noisy". That can be a good thing since it allows us to see more extremes.

The last extreme we got was a warning sign of too much optimism right before last week's mini-plunge in equities. Now these investors quickly switched camps, and are showing too much bearishness. While that obviously does not guarantee a rally, it does help the bull case for at least another push higher.

For the short-term, I'm interested on the long side due to the exceedingly positive seasonality we're about to enter, the new AAII bearish extreme, and the potentially positive mindset heading into the end-of-month Fed meeting.

For me, none of those factors are enough to trigger a trade, so what I'm looking for are either some solid oversold readings among the shorter-term measures we follow, or a breakout and hold above 1520 in the S&P 500 cash index. Either one of those should be enough to generate positive short-term long-side results, given the other positives we went over.

Even so, this is a treacherous environment for short-term traders, as after-hours earnings releases subject us to a continual barrage of opening-gap risk, and every little piece of economic data will be scrutinized and bet upon as it adjusts the odds of a rate cut at the FOMC meeting. No matter long or short, it seems imprudent to be aggressive either way.

As of:

SPX 1511

HELP ARCHIVE

A trader would have done quite well the past few days by shorting the opening prices, playing a round of golf, having some lunch, then coming back mid-afternoon and going long. Hold overnight, then repeat.

This morning I went over a few potential positives, and the setup I was looking to see for a long entry. What I was looking to see was the S&P 500 cash index break out above 1520 and consolidate above that area for a few hours.

It did break out, but was not able to hold for more than a few minutes, and the 20-point drop subsequent to that failure is the reason I wanted to see the breakout "confirmed" by being able to hold for a few hours. This is a very treacherous tape for both sides in the short-term, and I'm proceeding very carefully because of it.

Microsoft reports after today's close, and that will likely be the major after-hours focus. As has been the case for the past week, anyone holding positions overnight is subject to significant gap risk. We shouldn't be surprised to see the S&P open tomorrow's trading 5-10 points from where it closes.

After tomorrow, we're going to be heading into some very consistent positive seasonality, lasting through the first few days of November. The first part of that trade may be helped even further by the expectations of a rate cut by the Fed, or at least the rumors of it. If we get some decent oversold readings among our short-term indicators in the next day or two, or see a breakout (and hold) above 1520 in the S&P, then I'll be looking to take at least a smallish shot on the long side. I probably will not be doing anything this afternoon given the gap risk and MSFT's looming report.

As of:

SPX 1511

HELP ARCHIVE

Good Thursday morning...we begin the day with some mixed news, but positive reactions in the broader market averages, at least so far in the pre-market.

That was true on a short- and intermediate-term basis. There were some things still pointing to higher prices (e.g. declines like last week in the context of a longer-term up-trend tend to lead to intermediate-term rallies), but there were also some solid signs pointing downward (e.g. evidence of excessive optimism among several of our sentiment guides, and some odd breadth divergences). That kind of combination is most often seen prior to very choppy markets.

Within this kind of seemingly edgeless (to me) market, I tend to pull back and wait for something with a better-defined edge. That can be a good strategy during whippy moves like yesterday, but it hurts if/when we see a trend emerge.

Yesterday afternoon's rally felt extremely "forced", and more than coincidentally it occurred just as some of the broad indices like the S&P 500 were about to break their Monday lows. Whatever the genesis of the afternoon rebound, it has shifted the short-term sentiment and we continue to build on that momentum this morning. If we can hold for awhile without reversing that afternoon reversal, then we're going to have traders looking at the looming positive seasonality and the upcoming FOMC meeting.

And that seasonality is astoundingly positive. Holding the S&P 500 during the last three days of October through the firs three days of November has given a positive return during every year of existence of the S&P 500 tracking fund, SPY. The 12 out of 12 winning trades returned an average of +3.3%, with an average drawdown (i.e. maximum loss) of only -0.7% compared to an average maximum gain of +3.6%. That kind of thing shouldn't be ignored.

We also got a piece of potentially good news this morning in the form of the AAII sentiment survey. Unlike the Investor's Intelligence survey, which focuses on newsletter writers and barely budged last week, the AAII poll is strictly for individual investors. It is much more "noisy", jumping around from week to week, but that can be a good thing since it allows us to see more extremes.

Those extreme tend to be good at highlighting market turning points. The last extreme we got was a warning sign of too much optimism right before last week's mini-plunge in equities. This week, these investors quickly switched camps, and are now showing too much bearishness. That's a significant change, and while it obviously does not guarantee a rally, it does help the bull case for at least another push higher.

Bottom line, I've been twisting in a seemingly edgeless environment for the past couple of days, not willing to risk much capital either way. I continue to harbor doubts about the intermediate-term, and the short-term doesn't seem a whole lot clearer, but I am intrigued by the exceedingly positive seasonality we're about to enter, the new AAII bearish extreme, and the potentially positive mindset heading into the end-of-month Fed meeting.

We also have a little "W" bottom forming on the intraday charts in the S&P, with a move over 1520 in that index technically suggesting that we have seen a short-term low, so that's something many will be watching. A violation of 1490 would be a big negative and it's the main line in the sand I'm watching here.

I'm not yet sure what my trigger would be for another long entry. I would like to see a move over 1520 to help validate the idea that we've seen a low, but by then our short-term stuff will likely be stretched and suggesting a rest. The best setup would come if we see a breakout over that level, then a consolidation above it for several hours. That's the kind of activity I'll be watching for as the day progresses.

Even if we happen to get that kind of reaction, this remains a treacherous environment for short-term traders, as after-hours earnings releases subject us to a continual barrage of opening-gap risk, and every little piece of economic data will be scrutinized and bet upon as it adjusts the odds of a rate cut at the FOMC meeting. No matter long or short, it seems imprudent to be aggressive either way.

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