Trade Triangles And A Market Reversal

It's been a busy week for me, with work keeping me on the road most of the time. The market also turned as volatile as I have ever seen during that period of time.

So what the heck is going on?

I could talk to you about the current credit woes, about inflationary risks, about interest rates...

I'm not going to, though. Look back at my August 1st post, and the chart image of the S&P 500 that I posted. The graphic identified 1,437 as major support. Let's then look at the chart below, and see what has happened...

Support at 1,437 held for several days, but finally cracked on August 14th this week. My positions had been hedged, but once I saw support giving away I wanted to pare my positive delta. That's when I started closing positions, and currently hold just three.

Of those three, one is a very wide iron condor that I adjusted anticipating further downside. It currently has a very low delta and is not causing me much worry. I have a calendar spread on OIH, which has consolidated but not was wildly as the overall market. That position has a locked in, guaranteed profit so I am willing to ride out this correction and see if OIH resumes its upward trend. I also have a bull call spread on Costco, but that stock has held up fairly well and the current position was rolled into leaving me with a very limited risk of loss.

Everything else is in cash...

So, Thursday was a reversal day. That was a very wild ride, with the DJIA selling off more than 300 points during the day then covering all but 15 points by the close. The rally continued yesterday.

Is the correction over?

Perhaps. By careful, however. MarketClub still has not given us a green trade triangle on the daily, weekly or monthly charts. I would suggest waiting until you see a green trade triangle on the daily chart, before getting long the market. More conservative investors may want to wait for a green trade triangle on the weekly charts.

A lot of people were short this market. All of this buying we saw at the end of the session on Thursday may have been part of those shorts covering their positions, creating a reversal day. The DJIA was 200 points higher on Friday morning, which probably caused anyone with open short positions some pain forcing them to cover.

Are the bulls back? Maybe.

Let's make sure this rally is the real thing before we jeopardize our capital.

Let's put this in perspective. The S&P 500 is currently up 1.9% from where it started this year. If you had bought the index, you've given up most of your gains from the first seven months.

My options portfolio was up almost 40% before this correction and I've seen a 17% draw down this month. It is always when the market changes direction that you are most likely to see your losses. The difference between being up 20% versus 1.9% is in learning to avoid risks and limit any losses when they occur.

This is a very difficult market to trade or to call a bottom on, so keep your "powder dry" until you see confirmation before entering any directional trades. The trades that I currently favor right now are market neutral, vega neutral, short premium trades. The iron condor I mentioned earlier falls into this category.

Have a good weekend!

Christopher Smith
TheOptionClub.com