Market Restraint Fades a Little

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  • on February 8th, 2011

After 2 months of remarkably controlled breadth, the % of stocks above their 10 Day MA finally passed 80% on Monday.  This gets us into range of one of my favorite counter-trend trades, as I love to short a heated bull market for a 1-3 day hedge.  It allows me to keep existing longs at a time when I’m dying to sell something.  The trade has the following specific parameters:

1) Index +1% Day- the smell of beta chasing needs to be in the air

2) % Above 10 Day MA >80% from >70%– I don’t want just a high #, I want a high number that started from an already high #

3) News Reaction- the “reason” for the spike needs to be identifiable for the media to sell the excitement

What I’m looking for is a lack of restraint, a day when the shackles come off and those who couldn’t buy yesterday cave into the emotion today.  This has been a successful strategy in identifying short-term extremes.  The problem is, after offering regular opportunities in the prior months, I haven’t had a setup since the November 5th-8th window.  This has been a huge disappointment, as I had typically counted on 1-2 of these setups per month no matter the conditions.

It’s a sign of incredibly organized market energy that I haven’t had a short setup in 3 months, but now the potential is there.  I like that this last spike came during the typical early month strength, a nice crutch to lean upon if taking the other side.  Lacking the catalyst of a frothy news environment to fade, this window will pass without a trade…but the potential is there for the first time in months.

Monday was the first time I dusted this strategy off, and prepped my position sizing model to prepare accounts for the trade.  And then market restraint kicked in, and what looked like a +100 DJIA day became a modest gain.  Sign of weakness?  Perhaps, but a market with this kind of energy has to be given room to explode, and again it stopped at the edge of fear abandonment.

The trade is on my radar for this morning…if news flow is positive and markets lift to Monday’s highs without breadth confirmation I’ll stand ready to pounce on my favorite hedge idea by buying $TZA.  Volume was light on Monday, and sometimes it takes the next morning for the market to finish its business.  But so far the “reason” is not there; in fact, China announced a rate hike and the $ES_F is flattish.  That’s an easily attributable reason for a selloff, but for a rally?  I need something, be it more high profile mergers, blowout earnings, or something dovish from a Fed governor…news can come out of nowhere, so we’ll see.

It’s a sign of the market’s mission to move higher that I haven’t had a short setup in 3 months.  This doubt has kept emotions in check and prevented a real blowoff.  But the elements I require are there, and I’ll be ready to fade a good news spike, if it comes in the next day or so.  Knowing this market, we’ll drift and some bad news item will created even more doubt, but I stand ready to attempt a $TZA 5-10% quickie just in case a little too much excitement comes in.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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