Trade Idea for 10/06/08

Friday afternoon's action showed that trader sentiment is what guides market action, not news. Monday the bailout bill failed to pass, and the markets tanked. Friday the bailout bill did, in fact, pass, and the markets tanked. Different input, same output. Why? Because sentiment is horrible. Every piece of news right now is a selling opportunity. It doesn't matter what the news is, it will be interpreted in the worst possible way. The fools in Congress have no idea what they are dealing with if, as I am starting to believe, their goal is to make sure the market rises. The market will choose when it will turn, regardless of Congress!

Speaking of the turn, I actually think it may happen soon, maybe as soon as this week. How do we recognize the turning point when it happens? Generally speaking, by sentiment that is so panic-driven that it will exceed any panic-driven selling we've seen thus far. A waterfall decline that happens in a short amount of time. What a nice thing to look forward to in the next week or so :-) Andy Askey at PTV Investing has determined that October 11th, next Saturday, is a relatively important cycle turning point. And as TK of Trading With TK observes, September & October are the months of major market turns, marking tops and bottoms. Indeed, the major market top occurred last October 11th. It would be an interesting symmetry if this October 11th (well, the 10th or 13th) turned out to be the bottom... of Major Wave A. Yep, that's right; even if we do see a bottom, it will not be THE bottom. That might not happen for a few years yet.

In the same way that the move from last October to January 2008 formed a perfectly complete a-b-c pattern that was really just wave A of a larger pattern, so does the move from last October to sometime in the near future form a complete A-B-C that is really just wave A of an even larger pattern. It's like an onion, and the level of complexity is a function of just how large the 5-wave pattern was that peaked on October 11, 2007. Fortunately, even if it's not the bottom, the upcoming turn will be a tradable bottom. Please note that the last candle on the chart was one that I drew in for illustrative purposes.

How can we trade this hypothesis? In fact, the reversal itself is not that tradable. The best place to be right now is cash. The best time to buy is after the turn, as stocks are coming back up. Buy after the bottom happens, not in anticipation of it. At that time there will be setups, and I'll share what I find. If you feel like you just want to try to nail that bottom, buy some out-of-the-money call options with October expiry for the S&P when you recognize that the market is in a major panic mode. Or you can buy them Friday or next Monday (assuming the 11th will indeed be a turning point), spending an amount equal to no more than 1% of your portfolio, preferably no more than 0.3%. With options in this volatile a market, you must act as though you are risking your entire upfront investment.

On Friday AIG was up over 20% at one point, only to close in the red. Generally with gains of that size, you want to sell at least a portion. MI opened at 24.00, gapping over the buy price, only to fall from there. The recent examples of AIG and MI illustrate the hazards and opportunities when stocks open above their buy prices. In AIG's case, the gap up on the day we bought it was followed by a pullback that touched the buy price, only to take off from there. Congratulations if you bought on the pullback. However, MI never stopped pulling back, so doing the same with that ticker would have meant a loss. My preference for stocks that gap up is to buy above the new high of the day, because it's safer. MI never made it back above 24.00 the rest of the day, so following such a strategy would have saved you a loss. In the case of AIG, such a strategy would've meant buying at 3.83 instead of 3.57. If you did buy MI, at least it was a reduced portion (or should've been.)

Current Holdings
Ticker	Basis	Closing Price	Perf.	Sell-Stop	Additional Exit Guideline	Chart
AIG	3.57	3.86	+8.1%	2.99	Consider selling at open	Chart
SIGA	4.01	3.33	-17.0%	3.19	SELL!	Chart
SCC	104.53	113.65	+8.7%	103.99	Be on alert for a day of extreme panic-selling; consider selling that day	Chart
MI	23.76	22.60	-4.9%	19.79	Consider selling on a close < 20.74	Chart

Not a lot for tomorrow. It looks like a bad open, with futures pointing to another triple digit drop in the Dow.

Trade Idea for 10/06/08

Ticker	Entry	Exit A	Exit C	Chart
SF (Stifel Financial)	50.31	47.78	44.47	Chart

Please refer to "How To Trade The Ideas" (right-hand side) to read this table.