DummySpots.com

We got our buy signal, and we got long. In the previous post I’d said

I see Thursday 8/16/07 as a PRIME, and possibly the LAST, opportunity for a buy signal to emerge before we have to look away

and I also said

I will get long very aggressively on any good OGRe (Opening Gap Reversal) once it trades back into today’s range.

This OGRe wasn’t a pretty one, however. (For a more thorough discussion of how I view OGRes, see this post about Trading Opening Gap Reversals). We got our gap down, but then spent the day alternating between ecstasy and agony with those wide swings… until 3pm EST, that is. Then we got that outrageous “4 dollars straight up in 50 minutes on huge volume” rally right at the end:

The daily chart looks more like a nice clean OGRe since it doesn’t show those intraday vascillations:

Note that, per the Gospel According to Steve Nison (aka Japanese Candlestick Charting Techniques) it’s not a hammer since the lower shadow isn’t at least twice the length of the real body. However, the real body on this monster is $2.31 wide, and the lower shadow is another $2.79 below that, which is still jaw-dropping.

Long, But Not For Long

This trade, like most I’ve written about the last few months, is based on my current RSI(4) -based methodology. These trades typically last from a few days up to about three weeks, with the majority on the “few days” end. So this is still a quick little swing trade in my book, not a pronouncement that we’re headed back for all-time highs.

So Was This The Bottom?

I don’t think so. The macroeconomic factors haven’t resolved in the least. In fact, I’ve continually made fun of the talking heads’ using euphemistic language like “housing slowdown,” “slump” and the ubiquitous “soft landing” … we’re not even close to the last shoe dropping on the housing bubble (can we all agree on that term now?). I firmly believe there’s a Dragon in the Corner and that we’re about to enter the recession portended by the yield curve inversion starting in December 2005 (remember, the recession often takes 18-24 months to show up, but of course the choir has endlessly sang “This Time Is Different”).

Note the deflationary symptoms rapidly emerging: tight credit, reduced money velocity, and hey bugs… check your gold prices– who says gold goes up because people buy it when they’re scared? People are scared as hell right now, but gold is faltering because of the risk of big “D”. Oil’s down, too, thanks to the stronger dollar. And yes, I believe the Fed’s response will be to lower the target Funds Rate soon and start increasing money supply vigorously, but in this case, I’d agree that it’s about their only choice since we’re so far down the Rabbit Hole.

Also, I’ve extensively (exhaustively, painfully) backtested the RSI(4) method I currently use, and it’s told me something: in uptrends, it tends to cycle from the high 20s to the mid 80s, sometimes spiking into the 90s (i.e. skewed upwards overall). In downtrends, on the other hand, it tends to drift up into the 70s, then soar down into the low teens or even lower. The last few cycles, it’s been acting less and less like these are “pullback in an uptrend” swings, and more like full-fledged downtrend thrusts. I may be switching from buying drops to shorting rallies in the very near future.

So You’re Overtly Negative, But You’re Aggressively Long Right Now…

Precisely!

After yesterday’s solid selling, my current RSI(4)-based strategy has me going long on any close above 143.55 today:

On another note, Ugly has a post from a few days back called Jesse Livermore is a bad role model for traders. Some interesting discussion in the comments (of course I had to put in my 2c) relating to trading, and more importantly, to depression. Clinically depressed and Bipolar people are often drawn to trading, and it destroys many of them unless they learn to use it as a tool (a mirror, as I’ve discussed before), and not a way to try to “succeed” when what they view as their “failure” is actually coming from the inside.

Cheers. Let’s make some money.

VMWare’s Stock Rises 76% in IPO. The headlines say it, the anchors on CNBC repeated it a hundred times, and if you’re young or new to trading, you may be misled by it.

The implication is that you could have bought VMWare this morning and sold it this evening for 76% more. That would be, as we say down here, a damned lie.

VMWare opened at 52.00 per share. That’s about where your market order would have been filled (although there were quite a few prints up around 55.00 as well). VMWare closed at 51.00. You would have lost 2% of your money, and you would have been lucky. Back in the 90s, you would have lost much, much more on virtually any IPO. A good friend of mine lost a ton of money with a market order to buy an IPO at the open- the IPO of a little company called Yahoo!

The IPO of VMWare was “priced at 29.00″; the only people who could get it at that price (or lower) were the insiders, who got their shares before it was unloaded on offered to the public.

Pay no attention to the headlines or the cute anchor chicks getting all excited about them. Look at where you could have bought that IPO, and where you could have sold.

And stay away from these things.

I don’t recommend options trading. In fact, the majority of the time I spend discussing options with folks is trying to talk them out of pursuing their latest, greatest idea.

However, there are very limited situations where the leverage offered by Puts and Calls comes in handy. The trade I entered yesterday and just closed this morning is one example.

Here’s what led to the trade:

• A failure of a long entry signal to materialize based on Friday’s action. To me, this said that the rise in the market yesterday was questionable at best, and possibly a complete fakeout. Note that without a disciplined trading plan, I would not have been anticipating a long entry signal and noting its absence; I would have been emotionally chasing the market and trying to stay on the “winning” side, and that is, as they say, a loser’s game.

• Options Expiration Week- with only a few days left to expiration, there is very little time value remaining in options prices; if I see the potential for a quick (albeit small) move in a stock, this is the period where I’m most likely to attempt to exploit that move with options.

• Irrational Exuberance - seeing the relief on everybody’s faces that the “scare” was “over” and their retirement accounts were “safe” reinforced my suspicion that this was indeed a false rise in prices. Did they really think this could all work out overnight? Then when I saw that midday headline from some journalist having an orgasm about the Bulls being Back In Charge, I took it as a signal that the optimism was completely out of control, and I bought Puts.

With a little help from Lady Fortuna, those Puts were entered near the top of yesterday’s sideways action, and I sold them a few minutes before I started writing this post for a 57% gain after this morning’s selloff.

Why am I not “holding out for more”? Greed. The necessity of differentiating between “letting your winners run” (one of the most worn-out cliches in all of trading) and “being greedy” is crucial. I entered this trade due to what I saw as an overbought market and irrational exuberance in the public’s attitude. This morning, the market is down and Joe Schmo is crying about his 401(k) again. The situation has resolved, and to stay in the trade any longer would be hoping for a larger gain and being greedy. Hope and Greed are the parents of the rotten child we call Chapter 13. They should not be our friends.

I had not intended to take a trade today. As I documented on Friday, had we gotten a close below 144.10 on the SPYders then, and a positive close today, I would have gone long.

However, Friday’s close of 144.71 nullified my setup, so I was back on hold, waiting for another downswing before going long.

Then midday today I checked Yahoo Finance, and they had a glaring headline that said something like “Bulls Retake Wall Street”… and I knew what I had to do: I immediately contacted my broker and bought PUTS.

P.S. I’ve scrolled through their “headlines” tonight, and I can’t find that one now. Wonder where it went…

A Larry Kudlow piece today contained an analogy by one of the guests that was just perfect: He mentioned that Repos (aka Repurchase Agreements) are basically like the Fed acting as a pawn broker for the banks. And he’s exactly right. Here’s how it works…

Bubba Has A Liquidity Crisis

When one of my redneck buddies blows too much of his pay on beer and fried chicken, he sometimes runs a little short on cash for the routine stuff. You know, like rent and electricity. So he takes an asset, say the wife’s wedding ring, down to the pawn shop on Texas street, and the guy behind the counter gives him a few hundred bucks.

Bubba’s a good guy at heart, so he uses that cash to pay the rent or buy the groceries. Then when he gets his paycheck on Friday, he heads back down to the pawn shop and pays the broker the cash back, plus a little interest, of course, and brings honey’s ring back home. All is well, at least for the moment.

Banks Are Bubbas Too

What has been happening the last few weeks is that banks (redneck beer-bellies that they are) have been having trouble meeting their own financial obligations because no one wanted to pay the asking price on some assets they were trying to sell. What assets? Subprime mortgage paper- the notes that amount to I.O.U.’s from millions of our irresponsible neighbors who got into houses they couldn’t afford.

Well, if the Fed just stood by and let the banks look at their creditors (ironically enough, often that’s each other) with a big blank stare and a hangover, things would get really ugly really fast. Banks would begin to default on their obligations and the domino effect would crash the entire economy, possibly in a matter of days.

So, Uncle Ben Bernanke straightens his “Cat Diesel Power” cap, spits some Skoal juice into his ever-present styrofoam cup, and steps up to the pawnshop counter to save the day.

So far, what we’ve described is your normal, everyday overnight repo operation. “Repo” is the nickname for Repurchase Agreements, which simply means the Fed maintains liquidity by loaning the banks cash with some asset as collateral, and the banks then repurchase those assets in the designated time (hence the name- overnight repo, 3-day repo, 14-day repo, etc). This is how Repos differ from other Open Market Operations where the Fed purchases treasuries to permanently add cash to the system… repos add cash temporarily, then take it back, just “keeping the wheels greased,” so to speak, no net long-term change in the overall money supply.

Sounds familiar, no? That’s exactly what the pawn broker does for Bubba. He enters into a repurchase agreement with him for the wife’s ring.

Good Money for Questionable Collateral

But here’s the crucial difference with the Fed’s recent actions: they have agreed to take the unwanted subprime paper as collateral on the repo loans. Typically they would be getting Treasury notes as collateral. Imagine the pawn broker giving Bubba the cash loan and taking as collateral Bubba’s used wristwatch, which was valuable once upon a time, but no one wants it now because Bubba’s been wearing it while he replaced timing chains and camshafts, and it’s all banged up.

The pawn broker would have to be pretty worried about Bubba’s financial state to take a risk like that, wouldn’t he?

The Federal Reserve is providing tens of billions of dollars in liquidity to keep the banking system functioning, and is accepting moldy subprime paper (aka Mortgage Backed Securities) as collateral without significantly discounting those securities (it wouldn’t be as big a deal if the Fed were loaning, say, 40 cents on the dollar for the value of these notes).

That tells you how worried Uncle Ben is about the banks and their liquidity problem. And that’s the real news.