THE PROBLEM WITH FADING EXTREMES

Just strictly conceptually speaking the idea of fading extremes is attractive. We can peruse any chart and see a huge spike up or down in price, then the monster reversal from that price movement. It is enticing to think about how much money you can make from timing those correctly. That is a correct view, you can. However, when you get into the actual act of doing this, it is very very difficult. Our current situation I would say qualifies as an extreme. We are already into standard deviations ( plural ) down. By mathematics this move is extremely oversold right now. We had a more extreme move to the upside over the last 2 years that was far more overbought than this is oversold. There are several measures you could have looked at that would have told you long ago to short the overall market.

So we have two moves both extremes, yet look how incredibly different they are. I would be impossible to tailor an approach to effectively fading both of these extremes. They are entirely different.  Standard deviation analysis is somewhat helpful, but then you have to decide what time frame for the deviations to use. That is similar to Fibonacci analysis. The ratios are great, but which points you view the magic .618 level between is completely subjective. Do you take it from the last pivot, the lowest pivot on the screen, the lowest pivot going back to the March 09 low? There are hundreds of magic numbers. We can be sure the market will stop at one of them, but how in the hell do you know which one?

Here in this example you see the main difference between in general how prices rise and how they fall. They tend to creep slowly higher in rallies, and plunge during declines. This is what attracts so many people to the short side of the markets. It is not being negative, it is the fact that the returns are bigger over shorter periods of time when you are right. It has been my experience learned from getting run over, that fading slow creeping upward markets is not a good idea. It is also not a good idea to buy markets that look like the current market does. The slow creepers tend to just keep creeping. The above type moves often accelerate down to a crescendo low.

There are certain tools to use to attempt to time some of these moves, and I have covered them throughout the last couple of years in here. The VIX is exploding higher now which will always be true in a situation like this. Keep in mind if you use the VIX, look at it on a relative basis and not an absolute basis. Where it is in relation to recent price levels, not where it is historically.

Currently we are in a very dangerous spot. We could very well bounce at any moment. We could also very well completely roll over for a big wipe out. The momentum is tough to reverse during a slide like this even by the PPT. It requires hundreds of billions of dollars. I suppose they have that at their disposal since they can print whatever they want. They can launch their buy programs, but when they move things up like yesterday for awhile, they often get met with big volume sell programs, which overpower them. We know behind the scenes with their beloved banker friends they are "suggesting" buying not selling here. However, if you are a fund manager at some point you do have to look out for your clients. If you suspect something larger is at hand, you are still going to exit longs regardless of what "suggestions" might come your way. We also have foreign money which the PPT cannot control.

We will be able to see if the PPT has both hands working on buys if we see the Large Trader position go up during this decline. We know "real" Large Traders trade on momentum, and sell on 20 and 40 day lows, so their positions would be going down during a decline like this. There is only one group that would fall into the Large Trader category of the COT report that would be buying during a time like this, the PPT. Let's watch that closely. I still think we have more downside here in the near term, but a bounce can happen at any time. I told you yesterday that I thought we would close down since the prior days reversal would likely be undone and it was. Score one for me there. Today I am not sure. Once again I have my trades on and my live quotes off so I have no idea what is happening overnight at all. I do think there is a risk of a sharp rollover for a couple days then a very sharp bounce and I would weigh the odds in that direction. However, an oversold bounce could come at any moment. That bounce is a sell when it comes.

The Dollar Index above has interestingly enough not exploded higher here. The correlation between stocks and the Dollar that the FED created, appears to be unwinding here. Remember in the past they generally traded in the same direction not opposite directions. We do have a nice buy setup here if we hold at these levels. That would also mean sell for other currencies. I think the Swiss is the one exception as that seems to be the flight to quality place along with Bonds right now. Watch the Dollar Index closely for buys down here.

Good Trading to everyone