Friday, October 23, 2009

Will Be Taking Profits on Index Long Positions this AM

While not necessarily part of our core strategy week in and week out, trading off technical conditions on the general market rather than buy / hold / sell / short of individual stocks have provided some excellent icing on the cake during this big run in the market. We will have completed another quick (and dirty) in and out move which exposed us to very little risk, and gave us a quite sizzling profit. In fact it happened a lot faster than I anticipated...

My goal here is to outline my general thinking, and be transparent as possible on strategy - so one can see this is not just random dart throwing. Mistakes, flaws, successes - all are there to see. As a caveat once this goes from virtual to real, I won't be able to describe things in advance as that is against SEC regulations, but for now you are seeing most of the cooking.

Outline of the strategy that got us here:

(1) Last Friday we said the gap at S&P 500 level 1075 looked like it might fill relatively soon [Oct 16, 2009: Current S&P 500 "Gap" Might Fill Sooner Rather than Later]

If you are newer to the site a gap is simply a "hole" in the chart; where a stock (or index) opens at a price far higher (or lower) then the previous days close. We call this a gap - generally on indexes these fill rather quickly... 2-8 weeks perhaps. On individual stocks it is much more variable - could be in 48 hours, could be in 2 years, could be "never".

The chart looked like this last Friday

(2) Frankly on Monday I thought "so much for that" as the S&P 500 made a race to 1100 - kind of wavered on what to do since I am underexposed for a new leg up... decided to wait to see how the market acted around 1100. If the market broke north of that level we'd have to find a way to join in despite the before mentioned gap.

(3) Monday, Tuesday, and Wednesday through 3 PM we made repeated attempts at S&P 1100 but really did not break through that level... a "big round number" that means little other than with human psychology. Since it was a 50/50 proposition if we would break through I basically sat on my hands. Someone who was more active (and something I sometimes do, but did not do this time) would have an opportunity to place a short position on to hedge their portfolio just under S&P 1100 in case this proved to be resistance. If you are "wrong" in that trade and the market broke through S&P 1102 or so, you have to cover - lose money on your hedge, and join the bulls. If you are correct you can make some good money on a drop from just below 1100 to 1075. Again, I chose not to do this trade this time around, but in similar set ups in the past I have.

(4) Out of the blue we had that 45 minute selloff late Wednesday, where the S&P 500 dropped 1.5% in under an hour. That happened so quickly it would of been hard to react to even if one chose to; when things move that violently it is risky to be involved one way or the other. We dropped to S&P 1081; but my gap fill was now back on the table.

(5) Overnight Wednesday to Thursday, futures actually dropped to our required level of S&P 1075 but as I wrote here - I wanted to see it happen during the normal market hours so despite the market jumping into green in the opening minutes Thursday I stalked...

(6) Finally in the 10 oclock hour our time had come, S&P 1075 was "filled" and then it is the nerve wracking decision - as I wrote in [Gap Fills at S&P 1075 Perfectly] the trade was laid out there in black and white but when it's so obvious I always have nerves. Because in my previous 12+ years "obvious" rarely works for too long. But it's been working nonstop for months on end this time, so we went with our lemmings and bought once we saw 1075 was relatively firm; basically as the market filled, tested, then stabilized around 1076/1077 was our "go time". As we wrote...

The gap filled perfectly at 1075; since this market has become nothing more than computers using technical measures we should at least have a cursory bounce here - Ive bought index ETFs and calls for the bounce (if and when).

Here were the 2 positions I mentioned, with an exit strategy of:

A move below S&P 1073 will have us out of these instruments... then we'll have to asses what the market does around 1071.

We (a) put about 4.5% exposure into SPY 108 calls, and (b) 14% into a 3x levered index long ETF (symbol: TNA).

Further thoughts - Generally we've been using 5-10% of our portfolio for SPY calls on "breakouts", especially of the "double top" variety that we've posted multiple examples of in the past 3-4 months. In this case since this was a gap fill trade rather than a breakout, I was using the low end of that stick. As for the levered ETF since we were below our normal long exposure as a % of portfolio, I wanted to supplement that with a pretty good sized long exposure for a trade.

My thought process inwardly was I'd be happy with roughly S&P 1090 to let go of these 2 positions. If it happened in 3 to 5 sessions I would be thrilled. The fact it happened in a mere hours was a surprising but pleasing development. So next comes step 7 and that is finishing the trade. Someone far greedier than I will hold out for every last penny...I am content to finish the trade and lock in what turned out to be a 24 hour rental of our cash for superior return. We received our gain and by mid morning our portfolio returns to a low risk model. Do we potentially leave some on the table if the market keeps running to upper 1190s...yes. But, there are no guarantees and the next 10 points could be down rather than up. There is always another trade waiting and the 'easy' part of this trade has been taken. If we can pull off 1 trade of this nature every 6 to 8 weeks we have ourselves an excellent year ... and with very little long term risk to capital. In my world ...the best combination.

I expect our next foray into this type of trade to be on any breakout north of SP 1100 if and when. We can also expect to lose on this type of strategy eventually because nothing works constantly...but until the pattern breaks we keep taking what the market gives.

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