Anticipating the Mother of All Short Squeezes ~ The Risk Averse Alert

Friday, January 23, 2009

Anticipating the Mother of All Short Squeezes

One thing technical analysis affords is capacity to step away from trade-related noise and see things from dollars and cents perspective. Your thinking enters into the big picture where everyone involved is trying to make a buck.

And in the stock market all ambitious soul must do one thing in this attempt...


Buy and sell ... in hope and in fear ... with every last share counted and reported in the volume of shares exchanged.

NYSE weekly

Check out volume on the Big Board during last year's October-November gassing. It hardly presents the picture of a market consumed with fear, much as one might otherwise expect given circumstances. In fact, you might conclude what's reflected is a certain measure of complacency.

Probably more to the point, though, is the likelihood that, the majority simply got caught unaware. This does not bode well, longer-term.

Yet despite this reason to be longer-term bearish, prospects for a near-term melt-up remain. Indeed, the message relayed by the volume of shares exchanged over nearly the past 20 months supports this probability.

First, ask yourself this. If last year's disaster could not incite heightened selling interest, then why would those holding shares throughout the bloodbath choose to sell now? Absent any unexpected catastrophe, these folks likely will add little selling pressure straight ahead. They're probably holding on for dear life ... looking for a better price. If not this, then they're likely not worried at all (Warren Buffett comes to mind).

None of this is meant to take away from the fact that, the stock market can fall of its own weight. We see with our own eyes how this was demonstrated last year. So, the question presently is whether this trend could continue. And the answer, of course, is it could.

(Indeed, diminished volume accompanying selling over the past couple weeks has been noted in recent commentaries, and although mentioned as being reflective of selling exhaustion, its occurrence also highlights the point being made here.)

Yet furthering odds the market will move higher, near-term, we find volume over the past 20 months raising sight of an interest apparently very much attune to risk shadowing the stock market. This contingent evidently bailed out in a big way very near the top.

Look back to mid-2007. It was then the beginning of the end of wildcat finance swept over the stock market. Selling hitting the NYSE July-August 2007 was on volume rivaled only by that registered five years earlier, as the NYSE Composite fell into its July 2002 bottom. Apparently some powerful, collective interest foresaw much worse to come, possibly explaining why an increased number of shares was offered up for sale so near the market's top.

And lo and behold, much worse did come. Yet with each successive swing lower peak volume has diminished. So, what gives?

Could the concern of those who near the '07 top saw the urgency of a deteriorating situation in global credit markets be abating? Probably not. Were this so, then volume would give some indication buying interest is increasing. Yet we see nothing of the sort.

So, what perspective might be gained?

Well, it's no secret I think elimination of the uptick rule (July 6, 2007) right at the time the stock market topped was no coincidence in relation to what followed. Indeed, those who bailed out of the market at the top probably are the same players who made a killing all the way down ... likely those whose structured finance money machine was grinding to a halt.

However, what short sellers need most is some way to draw in sellers. And if fewer players are willing to sell (as increasingly appears the case), then the market's short sellers are fixing to be squeezed. Why? Easy money. You see, the shortest distance between two points is not a straight line. Rather, it is the path of least resistance.

This is time when sharks begin eating each other.

NYSE weekly

None of this cancels out the likelihood significant resistance exists overhead. Some (many?) who went long mid-September '08 (Lehman bankruptcy week) ... having held their position all the way down ... probably will welcome any opportunity to get out somewhere near even.

(Recall there was a considerable pickup in volume the week Lehman Brothers failed. So, there likely are plenty of players who went long that week itching to get out.)

This puts resistance in the NYSE Composite somewhere in the vicinity of 8000 ... right about where the lower end of its channel containing five waves from 1974 was violated to the downside last year.

Now, it's quite some way from here up to this area where overhead resistance can be expected. Yet finding reasonable rationale for anticipating subdued selling pressure, probability increases the path of least resistance, near-term, is higher.

Furthermore, this move could manifest by way of the mother of all short squeezes. This view, of course, is driven by Elliott Wave considerations, as well as underlying technical conditions showing strength building. Just how quickly the market rises to its identified resistance is entirely a matter of speculation, though.

Beyond uncertainty projecting the speed at which the market might melt up, it is difficult imagining the market falling apart so soon after last year's performance. Likewise, despite the market having entered a corrective period whose Elliott Wave counterpart is the 1929-1932 collapse, chances are the wave form to unfold in the present instance will be of an entirely different complexity and duration (likely lasting longer).

In fact, one might still anticipate a further fall to the area where indexes last traded in 1994 sometime over the next few years, and yet suppose the market's correction of its gains from 1932-2007 might not be completed. In light of this possibility indexes subsequently could even rise to new, all-time record highs sometime over the next ten years ... and yet only be setting up for still another fall ... one whose impact quite possibly proves most devastating of all.

The point here simply is, despite fundamental vulnerabilities, there are several ways in which the stock market might be impacted over the weeks, months and years ahead. Near-term, the outlook remains positive, so I am remaining long the stock market, enduring sharp breaks for as long as they look to be quickly recovered...

Fast Money
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© The Risk Averse Alert — Advocating a patient, disciplined approach to stock market investing. Overriding objective is limiting financial risk. Minimizing investment capital loss is a priority.

Analysis centers on the stock market's path of least resistance. Long-term, this drives a simple strategy for safely investing a 401(k) for maximum profit. Intermediate-term, investing with stock index tracking-ETFs (both their long and short varieties) is advanced. Short-term, stock index options occasionally offer extraordinary profit opportunities when the stock market is moving along its projected path.

Nothing is set in stone. Nor is the stock market's path of least resistance always known. More often than not, there are no stock index option positions recommended.

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