Trampled by a Correlated Trade ~ The Risk Averse Alert

Friday, July 16, 2010

Trampled by a Correlated Trade

You see, this is what happens when some majority of suckers take the same bait. You get a "correlated trade." One easily imagines a portfolio manager or three tonight feeling a little less prudent exercising call options, then attempting to take some profits. In so doing they joined a crowded trade whose same action all day drove prices persistently lower.

Hey, it's a jungle out there. Yet not so thick as to disguise distribution.

OEX 5-min

Well, probably gone is any prospect for an upwardly biased fourth wave of five waves slated to form wave (c) of (2). This was thought likely a couple days ago. Yesterday's giddy close commemorating an Alan Schwartz sighting in Washington DC seemed to substantiate the possibility. This was not to be, however.

So, less likely for the moment appears a super-charged rocket higher rapidly completing wave 5 of (c). Likewise, wave 4 of (c), although probably near its lowest, might produce further sideways trading before wave 5 of (c) commences.

Indeed, given the fact today's technical damage was considerable, an alternate wave count for wave (2) might be in order here. The "complex-to-simple" dynamic previously cited might better be revised slightly, seeing that five waves up from June 29th bottom formerly were thought likely to unfold without scarcely missing a beat, but today endured a heart attack...


Here's the deal... Divergences registered by both RSI and MACD at consecutive, lower OEX highs reached in the aftermath of May 6th's flash crash, wherein both measures set higher highs, once again may be coinciding with yet another downside reversal occurring in the formation of wave (2).

Indeed, should this negative technical circumstance in fact be persisting here, then today's decline is unlikely marking the end of the second wave (b) of (2) as is indicated above.

(Again, my drawn projections typically are meant to suggest a prospective flavor of things to come — the gist of the market's direction — rather than imply timing to any prospective move.)

So, a second wave (b) unfolding in formation of a complex corrective wave (2) (still seen developing in complex-to-simple fashion) probably will soon end present similarities to the late-February period noted yesterday. With technical weakness strongly reasserted today, it's possible formation of this second wave (b) of (2) could consume much (if not all) of next week's trading.

Now, you might be wondering why I am discounting possibility that, big, bad wave (3) of (C) down could have begun. The simple fact of the matter is there are too many suckers just hankering to be fleeced who have yet to take the bait, hook, line, and sinker.

Go back to yesterday's discussion highlighting the CBOE Put/Call ratio. As long as nothing profoundly disturbs the illusion of the global financial system's solvency, there is a good chance we will see the CBOE Put/Call ratio rival its lows set at market peaks over the past year before wave (2) of (C) completes.

The fact of the matter is we should expect a measure of confidence greater than that registered during the market's advance into late-April top before the lug nuts are seen prime for falling off. Such is the typical order things. Elevated call option buying revealing confidence in a contrived rally (facilitating distribution) would sound a red alert indicating imminent trouble looming (namely, wave (3) of (C)).

Fast Money
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