Been There, Done That ~ The Risk Averse Alert

Wednesday, August 24, 2011

Been There, Done That

Following last Thursday's throttling I noted a certain measure of "capitulation" fitting a fifth wave down — i.e. in forming wave 5 of (1) of C.

Then, yesterday I put forward the supposition that, a so-called "fifth wave failure" might be seen completing five waves down from the S&P 500's July 7th peak.

So, tonight it occurs to me that, the present moment finds more or less is the same manner of circumstance as existed during the latter half of June just prior to the market's final lift in counter-trend rally off March '09 bottom...


These similarities are marked in red. You might recall, too, that, on June 23rd I noted capitulation likewise accompanying what turned out to be a fifth wave failure at the conclusion of wave c of 4 of (c) of B.

Now, the reason why this prospective similarity is compelling is reasonable expectation that, during formation of wave (2) of C a challenge of the S&P 500's 50-day moving average seems likely to occur, particularly given the depth and violence of the market's decline in forming wave (1) of C. So, maybe this will happen sooner rather than later. Maybe another entirely suspect advance much like that from late-June through early-July is in the midst of unfolding right now.

Should the S&P 500, indeed, proceed to approach its 50-day moving average without so much as giving any serious challenge to its low on Monday, then the likelihood that, volume will continue coming in seems a virtual certainty (likewise would this further confirm that, those long equities, indeed, are weak hands, much as volume similarly revealed late-June through early-July).

Not forgotten is the fact that, in addition to there being no technical divergences at Monday's conclusion of wave (1) of C (this on account of wave 5 of (1) being a "fifth wave failure"), also failing to materialize was the full measure of long equity hedging (via put options) handily exceeding that at May 2010 bottom, the likes of which I had been anticipating as indicating a well-defended bottom in place. Both are negatives, and all the more so if the market advances more or less unchecked over days ahead.

So, let's take a closer look at the CBOE Put/Call Ratio for some clues about what might be expected, should the S&P 500's presumed, upcoming advance slated to challenge its 50-day moving average develop similarly to the S&P 500's advance from late-June through early-July. There were some notable indications of trouble ahead whose similar appearance at present in all probability will be equally foreboding...


First, a whole lot of hedging, relatively speaking, accompanied the S&P 500's lift into its July 7th peak. So far, so good.

Then, as wave 2 of (1) of C was unfolding, suddenly call options were rather in demand. Hindsight suggests these were hedging short equity and/or futures contract positions.

Strong hands typically are prone to hedging their bets, so let's keep an eye on this over the immediate period ahead.

It's possible that, the S&P 500 could advance to the vicinity of its 50-day moving average and in so doing complete but wave a of (2) of C. Wave b of (2) then might sink the S&P 500 to its support at 1050-ish, with wave c of (2) following, and lifting the S&P 500 back up only to 1100. In other words, a so-called "running correction" still could form in wave (2) of C position, and in the course of its development might not see a relative pickup in call option activity until wave c of (2) forms.

No matter how wave (2) of C evolves, we should see a notable, relative increase in call option activity just prior to devastation awaiting wave (3) of C down hard...

Fast Money
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