Sunday, August 28, 2011

Week Recap And How To Trade In The Near-Term

This past week was another volatile one, but it seems the trading range is decreasing forming a pennant on the S&P 500 chart.

These formations are usually viewed as continuation patterns meaning that we will have further downside from here. This is definitely a possibility but after finishing the week up 4.7% and rallying on bad economic news, I'm bullish for the near-term. The week was capped off on Friday with revised Q2 GDP coming in at 1% on expectations of 1.1% and the much awaited Jackson Hole speech from Bernanke. The expectations were for him to just reiterate that the Fed is watching markets closely and will use any monetary tools they deem necessary. However, we got a little unexpected news when he said that the Fed's September meeting would be extended from one day to two days to have extensive talks on monetary policy. Initially, the market sold off as he did not confirm QE3 was coming, but then had a sharp rally. I think this rally occurred because people realized that an additional day of Fed meetings means it's more likely we are to get some kind of further easing (whether that easing is QE3 or Operation Twist, we will have to see). So, we got a sharp rally that held up the whole day even with Hurricane Irene approaching. Economic data continues to be weak and I expect that to continue, but markets aren't always rational and very well can rally for awhile.

The big headwind for the market continues to be Europe where things seem to be getting worse and worse. Christine Lagarde, the new head of the IMF from France, just endorsed using the European bailout fund (the EFSF) to assist banks with capitalization problems. This puts Germans in an awkward situation as they are the ones in the best financial situation and would be hurt the most by a further increase in the EFSF which would need to be substantial. $230 billion in government-guaranteed European bank debt matures in 2012 and needs to be paid for somehow because God forbid bank debt investors take a loss. Germans are growing weary of their sovereignty and financial stability slowly being drained and Europe is growing increasingly tense.

If Europe is quiet this week (or manages to stay out of the mainstream media), I think we rally up until Friday when we get nonfarm payrolls (NFP) and the unemployment rate. The unemployment rate is expected to come in unchanged and NFP is expected to decelerate to +75,000. I expect continued poor economic data and a miss in the NFP number, but it's always hard to predict these numbers since they are unreliable and manipulated.

Gold prices continue to be volatile and we got the margin hike this week that I was expecting. I sold my gold long on Tuesday morning when it looked like the parabolic rise was topping. Shanghai raised margins Tuesday and the CME raised them on Wednesday causing gold to sell off from about $1900/oz to $1750/oz. It only sold off for two days and is now rallying back hard. This volatility has me concerned that we will see another margin hike like we did with silver in May. To see what a series of margin hikes can do to prices, check out the chart of silver:

The first margin hike is indicated by the green arrow. We had a 2 day sell off and then continued higher. Then, another margin hike and some more and you see how margin hikes can manipulate prices catastrophically to the downside. Gold is acting the same way. View the gold chart below:

Green arrow indicates the margin hike
As you can see, gold is acting scarily similar and this is a cause for concern. If in gold, be ready to sell at any sign of a margin hike.

With so much volatility and downside risks, it still is a daytrader's market and that's how I'll be trading. On Friday, I rode the rally up via AMZN and sold at the end of the day not wanting to hold over the weekend. For risk-on days, I will be entering any high beta names that have bullish patterns. For risk-off days, I will simply trade via the 3x leveraged ETFs like TZA, EDZ, and FAZ. (If you want to know what I'm trading realtime, follow @Trader_Gator)

Volatility is the name of the game, so stay nimble and be cautious. Capital preservation is the most important right now, so don't get cute and don't be stubborn or ignorant.

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