Saturday, October 15, 2005

Complacency, conspiracy, and liquidity

I know what investor complacency is. It is running in and buying every "oversold" dip in the market because it has worked for the last three years. Or buying on a bullish osscilator crossover coinciding with a put/call ratio of 1.0 because "thats what markets do when they bottom".

This past Thursday morning, the market was on the precipice. It was going to crash or rally. I was already short up to my waist, but I sold even more stocks. I sold stocks to a lot of different people, some of them were complacent buyers, and others were sharpshooters like my friend Jarod, who correctly called the short-term bottom that morning. I don't trade like any of those people though. I'm perfectly happy to sit short through a limp-volume rally in a market that has been trending down for a couple months because it tells me that my position is as secure as I could hope for.

The problem with being on the wrong side of a rare event is that you can't count on liquidity when you need to get out. However, on the other side of the trade you have plenty of liquidity if it moves against you, and the best situation in the world when it moves for you.

My point is that there are catalysts in place for a rare market event in the next couple of months: Greenspan and Snow are over in Beijing hashing out currency and trade issues while congress has their finger on the trade war button labeled "currency manipulator". Meanwhile, back in the states, the Refco (RFX chart) plot keeps thickening. It now looks like Goldman Sachs (GS chart), Bank of America (BAC chart), and Grant Thornton may get dragged into the mess, and the smoke is far from clearing. And bond yields keep creeping higher as the yield curve is getting flatter.

Maybe this is all much ado about nothing, but the market seems to indicate otherwise: the nasdaq composite is already down about 7% from its high in August, but it really hasn't broken its intermediate up-trend until a week or two ago. This is why over the past week I've changed tactics from hedging a lot of long positions with a large short position in the QQQQ, to hedging a lot of short positions including the QQQQ with only a couple of long positions that are still technically healthy. The nasdaq still has long-term support near 2000, but if that price level is broken, the market will have confirmed my positioning.

I can't wait to see what Bill Cara has to say in his week in review today. His commentary this past week has been timely and informative. I can't recommend his blog enough to anybody who hasn't seen it. It is great to see Bill really back into his rhythm, and I suspect it has a lot to do with him smelling blood in the water.

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