Hardcore bears are starting to come out from hiding spurred by last week's price pullback in the equity market. Over the last month market watchers have observed extremely overbought conditions in the major stock indexes and intimated a price correction was due. The steep price drop in the middle of the week helped snap the S&P 500 index's streak of seven consecutive weekly gains. The bears add additional fuel to the fire by pointing out the bearish divergence in the equity indexes where momentum starts to wane as prices make new highs. One confirmation of trend strength is when the price goes higher and converges with the momentum oscillators and indicators to go up in tandem. When the momentum signs start to diverge even as prices rise, it is considered an early cautionary alert of a possible trend change. Similar to when you throw a tennis ball up in the air, momentum in the speed of the ball is going to slow before it eventually hits its apex and reverses. Take a look at the SPX chart below and you can easily see how when the current bullish move started at the beginning of the year the RSI and MACD indicators converged to move up in synch with the price. The momentum indicators started waning the past week and of course stock prices followed suit midweek. The bears are on hanging on the this particular sign because of the possibility the U.S. Stock market might join the bearish divergence party that weâ€™ve seen throughout Europe this year. The EuroStoxx50 is down over 8% for February. Italy is down over 13% from its January highs, Spain is off more than 10%, and even the â€œqualityâ€, Germany and France, came off 6% and 7% respectively - all these corrections following bearish divergences between price and momentum.
Current price action is reminiscent of the end-of-year Fiscal Cliff melodrama between the White House and Congress. Now we are being warned of the implications from "Sequestration" budget cuts. It is difficult to put much conviction in the market' reaction at this juncture until there is a more definitive course of action in Washington. It actually may not matter what the final sequestration resolution entails as long as the element of uncertainty removed. The market is very good at adapting to changes in the economy and/or governments' policy proclamations, but it is usually uncertainty that puts investors in a flux.
It is usually best to "trade what you see" and not "what you want". Based on recent market behavior this weeks' price action can be expected to support a longer term bullish trend. This market keeps getting driven up by overzealous shorts trying to pile in while bulls keep buying the pullbacks. For the first time in a while, equity prices experienced a substantial drop and right on queue investors stepped to bid stocks back up. As mentioned above, over the past few weeks or so market pundits have suggested stocks overbought levels would need to be absorbed before prices could move much higher. As highlighted in the SPX chart below, the major stock indexes finally resolved their overbought conditions. Certainly you can do further analysis and attempt to present a strong argument of an impending trend change. But until we get a confirmed change in the current uptrend, you would be attempting to pick a market top, and as also confirmed in the chart below, investors betting on top have been losing money all year.
The February 21st Couch Potato said "...The dollar is displaying strength compared to other currencies and this is pressuring commodity prices. However, technically, gold is severely oversold...prices should hold at current support...the current $152 price acted as resistance up until the end of June 2011. Then, following the technical analysis "change of polarity" rule, in August when the price broke through resistance the $152 level converted to support. Basically, after converting to support in August 2011 the $152 price level has held firm and is obviously being challenged... over that time period the Relative Strength Indicator (RSI) has never been oversold as it is now and the price has always recovered when it reached oversold levels..." The latest concern over the recent collapse in gold is the dreaded â€œdeath crossâ€, a chart pattern in which the 50 day MA crosses the 200 day MA, to the downside. The death cross is considered a strong technical breakdown signal, presaging further deterioration. This event occurred on Friday, as gold sank 3%, below 1600 intraday, before rallying late to move up 1% and finish the session back above that level. Itâ€™s worth noting that gold made a virtually identical pattern last spring, when the precious metal slumped to 1527, before launching a summertime rally to 1798. Thus, further downside from here is hardly etched in stone. As confirmed in the chart below, the recent surge in the dollar contributed to the pullback in commodities, but the upward move in the currency appears to be trying to level off.
SPY Position Update -----------------------------------------------------------------
SPY closed at $151.89 on Friday â€“ the March position is approx. $400 in the black
The February 12th Couch Potato published a March expiration SPY call spread
The call spread is approx. $400 in the black (see tables below)
$155 strike price short call delta is -.1857 (81% probability this position will be profitable)
SPY Risk Analysis
We have not had the opportunity to execute a March put spread, therefore the only risk is the S&P 500 index continuing to move higher and encroaching on the $155 strike price SPY short call.
TLT Position Update -----------------------------------------------------------------
TLT closed at $117.03 on Friday â€“ the March position is approx. $400 in the black
The February 14th Couch Potato published a March expiration TLT put spread
The put spread is approx. $400 in the black (see tables below)
$114 strike price short put delta is -.2224 (78% probability this position will be profitable)
TLT Risk Analysis
We have not had the opportunity to setup a March TLT call spread, therefore the risk is treasury bond prices moving down and encroaching on our March $114 strike price TLT short put.
GLD Position Update --------------------------------------------------------------
GLD closed at $152.97 on Friday â€“ the March position closed approx. $1,400 in the red
The February 12th Couch Potato published a March expiration GLD put spread
On February 21st we published a trade adjustment closing out the March regular expiration put spread and opening a March Quarterly expiration put spread (see tables below)
GLD Risk Analysis
Gold appears to be stabilizing at its long term support level. If the price doesn't hold at support our March Quarterly expiration $150 strike price GLD short put will be at risk.
Anytime the market maker is willing to accept a limit price of less than .10 on one of our short strikes, we can buy back all the short contracts and sell the long positions on the same spread. However, if it is a week or so prior to the expiration date, we may be able to hold out for a .05 bid or lower.
If one of our short strikes is penetrated (closing price above a short call or below the short put) AND the delta rises to .65 we will look to close out this spread (buy the short contracts, sell the long) and roll it out to another short strike price. Unless this is option expiration week, do not panic and rush to close the trade, many times the market will reverse itself and remove the sense of urgency. If one of our short strikes has been violated and there is no price reversal, we cut our losses and live to fight another day.
Couch Potato Trader Disclaimer
All results reported in this section are hypothetical. While the numbers represented here may have been achieved or beaten by our readers, we make no representation that any individual investor achieved these exact results. The tracking for the plays listed in this section uses closing prices for the day the newsletter is published and it is not meant to imply that any reader actually received those prices (though many often do) or participated in these recommendations (even though many do). The portfolio represented here is hypothetical and for investment education purposes only. It is only an illustration of what type of gains a knowledgeable trader might receive utilizing these strategies. If you don't get close to these results, guess what. It isn't the fault of the strategies.