More Dangerous Than It Seems

Last Monday 9/13 I exited all my long positions and went to cash (see twitter feed). I will now explain what scared me so much on Monday that I felt the risk was too great to keep my long positions open.

As SPY hit 112.4 and closed a huge gap down from 8/11, I noticed that SPY was trading above the 50% retracement of the entire move down from 122 to 101 (highlighted in gray). I don't use elliot wave in my day trading but I have found it to be fairly accurate when utilized on longer term time frames. I decided to compare the time duration of the move from 122 to 101 to duration of the move from 101 to 112.4 (at that time) and noticed that the latter move had taken longer than the former. This implies that the first move (down from 122 to 101) is impulsive and must be labeled either a wave A or a wave 1 and that the second move (from 101 to 114) must be corrective since it has traveled less in a longer period of time.

Furthermore when you look at the chart it hits you right in the face that the move from 101 to 114 completely has a 3 wave corrective structure (labeled a,b,c). The second subwave (labeled b) is allowed to almost completely retrace the first subwave (a) and when SPY dropped to ~104 20 days ago, it came close to doing that. But this type of price action is again more characteristic of corrective waves than impulsive ones.

In short I realized last Monday that SPY may be on the precipice of beginning a wave C or wave 3 down. This wave will at the very least equal the length of wave A or wave 1 which is 122-101=21 SPY points. In other words, in 2 months SPY could be trading at 93!!!

On 8/11/2010 when SPY gapped down, it was the single largest hit I ever took on my portfolio. Back then I was overly bullish because things were different. SPY was at 112.4 back in early August and it had only taken 1 month to rebound from 101 to get there. The rebound looked very strong and impulsive and continuation all the way back to 122 looked very plausible. The mistake I made is that SPY stalled at 112.4 for too many days without breaking through and I should not have stayed bullish throughout (I later learned from my mistake and used the same argument to justify going long big time 20 days ago when SPY repeatedly failed to break 104).

But anyway the bomb that hit on 8/11 is something that I never want to experience again and so when I looked at this chart last Monday, I assessed that the potential downside from here is ~106. I didn't want to wake up one day with SPY trading down 2 points at 110, headed to 106. So I went to cash.

Now I know this may all be a load of crap and over pessimism on my part, but SPY is just now coming out of an overbought condition and littered with gaps to the downside. Very similar to the situation on 8/11. I can't guarantee that SPY will hit 93 in 2 months, but I have about 30% confidence that SPY will drop all the way back to support from trendline T1 at ~106. At that point SPY will bounce and may not look back, or SPY could break below trendline T1 and SPY would head to 93.

Yeah, I know you've been hearing these calls from raving bears for the past year but it's all about the right time and place. Now that they declared that the recession is over, it would only make sense for wall street to slap them in the face ;p