Tuesday, July 28, 2009

BGZ Stop Placement

Yesterday was the first time in the last 2 weeks that the data showed the "smart money" starting to really bet against further rally as evidenced by the highest OEX (S&P 100) put/call ratio since early June (it was 1.63). Additionally, the equity put/call ratio (dumb money) was the lowest in a couple months at 0.54. While this should only be taken as a short-term signal, I dare say it actually looks like it might "work."

Also, after 11 straight days of higher lows, today prices broke below yesterday's low. Also as of the time of this writing, the high made in the S&P today is slightly lower than yesterday creating a potential swing high. So, these factors at least give a reasonable "line in the sand" to set a stop, with potential for some downside awaiting a solid short-term oversold signal to exit the trade. As a side note, the OEX put/call ratio is running quite high so far today, again indicating that to this point the smarter traders are thinking that some more downside is quite possible.

Other points of note that may halt this trend for at least a bit are that the last 2 days, the Nasdaq volume has been very heavy compared to the NYSE volume. While this is more of a long-term signal that a short-term, even in an uptrend, when the ratio gets too high, there is usually a pause. Also, and maybe more indicative of short-term risk seeking is that Rydex fund traders have piled into bullish high "beta" funds over the last week or so. As of yesterday the data showed they were betting 6 times heavier on bullish high beta funds than bearish ones. Compared to past data that is very high. Even in trendshifts to the upside like mid March this year, it has consistently led to short-term pullbacks.

For those who are not familiar with Rydex funds or the "beta" concept......Rydex offers leveraged funds, both bullish and bearish. Much like SDS is a 2x bearish ETF and SSO is a 2x bullish ETF, Rydex would have similar funds available for investors with money in their funds. The SDS or SSO would have a higher beta than SH and SPY, respectively. So while Rydex is only one fund family, it is a large and popular one, and the data shows that their funds have been heavily shifted toward bullish risk taking in recent days -money is pouring into leveraged bull funds relative to leveraged bear funds.

Because of this, I think there is clear enough indication that a pullback is likely, that a stop can be set, and I'll live with the results. While setting stops is fine and just getting out when you've had enough can at times save you from further loss, my experience is that not setting a stop, and then exiting without any objective indicator will not lead to success in the long run.

Follow-Up Trade Action:

Place a GTC sell stop order on BGZ at 27.90. I will montior short-term indicators for exit in the near future - same goes for the current SDS trade.

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