What a week!! I must admit that my emotions ran the gamet from elation when the downtrend continued on Monday, to disappointment on Tuesday morning when the Fed increased its funding limits, to regained optimism on Thursday morning when the futures were down big, to frustration Thursday afternoon as the markets closed well and then back to elation again on Friday as the markets reacted negatively to the the Bear Stearns news. No, I am not happy that the economy and the markets are falling apart. I know a lot of people that are being hurt by the current circumstances. However, I do feel happy when my positions are working out as planned.
The main thing to remember though is not to trade your emotions, but to trade the markets and to trade your system. The only position I exited this week was a position in the SKF, the double inverse financials ETF. It was the only prudent thing to do as half of my profits evaporated before the open on Tuesday and there was no way to know if the markets were going to melt up for the rest of the week. When the SKF reversed off of support on Wednesday, I re-entered a smaller position in the SKF on Thursday, which appears to be working out so far.
You must have a plan so that you know how to react when unexpected events such as Tuesday's Fed announcement occur. I don't remember who said it, but, in general, when such events occur "get out quickly, and ask questions later". So, I exited the position without hesitation, and I re-entered the position when it appeared that the trend was not changed. Later on this year, I will talk about the rules that I use to deal with the unexpected. Most of the time, the best thing to do is to do nothing, but there are a couple of situations that require a response to protect your capital.
Even with all of the volatility this past week, nothing about the trend has changed. It is still down. The VLE is down. The Tides is down. The weekly price trend is down.
This past week there has been a constant barrage of people calling for the bottom. Maybe Monday was the bottom in the Qs. I just don't know. I have seen all manner of Elliot wave forecasts, some calling for new all-time highs, some calling for a large rally, and one showing an imminent crash, but one in particular really piqued my interest. It is the falling wedge pattern. In Elliot wave theory it is known as the ending diagonal triangle. It is commonly asserted that falling wedges are particularly bullish and that they retrace to the point of origin very quickly. I have found that this assertion is not that accurate. When the bullish resolution does work out, the retracement is very rapid, but the positive outcome is not such a high probability.
One example of a falling wedge was XMSR. On 1/25/06 it appeared that XMSR had completed a 5th wave down with an ending diagonal triangle and a rally was imminent. The stock collapsed and did not bottom until July 2006.
On the bearish side, there is the rising wedge. AKS appeared to have completed a rising wedge on 4/13/07. From there it exploded upward and has since doubled in price.
While the Qs appear to forming a falling wedge, it should not be assumed that the outcome is bullish. And when it isn't bullish, it can be very bearish.
Trading patterns can be tricky business and requires a different approach than trend following. Pattern trading can yield positive results, but a different approach to the entries and exits and risk management must be used.
So, since the market is down on all counts, we remain short until it proves otherwise.