Taking Profits

I was surprised somewhat by the lack of downside follow-through today given the news on Citi and GE, but that may be pointing to some exhaustion of the downtrend. As I had mentioned in my last post I would be considering taking profits on some short positions today with more downside. When I did not see an acceleration this afternoon, I took profits in (3) short stock positions and (2) index short positions. I still see some potential for more downside so I am not completely out yet, but risk for shorts is definitely increasing.

What concerns me the most here is that this may not be wave (5). So far, the major indexes have only completed 3 waves down from the January high. If we should start a strong rally from these levels or even slightly lower, we could be looking at a B wave. If that is the case, the current pattern would be an expanded flat in most indexes. This could point to the possibility of the most bearish of elliott wave counts, a P1,P2,P3-(1),(2)...(3). In other words, in this scenario, after completing wave C of (2) of P3 up toward the 200demas, the indexes would collapse in intermediate wave (3) of primary wave 3. This is why I really want to see more capitulation next week with one more up down sequence to complete the primary wave 1 count. I have been keeping this count in my back pocket and hoping that it could be excluded.

Regardless of the wave count, sentiment is extremely bearish by some measures and neutral by others. For example, the 10 day ma of the Daily Sentiment Index for the SP500 has reached an all-time low today, while the 10 day ma of the put/call ratio and the VIX remain neutral. New NYSE lows have been modest, while the McClellan Summation Index has moved down sharply. Divergences are typical in 5th waves, but mixed sentiment and breadth data are more typical of B waves.

The reason I am raising this red flag is that many, including myself, have been looking for the mother of all retracement rallies to begin soon. If the above scenario were to be correct, there will be many who buy this rally who will get creamed because it simply will not last as long as would be typical. A truncated 5th wave is one thing, but we must at least see 5 waves down.

An alternate view is that we are in wave (4) of P1. I do not think that this is the case since wave (4) would end up being twice as long in time as wave (2). This is certainly possible. I just don't think it is the most probable.

Understanding these possible outcomes can help us not be overcommitted to one preconceived view of the market action. Traders, however, should be trading the price action and not a hypothetical viewpoint.

Given the lack of intensity in the decline this week, I decided to exit shorts in A, ADSK and PLD as well as positions in DXD and TWM. Gains were around 20% on all but PLD. The gain on PLD was a nice 42%. I am still long the QID, SSG, SKF. I may end up with a scratch in those positions depending on market action next week.