May
3
V-shaped recovery?
Filed Under Trading
The stock market is still rallying strongly and my hopes for a drop last week to benefit my Darden trade went unfulfilled. Nevertheless, the beauty of buying an option, like I did with the Darden trade and the Nasdaq trade (which will be posted later this week), is that you are paying a “time premium” for the option, which gives you the luxury of not having to time the bottom perfectly or be exposed to a potential margin call from a market move which does not go your way. I feel confident holding the trade even though the market has rallied since I do not think this latest rally is indicative of a true bottom.
The market has shaken off bad news about two historic events: the bankruptcy of Chrysler and the Swine Flu.
Incredibly, the market seems to be chugging right along and unfazed by these developments. Being a fan of technical analysis (charting), I went back to the charts to look at the powerful recovery of March 2003. Right after the US invaded Iraq, the market began to soar. I went back to look at the chart to see if I could learn anything about that powerful, sustained rally.
Below is a chart of the rally:
As you can see, the rally in March of 2003 had two prior bottoms that were put in, both of which were nearly lower.
As a result, this level on the Dow provided a solid level of support (buyers), that stood at the ready to buoy (via buying) the market.
The same cannot be said of the March 2009 low. The bottom has not yet been re-tested and no solid base of support has been established. As a result, I think the March 2009 lows need to be re-tested until we can declare that the bear is dead and this rally is for real.
The March 2003 rally was preceded by trampoline-like bounces of +11%, -15%, +18%, -13% before the sustained rally of 30% that closed out 2003. I do not believe that the market can have a durable rally with a V-shaped bottom without putting in a rounded bottom or multiple touches of a bottom. I suspect we might see similar 2003-like bounces up and down before any sustained rally will take place.
Takeaways:
- The market hates uncertainty. The post 9/11 malaise and sabre-rattling around Iraq proved to be distracting and the market from post 9/11 to March 2003 was a wreck. Once the invasion and “quick victory” were established, there was more confidence in the market.
- A base or bottom needs to be established with considerable support, which has been tested more than once.
- In a “false bottom” such as this one, I feel comforted holding Puts against a consumer non-essential.
Note: I apologize for the lack of clarity in the charts, better charts are on the way.
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