There's Just No Follow-Through

11/11/08 9:00 AM EST

Good Tuesday morning...We begin the day with selling pressure in the pre-market futures.  The major indices are currently down between 1% to 2%, slightly better than overseas markets which are showing losses about twice as great.

Often, about the last thing we want to see in the morning is a gap up opening in the direction of our trade.  All too often, it reflects emotional trading and ushers in a wave of pressure in the opposite direction.

We saw a prime example of that yesterday, though at the time I could not find good evidence that the gap had a high likelihood of failure.  The overnight futures had been very strong since Sunday afternoon, rising more than 2%, and as we discussed last week, lopsided overnight futures trading has had a very good record at predicting market performance during regular trading hours.

It didn't yesterday.  Before the open, I mentioned that either we were going to set higher intraday highs after the first hour of trading (in which case we should close even higher) or we would fail almost immediately.  The latter was obviously the case, and it turned into a trend day to the downside for most of the session.

That dismal action leaves little doubt that we have still not seen an appreciable change in character from the past few months, a disappointing development given the longer-term positives that should be kicking in now.  Those positives include seasonality, along with the multitude of historic oversold readings in mid-October and subsequent signs of explosive buying interest - two 7% rallies within a month of each other, an exceptionally low Arms Index reading and the quick flip in breadth.

Last Thursday afternoon, we discussed what's happened after other "double-whammys", which also has historically led to a bounce in the market.  Because of all of those intermediate-term positives, and some oversold indications from our shortest-term indicators, I removed the short-side hedges I had put on a few days prior, leaving about a net 10% exposure to the long side in the S&P 500.  It's an admittedly tiny position, but volatility has been so high that the only way to control risk has been to either sit in cash or trade smaller position sizes.

My intention has been to keep that position with the expectation of those intermediate-term positives finally kicking in.  But we have seen so many unprecedented events over the past month and a half that I'm not willing to just fall asleep and forget it, assuming everything will work out and I can wake up two months from now with decent gains.

Instead, if the S&P drops below 890ish, then I'll be looking to exit.  That runs the risk of a whipsaw if the break below that level would be quickly regained, but I think that's the lesser of two evils - the chances that we could waterfall lower just seem too high to not put some limit on possible losses.

For the short-term, I'll be watching the Nasdaq 100 in particular.  We could have an interesting (very, very) short-term buy setup if the S&P opens above last week's low, while the Nasdaq 100 does not.  We have a few minor oversold indications in the NDX, so if that index opens below 1240ish while the S&P opens above 900ish, then the NDX rallies back above 1240, we should see at least a morning bounce.  Whether that turns into a resumption of the uptrend is doubtful, and is probably more hope than anything at this point.