Will you believe me if I claim that today’s market trend was a disaster? Well, if not take a look at the daily chart. In the morning we gapped up and everything looked bright, but we ended down. Extensively down, compared to the morning’s start.

Two days ago I tried to explain, why I was shorting the market (SPY) and pointed out three potential scenarios which would happen. I expected the market actually break down through the 50 day SMA. Well it didn’t happen. Let’s see what was moving the market.

I was thinking that European debt would be the weighting factor pushing the market down. At least as long as earnings report season progresses (Thursday, Friday when JP Morgan or Citigroup reports earning). I believed that the earnings can be the only catalyst which can turn the market up.

Well, I was wrong. Comments from FED were enough to push the market higher last two days and prevent it from breaking thru the first resistance (50 day SMA). So what happened yesterday? Ben Bernanke announced a stance of FED adopting a wait-and-see policy and the market jumped up. See the chart.

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When I saw the chart for the first moment I panicked (obviously, I was shorting SPY) and I tried to find the reason, why the market jumped up. When I found, that it was FED’s comment, similar to those we have been hearing for last three years, I calmed down. As you can see, later on the market slumped down and ended lower.

Today’s action wasn’t any better. Huge gap up, strong move up and at around noon the market deteriorated. closed the gap and ended in intraday loss. That’s why I consider today’s trend a failure.

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However, such action of increased volatility and responsiveness to worthless news (such as Chines growth, c’mon, guys, do you really believe in China? Just look at so many fraudulent Chinese companies these days being suspended from trading recently – YUII, RINO etc.), indecisiveness in direction and inability to move lower as I expected, I decided to take my profits of the table and wait what would happen next. I closed my short positions in SPY with nice 63% profit and I will wait for the next move. I still am bearish on this market and think, that it will go down. If that happens and the market shows this weakness to me I will re-enter my short positions. Another reason I decided to close positions was that I was holding naked puts (I typically trade spreads) and these are more dangerous.

There are a few reasons why I think the market will go down. European debt and US economical issues are one of the most important factors which will turn this market down. The only event which can do otherwise is shining earnings. I am still bullish on VIX, because volatility will be increasing these days.

You can see all my holdings here.

Today, the market reacted as I expected. After a strong run up in a very short period of time it was imminent that the market will correct. Being bullish near the first resistance or shortly above 50 day SMA was very dangerous. I myself was originally expecting the market bounce back down off of the 50 day SMA and continue down. Instead it broke through and continued up in even stronger bullish trend. Well, there was one “little” problem: volume. The volume was declining as the price was rising up. At the top, the volume was weakest! A great exhaustion sign.

Then the market gapped up. For me it was the point to re-enter my bearish positions (I re-opened those bearish positions which I was stopped out, because I entered too early). So I bought put options on SPY. The very next day (Friday 8th) the market gapped down. A great, nice island reversal signal (during the day SPY closed the gap, but at the end closed well below keeping the gap actually open). And today another gap down!

Is the market a bearish correction or a beginning of a new bullish trend?

I do not know it and we will have to wait for the answer. Right now the market is correcting the previous trend. But what actually is the overall market status? It depends on the perspective you are looking at the market and its trend. If you are a longer term trader (position trading for example) than we are in a sideways move. From that perspective I would stay aside. I cannot say, where the market will go.

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As you can see on the chart above, the market changed its move after a nice, long, recovery trend into a sideways move. From a long term perspective, if you want to take a bullish position, you have to wait whether the market breaks up above 137 points level on a high volume or take a bearish position if it breaks down below 126 level on high volume.

However, I like to play this market from a shorter point of view – swing trading. I do not know, where the market will go, but I can analyze what I can see on the chart at this point to get the clue, where we are going. Of course being long or short in a defined trend is a lot easier and less risky than the approach I am taking right now. I know it, but I want to do it and I have defined entry and exit strategy for this particular trade. So I can be playing this sideway trend and use sub-trends for swing trading (highly risky for most of the traders or investors).

So what I can see and what I can expect?

Given the bullish trend we had, island reversal signal I am expecting the market going down. And it actually happened. But how far down it can go? I can see a few targets here:

1. The market will hit 50 day SMA (see tag #1 on the chart below) and will be bouncing here for some time – if so I will liquidate my short position and take the profit here. However I am not expecting this much as I will try to describe later below.
2. It will break through 50 day SMA and will go down to first support line to test it (see tag #2) at 130 points level. This is the target I am aiming for.
3. The market will break through 130 level and will go all the way down to 126 level (see tag #3). If this happens I will open a new short position at break through level.

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Well right now I do not know which scenario will happen. Time will show. As I mentioned above, I am expecting the market to test the 130 level support, where I want to sell my put options. Why this level?

1. This market fall is happening on increasing volume, unlike previous uptrend, which was happening on decreasing volume. That means more selling pressure.
2. Bollinger bands are widening (see several red crosses on the chart highlighting upper and lower bands – blue thin lines). Well the Bollinger bands won’t tell you where the market will go, but it will tell you what momentum the market has. In other words, how much fear or greed we have. Compare this to another “fear/greed” index VIX. It basically shows similar output. If VIX is low, the market is calm, as it starts rising, the market is more boiling, see the chart below.
3. We slightly crossed 50 SMA on higher then average volume with gap down. If the market doesn’t close this gap tomorrow or few days later, this downtrend has more selling pressure and will go down.
4. Stochastic indicator is still in strong overbought range indicating bearish trend reversal.
5. As I mentioned in my other posts, the European debt is not over and it will come back – it is actually coming back as Italy, Spain and Portugal have problems which were shadowed by Greek’s issues and which weren’t solved yet.
6. Earnings season – this actually is the only point which can turn the market back on uptrend track. If we get good news in upcoming weeks, all (short) bets may be off.

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Pay attention to the market correlation with VIX. If we can state that the market is cyclical, it will repeat this pattern over and over. Of course, there is no guarantee, that it will go exactly as depicted, but all indicators I am looking at are signaling that it will.

And as I said above, there are many things which may change the trend, such as earnings. That is the thing I cannot predict (as well as the whole market of course) and that can change everything. All I can do right now is to react and be prepared to what the market will be doing, take some profits off of the table, buy more puts, or reverse all my trades to bullish. Right now I am still bearish in short term period, shorting SPY, but bullish in VIX (since it acts the right opposite than the market).

Happy trading