The bottom-picking thread (smelly fingers optional)

Discussion in 'Trading' started by Cutten, Sep 15, 2008.

  1. Cutten


    IMO stocks will bottom this week (trading bottom - I have no idea where they will be in 5 months). All the classic signs for a market panic are converging:

    1) VIX above 30
    2) Major corporate bankruptcies
    3) Authorities (not just US) panicking and trying to intervene and calm nerves, stabilize the markets
    4) Historic price falls (biggest one day drop since 9/11)
    5) Even the gogo stocks and sectors are now getting hammered
    6) Media going apeshit, loads of bearish headlines
    7) Joe public panicking

    All we need now is a true capitulation, brutal selling where you can smell the fear. It could well happen tomorrow near the open. Partly depends what happens with various companies, and what the Fed/PPT decide to do ;)

    In my experience it is not always possible to exactly time these lows. So I like to try and buy some calls and put on limited longs a bit "early", not too much size, leaving myself enough mental and financial reserves to scale up to a full position as the fear increases to breaking point and/or some kind of catalyst emerges to resolve the situation.

    So, this thread is for anyone who agrees with me, or disagrees constructively. Let's share tips on:

    i) timing the lows
    ii) assessing the risks (how to tell if wrong, where to place stops etc)
    iii) what trading vehicles to use
    iv) how much % exposure to put on
    v) which stocks should rise most in a rally
    vi) any hedging/spreading techniques to get the upside whilst reducing the downside
    vii) considering the various contingencies (e.g. 1 day gap down puke to 1150 then back up; week-long massacre to 1000; one-day mega-crash to 1000; Fed surprise rate cut insta-rally etc)
    viii) how to handle the news e.g. Fed decision & comments, AIG going under etc
  2. Cutten


    I like to put 1-2% at risk once the VIX hits 30, double up when the VIX hits 35-40, and then put full size (3-6% risk) if and when I see full capitulation, or some kind of catalyst like a surprise rate cut.

    Regarding trading vehicles, I like to use whatever is volatile and correlated to the S&P. In this case we have several candidates. Here are the rally plays that seem obvious to me:

    Carry trade: Long AUD (Aussie dollar) short JPY (Yen).

    Stocks: ES and ES calls. For more juice, choose battered blue chips that do *not* have bankruptcy risk. Or use ETFs that have been hammered. I would suggest GS/MS, and XLF/IAI. These have been crushed by the LEH/MER meltdowns, and should rebound huge once the lows are in.

    Commodities: CL (oil) and CL calls. USO if your account is small. Also watch other markets, try to find which commodity acts most resilient in the face of the market downturn (except gold/silver, they rally on panic so may fall during a stock bounce). Look at NG (natty), SB (sugar), CC (cocoa), and the grains (C, S, W) for "tells". Crude has been hit hardest though so I would expect it to bounce fastest and furthest once the lows are in.

    Bonds: these are a special case, since they rally on stock falls, and go down on stock rallies - except when the Fed cuts rates in a crisis. Then they can have another day or so of rate-driven rally, before they top out and the stock rally removes the flight-to-quality bid. So IMO you want to short bonds 1 day *after* the Fed/PPT cut rates in a panic, and the S&P is up big for 1 day at least. The 30 year (ZB) and 10 year are what I'd use. Puts are also worth a look.

    Individual stocks: I'm more a futures/ETF player so not so hot on this side. Feel free to make any suggestions.
  3. Cutten,

    I agree that we are close to a bottom, time-wise, but not so sure price wise. Meaning that if we bottom this week, we may have to test 1100, the prices need to go lower. Right now, given the news out there, equity prices are still too high.

    I doubt we will bottom at the open like in January or March, the crowd is conditioned now to buy gap downs and sell rallies midday. The bottom this time will either occur midday or at the close when everyone is scared to hold overnight.

    We may have a total give up after the Fed which seems to be what the bulls are banking on to rescue them with more rate cuts.

    If Citigroup becomes a single digit midget, then you know panic is in the air.
  4. m22au


    Thanks for the post Cutten.

    I agree with most of what you have written.

    All I can add is:

    AUD/USD is a little less volatile than AUD/JPY, but both pairs are worth a look.

    Some specific stock ideas, apart from GS and XLF:

    Steel and coal and fertiliser. All three are commodities plays, that should do well on an equity market rebound, and even better if oil rebounds at the same time.

    In some respects it's like choosing AUD/JPY over AUD/USD.
  5. Cutten


    Commodity stocks should benefit when we bottom, I agree. XLE/OIH/MOO are also worth a look. In fact they could outperform commodities, because they have suffered a double-whammy of falling stock prices and falling commodity prices. We could see these stocks rise 50% in 2-3 days from the lows. But it will be painful if you buy them early :)

    Do you have any specific stock picks in the steel/coal/fertilizer space? Would POT, MT, BTU, be a reasonable selection?
  6. Cutten


    Good point about the potential Fed fakeout.

    I agree that an intraday or closing panic low is more likely. We might even have a panic *week* if things get really bad - a bit like the post 9/11 week, or the 2000 nasdaq crash week. If Friday closes at S&P 1050 or 1000, down 20% on the week, most will be too shell-shocked and scared to buy. That's an extreme scenario though, and if we get VIX 37+ before then, I reckon that's a good trade from the long side.

    What about this scenario - we open lower Tuesday maybe 1175-1180 with high VIX, some panic selling & margin calls. Then stabilize and move back to 1200, filling the gap. THEN move lower for the real move down. Once the opening range is broken to the downside, it will scare people.
  7. m22au


    I haven't done sufficient homework to answer your question Cutten, however you should be OK with POT, BTU and MT.

    However I can make the following two simplistic observations:

    (1) When the rally comes, the tide will lift most (and nearly all) boats

    (2) The boats that sunk the most will rise the most

    For the reasons above, and for those with sufficient risk tolerance, the likes of FRE, FNM, LEH, AIG, WM could all be the best performing stocks this week.

  8. another sign of bottom marketwatch starting to use increasingly sexual terms to describe market sell off "U.S Selloff PUMMELS Asia"
  9. I remember the post 9/11 trade, it was a weeklong affair and the bottom was on a Friday. The bottom in 2002 was brutal, there was one stretch where market went down everyday in big chunks with hardly a rally and it seemed like tech stocks would go to zero, then we bottomed, albeit to retest a couple of times over the next few months.

    From the trading action and the price levels, I think it will take a panicky 3-4 days of trading to perhaps 1100 to find a lasting bottom that will hold on retests. I don't see a V bottom in the cards, we've already played that out in January, March, and July.
  10. Cutten


    Oh one last thing. If Cramer says sell, buy. If Cramer gets *fired*, buy on full margin!
    #10     Sep 16, 2008