The Big Short before the Big Long Trade

Updated: Apr 1, 2020

So we should be getting pretty close to the peak of this rebound based on historical trends. For example, in the previous 2 crashes such as 1987 and 2008 -- the market fell ~34% before bottoming and rebounding 20-25%. In 1987, the rally went for exactly 20%. In 2008, the rebound went for 26%. Take a look at the charts below:

The 1987 Crash

Crash: 34.19% in 11-Days Rebound: 19.77% in 2-sessions Fib Retracement: Exactly 38.20%

The 2008 Crash

Crash: 34.70% in 15-Days Rebound: 26.27% in 2.5 Days Fib Retracement: Exactly 50%

The 2020 Crash

Crash: 35.25% in 22-days

Rebound: 18.83% in 3-days

Fib Retracement: 34.58%

38% Retracement Level: $263.66

50% Retracement Level: $277.68

So here's the deal. I don't think there has ever been a scenario where the S&P 500 didn't at least retrace 38.2% of its losses after a crash or correction. A 38.2% retracmeent seems to be the bare minimum. I know as the major corrections go, it has never happened going back to 1987. We're talking corrections that are 12% or greater. Those corrections always see a 38% retracement of the losses. The 38.2% retracement level for the S&P 500 is $263.66. So we still have at least another 3-4 points of upside before we get a peak of some kind. The 50% retracement paves the way for another 10-points of upside. I don't think we'll get that there. We did in the financial crisis. But I don't think we'll see it this time. If we do, I thin it will be at a slower pace. The daily chart looks as if the SPY wants to push toward a peak of $270 which is the top of a major gap. See below:

Now that we are largely in cash in the folio, our plan is to just sit and wait now. We might consider taking DITM puts on the SPY if the SPY goes to the 50% retracment level. Again, we would be pretty considerate in how we approached a short position, but I do think a short position is in play at $270 on the SPY given the retracement levels. It is extremely unlikely that we will see a v-recovery as the coronavirus has extended consequences for the economy. So I think it would be a smart play even though we don't normally short the market or believe in shorting the market...the primary term trend has very likely indeed changed. We still need solid evidence via a set of lower highs & lower lows to indeed say that the primary term in a confirmed downtrend. And although we don't have that yet, I'm willing to front run the short opportunity given the fundamental damage that is cascading global economies in this environment.

For the short side of this trade we're currently considering a 20% position of the SPY January 2021 $260 SPY puts. Right now the SPY is near the 38.2% retracement level of ~$263. If the SPY rises to the 50% retracment level of $270, then we will get in the trade. @ $275 we would add another 20% allocation. Now if the SPY drops to $200 as we expect it will in the coming weeks/months, that position will more than double in value. We will keep the rest in cash & we won't allocate beyond 40%. So that if we were to take a 50% hit for example on those puts, it's a 20% loss net overall to the folio. For that happen however, the market would have been putting in a a full blown V-recovery pattern. Which I'm nearly certain is not going to happen in this environment.

So yeah that will be our next play. Again, we would need to see a 50% retracmenet for the most optimal risk/reward setup on the short side. Once we get a retest of the lows then we would be unloading our puts around a double in value, & then consider our next long opportunity via either call spreads or DITM calls.

Some of the greatest pearls shared by Jesse Livermore:

“Money is made by sitting, not trading.”

“The desire for constant action irrespective of underlying conditions is responsible for many losses in Wall Street even among the professionals, who feel that they must take home some money everyday, as though they were working for regular wages.”

“Buy right, sit tight.”

“Nobody can catch all the fluctuations.”

“There is a time for all things, but I didn’t know it. And that is precisely what beats so many men in Wall Street who are very far from being in the main sucker class. There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time. Not many can always have adequate reasons for buying and selling stocks daily – or sufficient knowledge to make his play an intelligent play.”

“It takes time to make money.”

“Don’t give me timing, give me time.”

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