Expecting a rally today...

I am expecting a rally today, and it might extend until Friday. Financial news services explained that the market was slightly down this week because of the "Swine Flu Scare." Of course, that is somewhat true, and of course, I do not, and one should not base their valuation of securities only the immediate news. It might rally because they are not focused on that now.

Of course, I do not have enough conviction to declare a position (for this short term view), and I do not like very short-term trading.

The market is receiving its epiphany that the rally is an illusion. (In fact, it already has.) The market will dramatically plunge when market participants realize that they cannot profit from the rally. It seems that, paradoxically, low volatility might actually set off a downward plunge. It seems that the market doesn't have enough steam for it to even hit $89.50 SPY.

I am thinking about finally declaring a large directional short position on S&P 500 and the Russell 2000 on Friday. The motivation for this is personal fear, as I fear I might be too late in going short before the sell-offs begin. Again, I do not think it would hit $89.50 now, and when I wrote about that price for declaring a short position, I was feeling more bullish in the short term (1-2 weeks.) Instead of $89.50, it would be $87.00-$88.00 as the entry point as that seems to be resistance. Even if I am wrong, and it does break out to $91.00-$92.00, I still think it has a nice risk/reward profile at that level. In fact, those losses would probably make me even more bearish and actually make the position more irresistable since the losses do not falsify my discount rate views.

I am starting to have strong convictions about when this rally would end and at what price, I would not be conservative and use hedges. My declared positions were largely market neutral during the bear market rally although on March 12, I declared it was a bear market rally and decided to remove hedges. This rally happened too quickly, but it was forecastable in hindsight. When I started the real-time experiment, I was bearish (on the really long term on global equity markets (especially the US, and probably Europe)), but it was obvious to me that entering the short positions then (when the market was already beaten down and when everyone was already pessimistic) didn't have a good risk/reward. Declaring a short position now has a nice risk/reward if we compare it to the risk/reward of going short at the beginning of March because everyone is not bearish as some expect the rally to continue, and that there is some disagreement.

I decided to become market neutral, and the rally happened too quickly. (to reiterate.) On March 9, 2009, I think the S&P 500 rallied about 6%. It was too late for me to call the start of the bear market rally. I thought it might be possible for the market to continue to fall at that point, and resume the downward slide. It was only possible to know that it was a bear market rally in hindsight and it took me March 12 to do it.

Again the market has a zero-sum character. For example, the S&P 500 has rallied about 25% from its recent high on April 17 when compared to the March 09 low. Could one make a 25% profit from longing equity futures by holding them? (One could make more if one knows how to trade the volatility.) Yes, if you did so on Friday March 6? But most people who did expect a bear market rally either bought too early or too late so they would make less than the 25%. If they all bought at the same time, they would bid up the price so they people who bought later would have less upside since the price was already bid up. (This market of course is weird as it seems that people are worried about price instead of value, but in a bear market context, the bull market scenario is best represented in the dot-com bubble.) Again, the aphorism buy low sell high works and it can make some people rich, but it cannot make EVERYONE rich.

But, we are still in a positive sum game right since if one bought equity futures, one would still have a gain even if it would be less than 25%. So where are the losses in this zero-sum game? I would say that people who sold their stocks (or short sold stocks) when everyone was already pessimistic and fearful (and afraid of loss and wanted to protect themselves.) They forfeited upside volatility to eschew downside volatility. Also, they people who expect the bear market rally to continue or people who think the market would recover soon would also lose. Of course, the latter group is practically non-existent now, and it would seem that some short term traders who think the bear market rally would continue would loss to those who would sell because they switched their focus to the long term.